CSX Corporation (NYSE:CSX), a leading supplier of rail-based freight transportation in North America, is set to release Q4 2012 earnings Tuesday, January 22. The company’s stock has fallen from $22 in October 2012 to around $20 now, primarily due to a slowdown in growth. However, the company fared better than its closest competitor, Norfolk Southern (NYSE:NSC), whose stock fell from $75 in September to $65 at present, primarily due to a 27% decline in net earnings during the third quarter of 2012.
The primary factor in the decline in stock price for the two companies was the weak demand for coal freight services, a trend which will affect CSX in Q4 2012, and will likely to do so over the next few quarters. Therefore, we think that one of the key metrics to watch during CSX’s Q4 earnings announcement is the firm’s margin trends, since a decline in the operating ratio will help the firm offset declines in revenues. Additionally, we will be closely watching CSX’s industrial freight and agricultural freight segments, as they can help offset any falls in its coal business.
During the third quarter of 2012, CSX reported a decline in revenue of 2%, which was driven primarily by lower volume in its agriculture and coal freight segments. The company reported a decline in operating income of 3% year-over-year as the operating ratio increased four-tenths of a percent to 70.5% from 70.1%. The small increase in operating ratio didn’t concern us much since it was essentially flat, but we will be keeping a close eye on this figure during the Q4 earnings announcement, since it shows whether or not CSX can cut costs as revenues decrease.
Slow Growth Expected In Q4 2012 And 2013
CSX’s growth, like growth for any other railroad company, is correlated with the growth of the global economy. Unfortunately, global economic growth is expected to remain slow over 2013 at around 3.6%. However, the improving employment situation in the United States could help kindle consumer demand in the country. If this occurs, we could see an increase in demand for industrial freight, which will help CSX grow its top line.
Efficiency Key For Margins
CSX has improved the efficiency of its rail network over the past couple of quarters. The company increased its on-time originations and arrivals to 90% and 80%, respectively, during the third quarter of 2012. Trains also spent less time in terminals and traveled faster on the network, as terminal dwell decreased to 23.2 hours from 25.5 hours and velocity increased to 23 mph from 21 mph year-over-year.
We think these efficiency gains are important for CSX’s margins since they mean that the company is using all its assets, and thereby keeping fixed costs at a minimum. Low fixed costs will help management improve the firm’s operating ratio, which has a direct impact on the company’s EBITDA margins. This is important, because if CSX's EBITDA margins stay flat over our forecast period (instead of increasing to around 42%), we would see around 10% downside to our current price estimate.
Industrial Freight Growth Key
With the decline in coal freight revenues expected during Q4 2012, CSX’s industrial freight and agricultural revenues will be important in helping CSX grow its top line. These two revenue streams faced different industry dynamics during the first nine months of 2012, and we will be closely watching how these segments fared during the fourth quarter.
Overall, CSX’s industrial freight division is currently the company’s biggest division, making up around 30% of its total value. If CSX’s market share in the industrial freight division increases to 38%, it would offset any weakness in coal and would cause a 5% upside to our price estimate. You can assess the impact of a change in industrial freight market share on CSX’s value by using our tool below:
We currently have a $22 price estimate for CSX, which is about 10% above the current market price.
Disclosure: No positions.