CSX Stock: Opportunities & Risks

CSX Corporation’s stock (NYSE: CSX) lost more than 35% – dropping from $73 at the beginning of the year to below $48 in late March – then spiked 50% to around $72 now. That means it has fully recovered to the levels where it started the year.

Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March helped the markets stage a strong recovery. Investors are now expecting a quicker economic rebound with economies opening up gradually, which will bode well for CSX’s transportation business.

But is this all there is to the story?

No, not quite. Despite the recent rally, Trefis estimates CSX’s Valuation at about $81 per share, roughly 12% above the current market price based on two key opportunities and a risk.

The first opportunity we see is to CSX’s Revenue growth over the coming years. We know 2020 will be a year marking a drop in revenues led by lower volume as well as an impact on pricing. However, as we look beyond 2020, with the containment of Covid-19 and availability of vaccines pushing the virus out of the center of attention and resulting in economic growth, we believe CSX will see a rebound in demand for railroad transportation. With the economy opening up and lockdown restrictions already being lifted in several cities, the industrial production is gradually picking up pace, and it will likely result in increased consumer demand in the near term.

The second opportunity we see is to CSX’s Expenses, which have been trending lower, when looked at as a percentage of revenue, over the past few years. CSX has been focused on reducing its operating ratio, and it managed to bring it down from over 69% in 2016 to a little over 58% in 2019. While the Covid-19 pandemic has resulted in increased costs for the company, CSX aims to achieve an operating ratio of under 55% in the long run, thereby boosting the margins.

That said, there is a risk associated with CSX’s coal freight business. There has been a decline in demand for coal as an energy source and increased use of cleaner fuels, such as natural gas. Climate change consciousness is growing. There is considerable social and political pressure on fossil fuel producers to reduce emissions, and on consumers to reuse, reduce, recycle! Large investors are backing out. The result – a lower demand for coal. For perspective, the U.S. coal consumption is expected to decline by roughly 40% between 2018 and 2020, according to the US Energy Information Administration. This means lower production, and lower need for transportation. Another factor why there is increased dependency on natural gas as an energy source is its low pricing. In fact, natural gas prices have plummeted over 50% since early 2017. For CSX, its coal shipments have declined in mid-single-digits on average over the last 5 years. This trend could continue over the coming years, and weigh on CSX’s overall performance.

The near term risk for CSX stems from the impact of Covid-19. Increased unemployment, lower consumer spending power, restrictions in place for various manufacturing plants means lower demand for railroad transportation, evident from the company’s Q2 performance. The company’s top line contracted 26% to $2.3 billion, primarily led by a 20% reduction in volume. Coal in particular saw almost a 50% plunge in revenues, led by lower volume and pricing. Looking at the bottom line, EPS declined 40% to $0.65. However, the situation is changing on the ground with economy gradually opening up. The rebound in economic growth and its timing hinge on the broader containment of the coronavirus spread. Our dashboard forecasting U.S. Covid-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus. Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture. The complete set of coronavirus impact and timing analyses is available here. For CSX, the key trend to watch out for will be the operating ratio in Q3, as the demand improves over the coming months.