With all the great things that have been going on in the railroad sector over the past few months, it was only a matter of time before someone would find some sort of way to bring them crashing back down to Earth. While the railroads might not be the sexiest play in everyone's portfolio these days, especially with all the hoopla surrounding Apple’s iPhone or the plethora of the M&A activity buzzing this year, I have to believe that some of the biggest hedge funds that have large positions in the railroad sector know value when they see it. Carl Icahn recently disclosed to the SEC that his firm bought 2.7 million shares of CSX Corporation (NYSE:CSX), and UK’s powerhouse hedge fund, the Children’s Fund, also announced that they were to buy a $500 million position in CSX. How can you not love a company that Carl Icahn loves or a sector that Warren Buffet has been investing in so readily? Riding coattails or not, I think that we can agree that many of us wouldn’t want to be in the path of the speeding train that is Berkshire Hathaway or Icahn & Co.
Of all the railroad companies being invested in, the one that sticks out in my mind has to be CSX. CSX is the biggest railroad company on the Eastern United States with as many as 37,170 miles of railroads, and they are determined to continue to add more lines in the near future. In 2006, CSX earnings grew 64%, they raised their dividend 50%, and they are now trading at a comfortable 16 times earnings. CSX is one of the few companies that actually has the shareholders in mind.
But the real reason that I think CSX will keep running higher doesn’t have anything to do with past numbers, but because of “black gold” and the potential future earnings. The price of oil is at an 11 month high and since May 29th many hedge funds are starting to acquire more and more oil week after week. So much so that I believe that they can easily push that price to $80 or more. Also, reports are that we should expect to see higher and higher diesel fuel prices by this fall. This mixture could be a goldmine for CSX. If these prices remain, it could start to hurt other company’s margins that use trucks to deliver their products. Think about it: A company who has a large fleet of trucks are going to have to foot the bill on the higher cost of gas. If a company mostly ships its products by truck then they are going to have to either raise the prices of the products they sell to offset the prices of fuel or lose the margins that they already have. High oil prices translate to high fuel prices and that is going to be costly for those particular companies. We already know how high gas prices can affect us because it’s hitting us at the pumps now. We take shorter vacations or not buy non-essential products to save money. On a larger lever, this is going to cut companies' already razor thin margins even before they pay the truckers. Shipping products across the country is becoming inept for companies when they can put more products on a single train and ship them across the country cheaper and much more efficiently. I can only guess that it takes at least three or four trucks to make up a train.
So wouldn’t it be much more intelligent for companies to use one train instead of four trucks? Listening to the urging from hedge fund managers, CSX is raising their prices by 7%, so that will give a boost to railroads notoriously thin margins. Additionally, with oil prices lingering near all-time highs it is pushing the demand for ethanol higher then ever before. Moreover, it is becoming increasingly evident that you can not ship ethanol efficiently through pipelines and this is apparent with CSX posting a 24% increase in ethanol shipping last year.
Another plus for CSX is that they are more than doubling the speed that their trains will be traveling. CSX said by the end of July their trains will be flying at 49 MPH. That’s double the speed they were traveling before with no added risk to safety. That means the products will be going to get to their destination much faster and more efficiently then ever before. With all this happening, CSX is produced an operating cash flow of $2.1 billion in 2006. That is a $1 billion higher than the operating cash flow they had in 2005. Aside from this, CSX expects to invest $6.4 billion into its operations over the next four years adding even more value.
Furthermore, CSX plans to increase its capital investments from $1.5 billion this year to $1.7 billion by 2010 or more to meet expectations of rising demand for railroad transportation. These capital investments will be mainly on new tracks, equipment, and technology. CEO Michael Ward has come out and said that CSX expects a record level of operating income and a raise in EPS this year. The company is known for being shareholder friendly and at the end of 2006 the board approved a $3 billion share buyback to be completed by the end of 2008 totaling 15% of the company’s shares will be off the market lowering supply and raising demand.