For investors looking for a large-cap company in a sector poised for long-term growth, CSX Corp. (CSX) is a dividend paying railroad company that is overcoming significant headwinds to shareholder value.
CSX Corporation, together with its subsidiaries based in Jacksonville, Florida is one of the nation's leading transportation suppliers. The CSX Transportation network encompasses close to 21,000 route miles of track in 23 states, the District of Columbia and the Canadian provinces of Ontario and Quebec. The company's transportation network serves some of the largest population centers in the nation with nearly two-thirds of Americans live within CSX's service territory.
Over the past five years the railroad industry has had to adapt to many changes. With North American coal demand on the decline and a general economy in the state of malaise, company management has had to find innovative ways to reduce costs to maintain earnings and create shareholder value.
In the section below I will analyze aspects of CSX's past performance. From this evaluation, we will be able to see how CSX Corp. has faired over the past four years regarding their profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.
Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.
- Net income 2010 = $1.563 billion
- Net income 2011 = $1.822 billion
- Net income 2012 = $1.859 billion
- Net income 2013 TTM = $1.900 billion
The slow recovery in the economy is displayed in the company's increase in revenue over the past four years. In that time period CSX's net profits have increased from $1.563 billion in 2010, to $1.900 million in 2013 TTM which represents a 21.56% increase.
- Operating income 2010 = $3.071 billion
- Operating income 2011 = $3.418 billion
- Operating income 2012 = $3.457 billion
- Operating income 2013 TTM = $3.496 billion
Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.
Over the past three years CSX's operating income has increased from $3.071 billion to $3.496 billion in 2013 TTM. This represents an increase of 13.84%.
A ratio that shows the efficiency of a company's management by comparing operating expenses to net sales.
1 - (Operating Expenses / Revenue)
- Operating Expenses 2010 = $3.071 billion
- Operating Expenses 2011 = $3.418 billion
- Operating Expenses 2012 = $3.457 billion
- Operating Expenses 2013 TTM = $3.496 billion
- Revenue 2010 = $10.636 billion
- Revenue 2011 = $11.743 billion.
- Revenue 2012 = $11.756 billion.
- Revenue 2013 TTM = $11.910 billion.
- Operating Ratio 2010 = 71.13%.
- Operating Ratio 2011 = 70.89%
- Operating Ratio 2012 = 70.59%.
- Operating Ratio 2013 TTM = 70.64%
When looking at CSX's operating ratio, you can see that ratio has dropped from 71.13% in 2010 to 70.64% in 2013 TTM. As a decline in this metric signifies strength, this indicates a slight increase in profitability for the company.
CSX has a target operating ratio in the high-60′s by 2015 and mid-60′s over the long-term.
ROE - Return on Equity
As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.
Net Income / Shareholders' Equity
- 2010 - $1.563 billion / $8.686 billion = 17.99%
- 2011 - $1.822 billion / $8.455 billion = 21.55%
- 2012 - $1.859 billion / $8.988 billion = 20.68%
- 2013 TTM - $1.900 billion / $9.848 billion = 19.29%
Over the past three and a half years the ROE is showing improvement. Since 2010 the ROE has increased from 17.99% to 19.29%. As the ROE has increased over the past four years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested, thus indicating an increase in shareholder value.
Debt And Capital
The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.
Total Liabilities To Total Assets, Or TL/A ratio
TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.
- Total assets 2010 = $28.141 billion
- Total assets 2011 = $29.473 billion.
- Total assets 2012 = $30.571 billion.
- Total assets 2013 TTM = $30.943 billion.
- Equals an increase of $2.802 billion
- Total liabilities 2010 = $19.455 billion
- Total liabilities 2011 = $21.018 billion
- Total liabilities 2012 = $21.583 billion
- Total liabilities 2013 TTM = $21.095 billion
- Equals an increase of $1.640 billion
Over the past three and a half years, CSX's total assets have increased by $2.802 billion, while the total liabilities have increased by $1.640 billion. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.
Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.
Current Ratio = Current assets / Current liabilities
- Current assets 2010 = $2.855 billion
- Current assets 2011 = $2.935 billion
- Current assets 2012 = $2.801 billion
- Current assets 2013 TTM = $2.200 billion
- Current liabilities 2010 = $2.537 billion
- Current liabilities 2011 = $2.687 billion
- Current liabilities 2012 = $2.627 billion
- Current liabilities 2013 TTM = $2.251 billion
- Current ratio 2010 = 1.13
- Current ratio 2011 = 1.09
- Current ratio 2012 = 1.07
- Current ratio 2013 TTM = 0.97
Over the past three and a half years, CSX's current ratio has decreased. As the current ratio is currently below 1, this indicates that CSX would be able to pay off its obligations if they came due at this point. From a long-term investment point of view I would like to see this ratio back above 1.
Common Shares Outstanding
- 2010 shares outstanding = 1.154 billion.
- 2011 shares outstanding = 1.089 billion.
- 2012 shares outstanding = 1.040 billion
- 2013 TTM shares outstanding = 1.018 billion
Over the past three and a half years, the number of company shares has decreased slightly. The company has decreased the shares from 1.154 billion to 1.018 billion.
Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.
Gross Margin: Gross Income/Sales
The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
- Gross margin 2010 = $7.349 million / $10.636 billion = 69.09%.
- Gross margin 2011 = $7.846 billion / $11.743 billion = 66.81%.
- Gross margin 2012 = $7.928 billion / $11.756 billion = 67.43%.
- Gross margin 2013 TTM = $8.059 billion / $11.910 billion = 67.67%.
Over the past four years, CSX's gross margin has dropped slightly. The ratio has decreased from 69.09% in 2010 to 67.67% in 2013 TTM.
The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.
- Revenue 2010 = $10.636 billion
- Revenue 2011 = $11.743 billion
- Revenue 2012 = $11.756 billion
- Revenue 2013 TTM = $11.910 billion
- Equals an increase of 11.98%.
Total Asset growth
- Total assets 2010 = $28.141 billion
- Total assets 2011 = $29.473 billion.
- Total assets 2012 = $30.571 billion.
- Total assets 2013 TTM = $30.943 billion
- Equals an increase of 9.96%.
Over the past three and a half years the revenue growth has increased by 11.98% while the assets have increased by 9.96%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.
Based on the information above we can see that CSX has produced strong results from a fundamental point of view. Revenues over the past three and a half years, have increased by 11.98%, the ROE has increased from 17.99% to 19.29% in the same time period. The company's revenues have increased more than the assets indicating the company is more efficient at generating revenue with its assets. A couple of notable blemishes on the company are: the gross margin has dropped from 69.09% to 67.67% and that the working capital has dropped below 1.
Transition from Diesel to LNG Locomotives
As indicated in the above analysis a key ratio in the rail industry is the operating ratio. As stated in the company's press releases CSX's management has been focused on reducing this metric.
With the burden of rising fuel costs and stricter emissions standards for locomotives set to take effect in 2015, major railroad companies such as Berkshire Hathaway Inc.'s (BRK.A) Burlington Northern Santa Fe LLC, Union Pacific Corp. (UNP), Norfolk Southern Corp. (NSC) and CSX Corp. (CSX) are searching for cheaper and more environmentally friendly alternatives. One of the alternatives that these companies are researching is powering their locomotives using LNG instead of Diesel.
In conjunction with General Electric (GE), CSX will soon begin field testing liquid natural gas-fueled locomotives. Currently, CSX is developing a test plan and will secure regulatory clearance for these tests. In these test, CSX will use GE Transportation's retrofit kit to switch its existing Evolution series locomotives to operate on both diesel and LNG.
GE retrofit kits enable existing Evolution Series locomotives to operate on both diesel and LNG. These kits are designed to substitute up to 80% of diesel fuel with LNG. Even with the two sources, GE states its use can reduce fuel costs by 50% without diminishing their performance. These retrofit models currently meet US EPA Tier 3 emission standards and also allows a fully-loaded train to travel further distances without refueling stops.
As the price of natural gas is expected to be lower for a long period of time, these retrofit kits look to make economical and environmental sense for railroad companies. Lorenzo Simonelli, chief executive officer of GE's transportation unit, recently stated: "If you believe the price advantage over diesel is going to stay here for the next 10 to 15 years, then LNG is a revolutionary fuel."
Over the past 8 years GE has spent approximately $600 million on its Evolution Series models. The retrofit kits will allow railroad companies to maintain their locomotives while saving on fuel costs and improving on stricter environmental standards. "Locomotives are at an inflection point in balancing engine performance with efficiency and adherence to emissions standards," said Russell Stokes, chief executive officer, GE Transportation. "As we enter a new era of energy sources and what's possible for rail transport, we are excited to partner with CSX and lead the LNG transformation for the industry."
In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.
I believe using the Discounted Cash Flow valuation model for CSX to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.
Even though there are variations in calculating this formula, this model is based off of a terminal value of $41.310B and a WACC of 5.95%. The terminal value $41.310B is based off of the company trading at a very conservative 9X EBITDA. Using these valuations, I have concluded CSX's value to be $29.71 per share.
In another method, I will use CSX's forward P/E ratios with estimated earnings to find the value. Currently, CSX has a forward P/E of 13.11 and FY 2015 earnings projected at $2.21. These two metrics lead to a target price of $28.97.
As of November 16th, CSX's stock was trading at $27.00 - Using the Discount Cash Flow Formula, this indicates the stock is trading at a 10.03% discount to today's price. If I calculate a valuation using forward P/E ratios this indicates a valuation $28.97 or a discount of 7.30%.
At this point in the market, I believe if you added a 50% position here and waited for "bad news" or the overall market to bring the price down, this would present and excellent opportunity to add positions in a company with excellent growth prospects.
Even though CSX's stock price has had a solid increase so far in 2013, I believe the stock has more upside from this point. As railroad companies are looking for cost saving options along with improving environmental standards, the adaptation of LNG locomotives looks to be a very interesting option. As locomotive technologies improve, there will be a decrease in fuel costs and a reduction in the operating ratio. If you are looking for a company with strong management that is adapting to environmental demands and pays a 2.20% yield, CSX is a strong long-term candidate for you portfolio. At current levels using the Discount Cash Flow Formula, I have calculated that CSX is currently trading at a 10.03% discount to today's price.