A Look At Our $56 Price Estimate For CSX Corporation

CSX Corporation (NYSE: CSX) has seen consistent revenue growth over the last few years, primarily led by price increases across its segments. The company now operates a rail network of more than 21,000 route miles in 23 states. In 2017, the company’s revenues grew in low single digits while the earnings growth was over 2x, reflecting gains from the U.S. tax reform. However, the company’s stock was rangebound over the last year or so despite the earnings. This can partly be attributed to uncertainty of the top management after the sudden demise of the CEO in December 2017. Below we take a look at what is driving CSX’s current valuation of about $56 per share, by looking at the expected performance of its business segments. We have also created an interactive dashboard analysis which you can use to arrive at your own price estimate for the company by modifying the various drivers.

Forecast 2018 EPS of  $3.23

Our $56 price estimate for CSX Corporation is based on $3.23 expected EPS in 2018 and a price to earnings multiple of 17, which is below most of the estimates for the overall sector. We expect a decline in net income margin to 24%, as the 2017 figure was impacted by a $3.5 billion reduction in income tax expense, amid the U.S. tax reform. We expect the margins to normalize in 2018 with an upward bias due to the lower effective tax rate. Our revenue forecast of $11.85 billion represents year-on-year growth of around 4%. Of the total expected revenues in 2018, we estimate $4.30 billion in the Industrial Freight segment and $2.20 billion from the Coal Freight segment, and other segments making up for the rest. Below we discuss our revenue estimates in detail.

A Rebound In Commodities Will Bode Well For CSX’s Industrial Freight Segment

We expect CSX Corporation’s Industrial Freight revenues to grow 4% to $4.27 billion in 2018. We expect this growth to be driven by a recovery in the commodities market, which will result in more shipments for railroad companies. Rail shipments of steel in particular were hampered by challenging business conditions facing the domestic steel industry and low oil prices over the last few years. However, the production outlook for 2018 looks strong. Major steel manufacturers have plans to expand their production facilities in 2018, which will result in more shipments. Similarly, looking at oil, the production in the U.S. is expected to be 10.7 million b/d in 2018, the highest annual average U.S. crude oil production level ever. Moreover, an increase in oil prices will boost drilling activity and increase the demand for crude oil related shipments as well. It should be noted that the WTI crude oil is expected to average $58 in 2018, reflecting a 15% growth from 2017 levels, according to EIA estimates. Favorable demand-supply dynamics with respect to these commodities will boost segment revenue growth. Accordingly, we forecast a low single digit growth, both on volume and pricing for CSX Corporation’s Industrial Freight segment.

Coal Freight Segment To Benefit From Higher Natural Gas Prices

CSX Corporation’s Coal Freight revenues are primarily driven by two factors:  1) Total Carloads of Coal, and 2) Revenue Per Coal Carload. With the increased use of cleaner sources of energy such as natural gas, which has also seen lower prices, the demand for coal has dropped drastically over the last few years, thereby impacting the coal shipments for railroad companies, such as CSX Corporation. However, the price of natural gas recovered strongly in 2017, and the railroad industry has seen a sudden rise in coal shipments over the last few quarters. We expect this trend to continue in the coming quarters, as the benchmark Henry Hub natural gas price is expected to average roughly $3 in 2018, and $3.10 in 2019, slightly higher than 2017 levels. Accordingly, we forecast a 3% revenue growth for Coal Freight in 2018, led by modest gains in volume as well as pricing. These two segments alone account for roughly 55% of the company’s revenues. CSX Corporation’s other segments include, Intermodal, Agricultural, and Housing & Construction Commodities Freight, which are also expected to see modest revenue growth in 2018, primarily driven by better economic conditions.

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