CSX: This Could Be A Catalyst

| About: CSX Corporation (CSX)
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Summary

CSX’s coal segment, which is 17% of revenue, saw a revenue decline of 20% last quarter on account of a steep decline in volumes.

CSX, however, can expect some stability in the coal segment going forward due to rising natural gas prices that will make electricity generation from the commodity expensive.

The cost of generating electricity from coal will increase just 3.7% next year, while power generation fuel cost from natural gas is expected to rise almost 20% going into 2017.

CSX might also benefit from favorable coal policy in the U.S. as one of the presidential candidates might remove the curbs on GHG emissions to promote energy independence.

Railroad company CSX (NYSE:CSX) has managed to keep its performance on the stock market strong this year despite a continuous drop in volumes. For instance, in the third quarter that was reported a few days ago, CSX's revenue fell almost 8% on a year-over-year basis. The decline in the company's revenue was in line with a drop of 8% in volumes, with the majority of the volume decline being driven by the coal segment.

Trying to overcome the coal challenge

In fact, volumes in CSX's coal segment were down by 21% on a year-over-year basis, which led to a massive drop in revenue from this segment. More specifically, CSX's coal revenue, which accounted for 17% of its overall revenue last quarter, fell 20% year-over-year to $467 million last quarter. This is a trend that we have seen for the past few quarters at CSX as oversupply and weak demand for coal have weighed on the company's results.

But, the good news is that CSX has managed to overcome this weakness in the coal segment by way of its focus on enhancing efficiency and reducing costs. For instance, its expenses dropped 7% in the last reported quarter on a year-over-year basis. This was the result of efficiency gains of $112 million and $53 million in volume-related cost reductions.

On account of its cost reductions and operational efficiency improvements, CSX was able to post earnings of $0.48 per share, beating the consensus estimate by 3 cents. However, investors should not miss the fact that on a year-over-year basis, CSX's net earnings in the third quarter fell more than 10%. As such, it can be said that even though CSX's cost cuts have allowed it to beat forecasts, the fact that its bottom line is on the decline cannot be ignored.

Given that coal accounts for a substantial portion of CSX's revenue and this segment has been under pressure, a turnaround in this segment will play a key role in improving the company's financial performance going forward. But, is a turnaround in coal likely? Let's take a look.

Cheaper coal could drive growth

All is not lost for CSX in the coal segment. This is because the recent rise in natural gas prices could arrest the coal-to-gas switch in the country, which will be a tailwind for CSX going forward. For instance, the price of natural gas has gone up from around $1.70/MMBtu in the beginning of March to almost $3.00/MMBtu currently.

As a result of this rise in natural gas prices, the cost of generating electricity from the commodity will increase. In fact, the EIA forecasts that the price of natural gas will increase to an average of $3.16/Mcf next year from $2.59/Mcf this year.

This will lead to an increase in the power generation fuel cost from natural gas to $3.61/MMBtu in 2017 as compared to $3.02/MMBtu this year. In comparison, power generation fuel costs from coal have been on the decline over the past few years. This year, the cost of generating power from coal is expected to go down to $2.16/MMBtu as compared to $2.23/MMBtu last year.

Even though the cost is expected to rise to $2.24/MMBtu next year, this will be an increase of just 3.7%. In comparison, power generation fuel cost from natural gas is expected to rise almost 20% going into 2017.

As a result, favorable coal market dynamics could prove to be a tailwind for CSX going forward and allow the company to arrest the slide in its financials.

Potential policy changes could favor CSX

CSX's coal segment might also benefit from a favorable coal policy. For instance, presidential candidate Donald Trump's coal policy favors CSX. His proposed energy plan focuses on establishing energy independence in the United States.

In fact, Trump plans to eliminate regulation aimed at curbing CO2 and greenhouse gas emissions, thereby reducing the influence of the Environmental Protection Agency. Moreover, his focus would be on increasing domestic production of fossil fuels because the return on investment on fossil fuels has shorter durations as compared to alternative energy sources such as solar and wind that require long payback periods.

As a result of the focus on increasing the domestic production of fossil fuels, railroad companies such as CSX would be in a better position to improve its coal volumes. Additionally, CSX might benefit from another potentially favorable policy development.

Both presidential candidates aim at spending heavily on infrastructure in order to strengthen the economy. For instance, Hillary Clinton recently proposed a $275 billion infrastructure plan for the next five years, while counterpart Donald Trump said that he would be spending approximately $500 billion to rebuild infrastructure in the U.S.

This news should be a welcome sign for CSX, which spends approximately 16% to 17% of its revenue on infrastructure every year. Therefore, both the parties' focus on spending on infrastructure will allow CSX to reduce infrastructure investments going forward, which will free up more cash.

Conclusion

CSX has been making the right moves to overcome the challenges posed by a weak commodity pricing environment. More importantly, the company could benefit from an increase in coal demand going forward due to reasons discussed above, while help from the government in creating more infrastructure will be another tailwind. So, it will be a good idea to remain invested in CSX despite weak volumes and declining financials as it can make a comeback in the future.

Disclosure: I/we 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.