On December 13th, CSX Corporation (CSX) received good and bad news. The bad news was that the company's freight train hit a tractor trailer in Ridgefield Park. This was the second accident of the week involving a CSX freight train in eastern Bergen Country. In the first accident, a sport utility vehicle was hit by a CSX train. However, in both accidents, the CSX's drivers were found not guilty and the trains remained safe.
The good news for the company was that its stock rating was reiterated by the analysts at the Bank of America and the stock price was raised to $32. Previously, analysts estimated the stock's fair value to be $29.
The analysts believe CSX is one of the best positioned transport stocks in 2014 as low expectations are being offset by better than expected volume growth. The company's fourth quarter-to-date volumes have beaten analysts' expectations and are up by more than 6%. This is well above the 2.5% target and indicates a further upside as the quarter comes to a close at the end of December.
Over the last five years from 2009 to 2013, CSX has slightly changed its revenue mix to expand its margins. The merchandise segment's contribution to revenue has increased to approximately 58% in YTD 2013 from 48% in 2009. The contribution of the coal segment has also increased whereas the contribution of the intermodal segment has almost remained the same. The company has actually reduced the contribution of its other segment.
The change in the revenue mix enabled the company to maintain its revenue growth even when the revenues from both domestic and export coal segments declined. The domestic coal revenues were impacted by lower electrical demand whereas the export coal revenues were impacted by the global oversupply.
A boom in the housing and construction sector along with the improved industrial index and growth in agricultural sector brought positive growth to its merchandise segment's revenues. The growth in the merchandise segment offset the negative growth in the coal segment and resulted in an increase in the YoY revenues by 1.73% to $9,026 million during the first nine months of 2013.
The merchandise segment provides expanded margins compared to the intermodal or other segments so a change in the revenue mix has also improved the company's operating margins over the last five years. The decreasing operating ratio shows that CSX has controlled its operational expenses as a percentage of sales and has eventually increased the operating income. However, the change in revenue mix is not the only reason behind this improvement. The company's management has also successfully implemented costs-saving policies.
During the first three quarters of 2013 the operating ratio slightly increased by 8 basis points due to inflation, higher incentive compensation and depreciation. However, the fuel expenses and equipment and other rents remained lower compared to the same period in 2012.
The higher revenues along with the improved margins increased the net profit margin as a percentage of sales. The margin improved by 18 basis points. Net earnings jumped from $1,416 million during the first three quarters of 2012 to $1,457 million in 2013. Diluted per share earnings increased $1.43 per share in 2013 from $1.36 per share in 2012. The cash dividends paid to the investors increased to $0.44 per share from $0.40 per share last year.
Sustainability of Revenues
The company is continuously increasing its revenue mix in the merchandise segment so I do not expect that the coal headwinds will impact its future net revenues. The continued weakness in Europe, slowing Asian demand growth, increasing coal output from other coal producing countries and falling international prices are projected to keep US export demand in 2014 at 107 million st compared to 118 million st in 2013 and 126 million st in 2012. Similar to YTD 2013, these factors would negatively impact CSX's coal segment's revenues in the fourth quarters of 2013 and 2014.
On the other hand, the housing and construction industry in the US is projected to increase by 5%. On the back of an improved rate of economic growth in Asia and the US and rising consumer indexes the global consumer goods sector and the automobile sector are also projected to boom in 2014.
During the first half of the fourth quarter of 2013 CSX experienced a 7% growth in its construction sector and an 11% growth in its industrial and intermodal segment. The agriculture segment, which experienced a negative growth in the first three quarters, also experienced a 7% growth in the first half of the fourth quarter. As discussed earlier, this growth is above analysts' expectations.
Based on these statistics, I expect that CSX will sustain its positive YoY revenue growth in both the fourth quarter of 2013 and full year 2014.
Sustainability of Margins
Over the last five years CSX's operating expenses, as a percentage of sales, have decreased by more than 470 basis points. Management is executing its efficiency-related costs savings plans so I expect the ratio to further decline in the future.
If we compare its multiples to its close rival Norfolk Southern Corporation (NSC) and the overall industry stats CSX's stock is inexpensive. The company's stock is undervalued based on price-to-earnings, price-to-book, price-to-sales and price-to-cash flows ratios. The price-to-earnings and price-to-cash flows ratios are more refined measures than price-to-book and price-sales ratios so to derive the fair values of CSX and its competitors' stocks I have given higher weightage to the P/E and P/Cash flows ratios.
Based on this valuation, the fair value of CSX's stock is $35.32 with an upside potential of around 28% while the fair value of Norfolk is $73.28 with a downside potential of 16.7%.
The improvements in the Asian and US economies improved the gains on CSX's stock. The current available statistics concerning volume growth in the fourth quarter suggest that the company's revenues will increase considerably on a year-over-year basis and result in an increase in per share earnings and cash dividends for investors.
The stock is also undervalued based on the multiples approach so I would recommend buying the stock.