After 80% Rally CSX Stock Now Looks Expensive

CSX Corporation stock (NYSE: CSX) is up 20% since the start of the year and it has gained around 83% from its March lows. CSX stock faces downside risk as the company’s revenues in the last two quarters have declined by 19%. The ongoing Covid-19 crisis and the economic uncertainty is likely to result in lower demand for its freight services. This is likely to impact the revenue growth rate of the company – leading to a drop in the stock price.

Following a large 83% rise since the March 23 lows of this year, at the current price near $88 per share, we believe CSX stock has reached its near term potential. CSX stock has rallied from $48 to $88 off the recent bottom compared to the S&P which moved 59% over the same time period. Better than expected results have helped the stock in beating overall markets. Moreover, the stock is up 60% from levels seen in early 2018, over two years ago. CSX stock has fully recovered to the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic, and it is now 10% above the pre-Covid highs. This seems to make it fully valued as, in reality, demand and revenues will likely be lower this year than last year. Our dashboard ‘Buy Or Sell CSX Corporation Stock’ provides the key numbers behind our thinking, and we explain more below.

Some of the stock price rise over the last 2 years is justified by the roughly 5% growth seen in CSX Corporation’s revenues from $11.4 billion in 2017 to $11.9 billion in 2019. The company’s EPS on a GAAP basis was down 30% from $6.01 to $4.18, due to a decline in Net Income Margin from 48% to 28%. This can be attributed to one-time tax benefits due to changes in the tax law, which resulted in higher margins and EPS in 2017. Overall, earnings on a per-share and adjusted basis grew over 80% between 2017 and 2019, led by higher revenues, margin expansion due to cost control measures, and a 12% decline in shares outstanding due to repurchases.

Finally, CSX’s P/E ratio increased from a suppressed 9x in 2017 to 17x in 2019. While the company’s P/E has now increased to 21x, it seems to be trading much higher compared to the levels seen over the recent years. We believe there is a possible downside risk for CSX’s multiple, and the stock is unlikely to see much upside after the recent rally and the potential weakness from a recession-driven by the Covid outbreak.

How Is Coronavirus Impacting CSX Stock?

The global spread of coronavirus has affected industrial and economic activity across the world, including CSX Corporation, as demand for transportation has declined led by an overall reduction in discretionary consumer spending resulting in reduced shipments of non-essential goods. This resulted in railroad companies taking a hit when the pandemic started. Coal freight volume was already on a decline even pre-Covid due to lower natural gas prices impacting the demand for coal, which fell further during the pandemic resulting in even lower demand for coal, and this will likely be the trend going forward as well. That said, with economies gradually opening up, there has been an increase in economic activities of late. This, along with lower fuel prices will bode well for railroad companies. The company reported a 11% y-o-y decline in total revenues in Q3. Furthermore, the company managed its costs well given the challenging environment and it reported only a 10 bps increase to 59.4% in Q3. The company’s earnings declined 11% to $0.96 on a per share basis.

While Q3 was better than estimated for the company, we expect overall demand to be lower in 2020 due to uncertainty resulting from the outbreak of coronavirus which leads us to believe that the stock is currently overvalued. In fact, revenues are estimated to decline 12% to around $10.5 billion, while earnings are estimated to be $3.59 on a per share basis for the full year 2020, 14% lower than the $4.17 figure reported in 2019. Along with the impact on revenues and earnings when compared to the previous year, the recent rally in the stock has meant an expensive valuation multiple for CSX stock, making it vulnerable to downside risk.

Looking at the broader economy, the actual recovery and its timing hinge on the containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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