CSX: Can This Railroad Stock Soar Beyond Its 52-Week Highs?

Jul.22.14 | About: CSX Corporation (CSX)

Summary

CSX has bounced back nicely after a weak start to the year, and now trades close to its 52-week highs.

CSX's momentum should continue as the company's end-market prospects are improving and conditions in the railroad sector are getting better.

CSX has an attractive valuation, along with solid cash flow generation.

Railroad company CSX (NYSE:CSX) is chugging along nicely this year. CSX's appreciation of around 10% in 2014 beats both the Dow Jones and S&P 500 indexes. The company is seeing robust revenue and earnings growth, and recently reported record revenue in the second quarter. Although CSX's revenue was slightly below consensus estimates, its earnings were marginally better. Looking ahead, there's a strong chance that CSX will continue gaining more traction, primarily due to positive end-market conditions.

Bouncing back nicely

Earlier in the year, CSX was severely affected by the cold, snowy winter weather, but has improved now along with the weather conditions. In addition, the economy is recovering, so the company is picking up momentum and expects to turn in stronger performances going forward.

According to CSX Chairman, President and CEO Michael Ward, "With the broad-based economic momentum we are seeing, the core earning strength of this company is improving and driving value for shareholders." The railroad industry was under pressure due to the transition of power companies from coal to gas. But, during the second quarter, CSX hauled 6% more coal. This is an encouraging sign, and indicates that the situation could improve further going forward.

Most of CSX's business segments performed well, exhibiting growth on a year-over-year basis, along with an improvement in its international volumes. However, its intermodal revenue declined 2%, as the gains in core pricing and higher fuel recoveries were offset by an unfavorable mix. This was mainly because CSX's crucial door-to-door business saw some weakness during the quarter.

Growth-oriented strategies and better end-market prospects

However, CSX is positive about its intermodal prospects. The company is growing its intermodal business by adding new services and making strategic investments. In line with this strategy, it started a new terminal at Winter Haven, Florida. A second terminal is already under construction at Montreal, which is expected to be opened later this year. According to management, "These two terminals together will add 350,000 in annual lift capacity." In addition, its Northwest Ohio facility is undergoing expansion, which will enhance its capacity by 50%.

As mentioned earlier, the coal business has been a matter of concern for the railroad industry as a whole. But recently, with the increase in gas prices, some improvement can be seen in the industry. As a result CSX was able to report an improvement in its coal volumes. Although the increase in CSX's domestic coal volume was strong, its exports declined. However, going forward, management expects demand to increase, driven by favorable conditions in most of its markets.

Some of its key markets such as agriculture, chemicals, automotive, etc., are expected to grow strongly going forward. In addition, CSX expects its intermodal business, which declined in the second quarter, to grow as its strategic investments and improving services support highway to rail conversions. For the third quarter, it is optimistic about its coal volumes as well, since utilities continue to rebuild inventories.

Moreover, the Purchasing Managers Index (PMI) was 55.3 in June, and a rating above 50 indicates that the manufacturing economy is expanding. Along with this, the Customer's Inventories Index was 46.5, indicating customer's inventories are low. This indicates continued strength and demand for manufacturing output.

A concern

However, CSX might face a regulatory concern. As AP reports:

The railroad is now hauling about 20 trainloads a week of crude oil to refineries on the East Coast. Those shipments of oil from the Bakken region of North Dakota and Montana have been a bright spot for railroads, but new safety regulations currently being pieced together could prove costly.

Federal regulators are expected to propose new rules for tank cars sometime later this year, and the Transportation Department has been developing other rules to address safety concerns after several fiery rail accidents involving crude oil.

Ward said he is excited about the prospect of new regulations calling for the railroad tank cars hauling crude oil to be redesigned and strengthened, but he's worried about the possibility of a 30 mph speed limit being imposed on trains carrying crude oil.

"That would be severely limit our ability to provide reliable freight service for customers and to support the timely, efficient passenger or commuter service," Ward said.

Valuation and conclusion

CSX has a trailing P/E of 17.57, which is quite cheap when compared to the industry average P/E of 23.19. Its forward P/E looks even more attractive at 14.68, which indicates that its earnings will improve in the future. Apart from this, CSX has strong cash flow. Its operating cash flow for the last twelve months stands at $3.13 billion, while levered free cash flow is $674 million. CSX's solid performance this year has pushed the stock close to its 52-week highs, but considering the end-market conditions and the company's smart investments, it can get even better going forward.

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