Buy or Sell CSX Stock?

CSX (NASDAQ:CSX) faces a challenging strategic position following Warren Buffett’s explicit rejection of acquisition interest. CSX stock tumbled as much as 6.5% after Berkshire Hathaway’s Warren Buffett denied rumors about potential railroad acquisitions, closing at $32.81 on Monday, August 25.

The selloff stems from dashed investor expectations for railroad consolidation. Union Pacific and Norfolk Southern announced a landmark $85 billion merger to create America’s first transcontinental railroad, connecting over 50,000 route miles from coast to coast. This mega-merger has triggered speculation about industry-wide consolidation, with investors hoping for a strategic pairing between CSX and Berkshire’s BNSF Railway.

The key question now is what should investors do with CSX stock – is it a buy at $33? We don’t think so. The company fares poorly on operational and fundamental parameters and isn’t cheap either. We’ll delve into the specifics in the sections below. That being said, if you seek an upside with less volatility than holding an individual stock, consider the High Quality Portfolio. It has comfortably outperformed its benchmark—a combination of the S&P 500, Russell, and S&P MidCap indexes—and has achieved returns exceeding 91% since its inception.

Image by Ernie A. Stephens from Pixabay

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Strategic Isolation Risk

CSX now faces the prospect of being left behind in a consolidating industry. With Union Pacific-Norfolk Southern creating a coast-to-coast behemoth and BNSF remaining under Berkshire’s control, CSX lacks a clear path to achieve comparable scale, potentially putting it at a competitive disadvantage. While Buffett met with CSX CEO Joseph Hinrichs in August to discuss “greater cooperation,” this falls short of the transformative merger investors had anticipated.

Fundamental Performance Analysis

Operational Weakness

CSX exhibits concerning revenue trends despite strong profitability metrics:

• Three-year average revenue growth of only 0.6% (vs. 5.3% for S&P 500)
• Revenue declined 3.3% over the last 12 months to $14 billion
• Most recent quarterly revenue fell 3.4% year-over-year to $3.6 billion

Profitability Strengths

Despite revenue challenges, CSX maintains exceptional margins:

• Operating margin of 34.9% (vs. 18.8% for S&P 500)
• Operating cash flow margin of 35.1% (vs. 20.2% for S&P 500)
• Net income margin of 21.9% (vs. 12.8% for S&P 500)

Balance Sheet Concerns

Financial stability presents mixed signals:

• Debt-to-equity ratio of 32.0% (vs. 20.4% for S&P 500) indicates higher leverage
• Cash-to-assets ratio of only 0.9% (vs. 7.0% for S&P 500) suggests limited liquidity cushion

Valuation and Market Position

CSX trades at a premium despite operational challenges:

• Price-to-sales ratio of 4.3x (vs. 3.3x for S&P 500)
• Price-to-free cash flow ratio of 30.6x (vs. 21.6x for S&P 500)

This valuation disconnect suggests the market has not fully adjusted to CSX’s strategic isolation and fundamental weaknesses.

Risk Assessment

Historical downturn performance indicates heightened volatility:

• During 2022 inflation shock: fell 29.9% vs. 25.4% for S&P 500
• COVID pandemic: declined 40.8% vs. 33.9% for S&P 500
• 2008 financial crisis: dropped 69.7% vs. 56.8% for S&P 500

The Takeaway

CSX faces significant strategic headwinds as industry consolidation proceeds without the company. The combination of declining revenues, premium valuation, and strategic isolation creates a challenging environment for shareholders. While the company’s profitability remains strong, investors should weigh whether current margins can offset the competitive disadvantages of operating as an independent player in an increasingly consolidated railroad industry. The market’s 5% selloff following Buffett’s comments appears justified given CSX’s uncertain strategic position and fundamental weaknesses across growth, financial stability, and downturn resilience. In fact, our price estimate of $30 for CSX reflects even more downside from here.

See, there always remains a meaningful risk when investing in a single, or just a handful, of stocks. Consider Trefis High Quality (HQ) Portfolio which, with a collection of 30 stocks, has a track record of comfortably outperforming the S&P 500 over the last 4-year period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.

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