Should You Buy CSX For The Long Run?

Feb.24.14 | About: CSX Corporation (CSX)

Railroad company CSX (NYSE:CSX) has underperformed the market in the last one year with shares gaining just 20%, slightly below the S&P 500's gain of 21%, and also trailing the solid gains reported by peers Norfolk Southern (NYSE:NSC) and Union Pacific (NYSE:UNP). Also, CSX didn't get off to a good start in 2014 as its results for the fourth quarter marginally missed analysts expectations.

Reviewing the performance

CSX's revenue increased 5% to $3 billion, while earnings declined 5% to $426 million. CSX is facing weakness in coal transportation, which accounts for nearly a quarter of its revenue. Coal volumes declined 5% in the fourth quarter due to shift from coal to natural gas in power plants in the U.S.

CSX's operating ratio, which shows expenses incurred to revenue earned for railroad companies, is also a matter of concern. The smaller the operating ratio, the better it is. Despite CSX's efforts to bring down the operating ratio in the 60s, it rose from 70.6 in 2012 to 71.1 in 2013. In a conference call, chief financial officer Fredrick Elliason said if the company has to reach even the low end of its forecast for earnings, the demand for coal shipments will have to turnaround by 2015.

Looking forward

However, investors need to consider three major factors before investing in CSX if they are looking at a turnaround -- what might fuel its growth, how the operations might run going forward, and what are its prospects. Let us take a closer look at these factors.

The first factor is what might fuel growth. Coal volumes have dipped 5%, but this decline was offset by the intermodal and merchandise categories, which provide strong support to the railroad company. Intermodal demand increased 11% while merchandise demand increased 7%. Merchandise demand was backed by growth in agricultural and industrial chemicals, which grew 16% and 18%, respectively. In addition, strong demand from energy and auto markets boosted CSX's total volume growth by 6%.

The second factor is how the operations are running. To assess CSX's operating efficiency, we need to go back to the operating ratio which compares operating expenses with sales to show the efficiency of the company. As we have already seen, this metric continues to bother the company. CSX is working hard to improve its operations and reduce costs, yet the operating ratio has increased from 70.6 to 71.1. While the company is sticking to its target of achieving an operating ratio in the 60s by 2015, investors are not sure how CSX plans to get there. Investors need to watch what management has to say regarding cost cutting in the days ahead.

Looking forward, CSX will be trying its best to improve its performance. CEO Michael Ward said -- "As the economy continues to expand, CSX is well positioned to leverage that environment to create sustainable long-term value for our customers and shareholders." According to CFO Fredrik Eliasson, "his company believes the U.S producers will play a larger role in the global coal market going forward."

So, although short-term growth will be effected due to declining coal demand, yet CSX is willing to give price concessions to U.S. exporters. CSX is outperforming its peers in the same industry. CSX saw a 22% increase in coke carloads compared to Union Pacific's 3% and Norfolk Southern's decline of 12% year on year. U.S. Energy Information Association, and CSX, expects that demand for coal will return in 2014 as inventories stabilize. If this is the case, CSX will benefit the most.

CSX also has some more catalysts working in its favor. Favorable pricing in the rail industry, enhancement of CSX's network and terminal capacity, along with the recovery in the construction sector could turn out to be tailwinds in the future. Additionally, CSX is also focused on improving operational efficiency, apart from offering improved services at reasonable costs to customers.

Valuation and conclusion

What's more, CSX is cheaper at a trailing P/E ratio of 14.94 when compared to both Norfolk Southern and Union Pacific. Norfolk Southern is slightly expensive at 14.98 times earnings while Union Pacific trades at an even more expensive 19 times trailing earnings. Also, apart from being the cheapest option in the industry, CSX also pays a healthy dividend yield of 2.20%, while a payout ratio of 32% indicates that the company can boost dividend in the future. So, investors should look beyond the short-term pain at CSX and hold the company in their portfolio as it looks promising for the long run.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.