CSX Corporation (CSX) operates in the railroad industry, serving its customers as a major transportation supplier for rail-based transportation services including rail service as well as the transport of various intermodal containers and trailers. CSX's operations are highly profitable and have proven the ability to generate large profit margins. Furthermore, the railroad transportation industry as a whole supports the capacity and potential for substantial growth and through CSX's keen competitive advantage derived from its operations across its wholly owned subsidiaries makes CSX a feasible investment for individuals seeking value as well as growth. This article begins with an overview of CSX's subsidiaries and captures the firm's most recent performance as well as the current performance of its peers. To conclude, investors with be provided with several forward looking valuation metrics projecting the future value of CSX's operations and equity.
CSX's first and largest subsidiary is its principal operating company, CSX Transportation. CSX Transportation provides a connection to the transportation supply chain through its rail network that is approximately 21,000 route miles long. This network serves nearly 23 states east of the Mississippi River, the District of Columbia, and the Canadian provinces of Ontario and Quebec. In addition, CSX Transportation serves more than 70 ocean, river, and lake port terminals along the costs of the Atlantic and the Gulf. One of its unique advantages is the intermodal business that links customers to railroads via trucks and terminals. CSX Transportation also serves manufacturing and distribution facilities through tracks that connect to roughly 240 short-line and regional railroads.
CSX's additional subsidiaries include CSX Intermodal Terminals, Total Distribution Services, Transflo Terminal Services, and CSX Technology. For further information regarding these smaller subsidiaries please visit CSX's company website.
CSX is currently trading right between $20 and $21 per share and with one billion shares outstanding its market capitalization is nearly $21.6 billion. CSX's market capitalization is fairly typical considering the average market capitalization of its peers deviates from a minimum of $10 billion to a maximum of $40 billion. In contrast to different industries, firms operating within the transportation industry tend to provide less exposure to risk in fundamental areas with issues surrounding cash flows and abnormal exposure lying within holding period returns. As for a large subset of firms in today's market, cash flow volatility remains an area of concern, however with CSX this is not the case. CSX's cash flows are highly stable and a timely collection of receivables helps maintain this. CSX's holding period returns reveal a beta value of 1.4, which is slightly of higher risk than the market beta of 1. But overall its beta is still relatively low. Also, CSX's alpha value is negative indicating that its security market price is currently undervalued.
To illustrate CSX's relative performance over the past five years, I constructed a graph using YCharts with its top three competitors including Canadian National Railway (CNI), Norfolk Southern (NSC), and Kansas City Southern (KSU). Notice the blue line depicting CSX's relative return over the past five years. CSX not only underperformed the market in FY 2012, but it significantly underperformed its peers as well. Taking into account the industry average for profit margins over the past five years, it is evident CSX has proven the ability to compete in this highly competitive industry. In addition, it also reveals CSX's poor performance reflected by a decline in its security market price in early FY 2012 can be attributed to the sharp decline in coal volume. The volume of coal transported declined by nearly 15% over this period. Going into FY 2013, CSX's management has taken this into account and anticipates increasing its carloads in all commodities except for coal.
Figure 1: CSX' Relative Five Year Performance
The price to earnings ratio has proven to be a useful metric for analyzing companies operating within the railroad industry. In figure 2, you will see CSX is trading at the near bottom of its five year valuation based on the P/E TTM ratio, and have been for quite some time now. While there are many other metrics in existence that should be taken into account such as the P/B, P/S, and P/FCF ratios, the simple P/E ratio does a fairly accurate job in revealing how fair these securities within the railroad industry are actually priced. And this simple analysis shows CSX is not even close to being fairly priced.
Notice the variation between CSX's P/E TTM ratio in contrast to CNI's, which is distinguished by the orange line above in figure 2. In a previous article of mine, Canadian National Railway: A Definitive Value Play, I provided an investment overview for CNI basing my thesis on a long-term value play that derives from appealing fundamentals and strong growth potential. In this article, I also outlined a significant factor historical trends reveal in regards to CNI's valuation. CNI's historical P/E indicates that on average its security market price has consistently been fairly priced, which from an investor's perspective is rather attractive. Taking a look back at figure 2, you will see CNI's current P/E TTM ratio is about 15.69, implying it is far more fairly priced than CSX. CSX is evidently trading below fair value.
Figure 2: CSX's & Industry Peers P/E Ratio TTM
Nearly 68% of CSX's common stock outstanding is owned by a combination of insiders and institutional investors, with insiders owning approximately 1% and the remaining 65% by institutions. The remaining 35% is owned by individual investors with majority of the owners residing within the U.S. To evaluate the potential upside for investors, I used the corporate valuation model.
Figure 3: Intrinsic Valuation Model
The model calculates the intrinsic value of the firm based on the future value of operations by first projecting free cash flows forward. It then uses a modification of the constant growth model with the firm's expected growth rate and weighted average cost of capital estimate. This allowed me to derive an intrinsic share value of FY 2012 and FY 2013. Note that by intrinsic share value, I am implying what the firm should be worth by that date given the inputs in this model. For 2012 FY, an intrinsic share value of $26.24 implies a 24.95% upside from current levels and the estimate for 2013 FY implies an extremely high upside of approximately 37%. Note this model is highly conservative and should be not solely used to base an investment decision. CSX's ability to rapidly increase its profit margins makes the growth potential for CSX's operations extremely difficult to value. Therefore, given the right catalysts and additional growth, the upside for investors has the potential to surpass these estimates above by more than double.
CSX has an excellent business model and operates in an industry that is competitive in nature, but solely on the basis of a heavy and prompt demand for the services it provides. CSX's management has proved its ability to achieve success as well as its dedication toward maintaining strong shareholder interest. CSX's profit margins and growing demand for its services will enable them to continue to compete in a highly competitive industry. Forward looking valuation metrics in the most conservative state are highly favorable for investors with CSX in mind for a long-term investment horizon.