I found it amusing that two analysts downgraded CSX (NYSE:CSX) after it had beaten earnings estimates by 9% (they've beaten estimates by about 10% each quarter for the past year). The reason, analysts said, was that coal volumes may drop for the foreseeable future.
I think the analyst downgrades provide a nice entry point for the long-term investor. Coal volumes have been dropping for years, and in spite of those significant headwinds, CSX has proven its ability to grow earnings substantially over time.
Ignore the analysts: long-term investors in the company should focus on CSX's impenetrable moat and its permanent and growing cost advantages over its competitors in trucking. CSX is a company that can leverage these to grow earnings for decades to come, no matter what happens with coal.
Unbeatable Efficiencies, Impenetrable Moat
Most value investors know that Warren Buffett purchased BNSF, a railroad that operates in the western United States. He explained his purchase in his annual report:
Both of us are enthusiastic about BNSF's future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That's three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs.
CSX, which operates in the eastern United States, moves freight with similar efficiency as BNSF and maintains the same advantage in operating costs over trucking. Importantly, railroads including CSX are constantly getting more efficient with respect to both fuel and labor costs. For example, CSX has made infrastructure investments to allow them to double-stack their containers over more of their tracks, and is investing in ports to allow quick transfer of containers between ships and trains.
Meanwhile, their main source of competition, trucking - has seen efficiency stagnate. And in the long-term I believe trucks will decline in efficiency due to ever-increasing congestion of the country's roads and infrastructure. Rails have a permanent cost advantage over trucking, and that advantage is increasing over time.
It's fairly evident that railroads have deep economic moats. There is simply no way to replicate the land and right-of-way that CSX (or other railroads) own - outside of buying CSX or another railroad itself. Since the United States will both import and export goods for a very long time, the economic moats around CSX and other railroads suggest they are great businesses for long-term investors.
Earnings Rise as Coal Volumes Fall
The two analysts that downgraded CSX gave the same reason: coal volumes are down and might continue downward "indefinitely." I suspect that analyst preoccupation with coal is causing them to constantly underestimate earnings: for the past four quarters, CSX has beaten estimates by 9% to 12%.
Let's take a quick look at CSX's history with coal from their 10K's.
coal loads delivered
It's pretty abysmal: from 2006 to 2012, CSX delivered nearly 30% fewer carloads of coal. The issue of lower coal volumes has been happening for a while. What has happened to CSX's earnings and stock price over that period? From 2006 to 2012, CSX's earnings per share nearly doubled from $0.93/share to $1.79/share, and its stock price more than doubled. Remember the span from 2006 - 2012 includes the financial crisis, the great recession and the housing bust. So in spite of many headwinds, the stock still managed to perform well on both earnings and stock price metrics.
In 2013, coal volumes continue to drop and CSX has shown year over year earnings growth every quarter, and solidly beaten analyst estimates (by an average of around 10%) each quarter.
I think of CSX as a company that is constantly widening its economic moat and increasing their transportation efficiency. Its history of growing earnings while coal volumes drop shows that their economic moat and efficiency trumps other aspects of the company that may be going poorly.
Panama Canal Expansion Provides Long-Term Growth
In 2015, the Panama Canal will complete its expansion, which will allow much larger ships to pass between Asia and the east coast. Currently, most trade with Asia goes through the West Coast ports and travels eastward by rail. The expansion should facilitate trade through the East Coast ports, where CSX is developing and expanding terminals. This applies not only to imports, but to exports. The middle part of the country houses a lot of manufacturing, automotive, agriculture and chemical industries, and the Panama Canal expansion should allow for more trade flowing East rather than West.
The eventual shift of trade towards East Coast ports is the reason I have selected CSX instead of West Coast rails. Another good possibility is Norfolk Southern (NYSE:NSC), for the same basic reasons.
CSX: Good Entry Point for a Long-Term Holding
I have presented the case that CSX has a strong moat and that it is capable of growing earnings substantially even when coal volumes fall. I'd argue the preoccupation over coal is masking CSX's long-term earnings potential, which allows long-term investors to enter at a relatively low price (its P/E of about 13 is substantially below the market). That growth should be goosed by the shifting of trade flows to the East Coast, facilitated by the Panama Canal.
Additional disclosure: This is a long-term holding of mine, but I added more on the analyst downgrade.