CSX Corporation (NYSE:CSX) is a leading freight transport company based in Jacksonville, Florida, providing rail, intermodal and rail-to-truck trans-load services. The company provides services for a lot of industries including, energy, metals, agriculture, consumer products, chemicals and minerals. The company transports raw material, intermediate and finished goods. CSX has gained about 20% since the start of the year, due to strong operations and future growth prospects.
The business model for CSX is relatively basic, generating revenue by providing transportation services to manufacturers, electricity generating plants and retailers by connecting the business value chain via a well-connected and expansive rail-road network. The railroad industry is part of a much larger transportation sector which provides cyclical exposure. Recovery in the global economy and US economy is encouraging for CSX; given the better than expected labor office figures, particularly last month, for employment and an increase in consumer spending, I expect CSX to continue growth.
Along with record low interest rates and the guarantee by Fed to keep the interest rates close to zero, the optimism concerning the economy is a major driver for the railroad industry. The argument that there are inflationary expectations, given lower interest rates, that could hamper business profitability, is not an issue, since CSX has bargaining power and will pass on the inflationary pressure on to the clients, given the nature of its business.
Railroad companies are divided into tiers. Tier 1 companies constitute 1% of the total firms but transport 70% of the freight. CSX's is included in tier 1 companies and high start- up costs work as massive barriers to entry and significantly reduce business risk. Increased fuel cost driven by the increase in the price of crude oil has shifted manufacturers and consumers preference towards railroads instead of road transport. As a result, CSX's top line has improved, and a decrease in expenses will have a positive impact on the bottom line.
Growth Opportunity in A Mature Industry and Peers
CSX provides growth prospects in a relatively mature industry with its commitment to increase capital expenditure by $2.3billion along with plans to give out dividend and buy back shares. This provides a strong case for the company's confidence in the economy and their business; it also depicts the financial strength of the company. Capital expenditure is targeted towards infrastructure development, improving efficiency and productivity in the long run. In terms of financials, the company has recovered from the financial crisis, although last quarter was relatively slower due to uncertainty in economic recovery.
CSX's peers include Norfolk Southern Corporation (NYSE:NSC) and Union Pacific Corporation (NYSE:UNP). Norfolk Southern and Union Pacific are also very well run companies. Norfolk generates about $1 billion in free cash flows each year. In addition, the company pays an annual dividend of $2 per share, yielding 2.6%. Union Pacific is the largest railroad company in North America. Union Pacific also generates impressive free cash flows (above $2 billion). Furthermore, the company pays annual dividend of $2.76 per share, yielding 1.97%. Union Pacific is trading at P/E Ratio of 17.2, relatively higher than its peers.
Valuation and Risks
The valuation matrix for CSX is attractive on relative basis especially, given it has one of the lowest P/E ratios in the industry and robust dividend yield. Both of these factors point towards an attractive valuation from a medium to long-term investment perspective. There are a number of risks involved; the most significant are 1) slower economic recovery and 2) decrease in oil prices adversely impacting the competitive advantage of rail over road freight transport. A slowdown in economic recovery can severely impact the demand for raw materials and transportation of finished goods. On the other hand, if oil prices come down, then trucking companies will be able to better compete with railroad companies, which may impact revenues. However, oil prices are expected to remain on the higher side due to the recovery in the global economy.
Companies operating in the railroad services business are extremely attractive to the investors who are looking for steady growth. These companies operate in an industry that has huge barriers to entry, which protects them from excessive competition. As a result, these companies have considerable pricing power. The most important factors for these companies are economic, as a slowdown in economic growth will directly impact the demand of their services. CSX is one of the best performing companies in the sector, which I believe is well positioned for future growth.