CSX Corporation (NASDAQ:CSX) is a key player in the U.S. railroad industry that operates as a transportation supplier for various industries and provides rail-based transportation services that include traditional rail service and intermodal containers as well as transportation via trailer trucks.
The year 2013 was regarded as the beginning of the freight railroad industry's upcoming growth. It is expected that there will be more ups than downs in the year 2014 for the railroad industry despite the slow economic recovery. Therefore, I am writing this article to assess CSX Corporation's performance during FY 2013 to determine the factors that will contribute to the company's growth in the coming years. I will also analyze the outlook of industry.
Growth Forecasts for the Industry
Before discussing the industry's outlook for 2014 and onwards let's determine how much the industry recovery benefited the company during FY 2013. To do so I will analyze the volume of freight operations the company recorded for FY 2013. The volume was a major revenue driver for the company especially during FY 2013 when revenue per unit earned by the company remained flat in comparison to the previous year. As a result, a 2% growth in the company's total revenue for FY 2013 was the result of a 2.03% total volume growth recorded by the company in FY 2013 in comparison to FY 2012 as shown in the chart below.
Volume Performance to Date
Source: CSX 10K 2013
The table above shows that the company's volume from the agricultural industry recovered from its 3.66% decline in FY 2012 and was recorded at 0.25% in FY 2013. Volume from the industrial sector continued its growth trend in FY 2013.
The housing and construction industry turned out to be a major contributor to growth in total merchandise volume and recorded a 4.18% growth in its volume in comparison to the previous fiscal year when the company recorded a 3.61% decline in volume from the housing and construction industry. Overall, total merchandise volume represented 42.24% of the company's total volume and increased by 3.52% in FY 2013 up from the 0.53% growth recorded for FY 2012. Coal volumes remained a headwind for the company's total volume in FY 2012 and FY 2013. Therefore I will discuss the prospects of the volume from the coal industry in the industry outlook heading below. The company's volume from intermodal operations that generated 39.49% of the company's total volume grew by 5.34% supporting the company's 2% growth in volume and ultimately the company's revenue.
Growth Prospects from the Industry
After facing difficulties over the past several years the U.S. freight railroad industry has prepared itself for a bright 2014. The volume from the coal industry will still remain a headwind for the railroad industry's total volume but the negative effects from coal will be offset by the housing and construction sector and industrial sector. This sector is forecasted to have strong gains in natural gas and petrochemical product shipments. Overall anticipated strong volumes for crude oil due to an increase in production of barrels per day, domestic intermodal, and gains in automotive carloads will help offset the three expected declines: coal, international intermodal and forest products traffic. If these projections are realized the large roads might surpass their peak traffic levels set seven years ago.
The Zacks Industry Rank for the railroad industry is currently #24 indicating the fact that the outlook remains positive for this sector. This ranking highlights the positive outlook of the industry triggered by current records of margin growth for the railroad industry in addition to a slight recovery in coal shipments. Looking ahead the rise in petrochemical shipments will also elevate the markets conditions of this industry to support earnings improvements and drive top line growth for the industry. Therefore the revenues and the earnings of railroads will see a boom in the coming year.
The overall transportation sector, of which the railroad industry is a part, is forecasted to record a 4.6% increase in revenue during the first quarter of 2014.
As a result of this anticipated growth, CSX Corporation has plans to make more capital investment on the coming year as shown in the pie chart below.
Capital Investment While Maintaining Margins
The pie chart above shows that the company is targeting a $2.3 billion investment in FY 2014. Core investment will remain at 16-17% of the revenue the company will earn in FY 2014. Fifty-three percent of the total capital investment spent by the company for FY 2014 will be used for improving infrastructure. The growth of the railroad industry is highly dependent upon the availability of required infrastructure. Therefore investments in infrastructural projects are a fundamental part of railroad development. According to the Department of Transportation (DOT), the demand for rail freight transportation will increase by about 88% until 2035 and to fulfill this rising demand the industry will need to upgrade about almost 90% of the railway capacity by then. Currently, the U.S. railroad industry leads less than 50% of total freight in America. This indicates a huge opportunity for the industry to increase its market share in the transportation sector. This opportunity can only be availed by constructing railroad infrastructure that accommodates the diverse requirements of shippers.
Although capital investments increase the growth prospects of companies they also put a strain on their margins. As a result it is crucial for companies to create a balance between capital investment and preserving their bottom lines. CSX Corporation has already structured a game plan to keep its margins safe. The company is attempting to save more than $130 million in efficiency savings for FY 2014 as shown in the chart below. This will support the company's bottom line and EPS will be saved from a negative surprise by the end of FY 2014. The company is targeting 10-15% EPS growth for 2014-2015.
Returns to Shareholder and My Take
The chart below shows that the company has a history of paying higher year-over-year dividends along with share buybacks.
The company currently has a new $1 billion share repurchase program announced during FY 2013 and that is expected to be completed by 2015. Overall, the company opted for a balanced approach towards cash deployment which includes capital investment for the company's growth along with cash returns for shareholders. The company is currently earning 19.2% ROE which is a greater return than the industry's 18.8%. The company has a 0.9 debt/equity which is higher than industry's average debt/equity ratio of 0.6. The company recorded a net reduction of $277 million in its total debt for FY 2013 so it is putting an effort into serving cash to reduce its gearing.
Overall, the bright industry outlook triggered from the growth in volume due to support from recovery in the housing and construction and oil and gas industries will grow the company's top line in the coming years. Additionally, the company has positioned itself well through capital investments and cost-saving targets that will help it to capture more growth opportunities. These factors indicate that the company is a good buy along with the rising cash returns the company pays to its investors. The high debt/equity ratio makes the stock a bit risky.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article