CSX: Reduced Risk, But What's The Upside?

| About: CSX Corporation (CSX)
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CSX Corp. reported a solid Q1 as revenue growth ramped up.

The railroad operator hasn't been able to rally beyond the $50 level.

The positive catalysts of new CEO Hunter Harrison still appear baked into the stock price without any downside risks factored into estimates.

My last article on CSX Corp. (NYSE:CSX) highlighted the unusual risks of owning the stock at $49 several months ago. At the time, the railroad operator had seen the stock double in roughly a year on expectations of an activist move that wasn't guaranteed.

Even after a solid Q117 earnings beat and the official hiring of industry legend Hunter Harrison as CEO, CSX is only trading around $48 in after-hours. Now, though, investors can decide if the stock is a buy with knowledge that the new leadership is in place.

Source: CSX presentation

The Q1 results were strong, with a big EPS boost due to a large 10% revenue gain that sailed past estimates. The prime increase came from higher revenue per unit on coal that drove a 31% increase in crucial coal revenues.

The coal pricing isn't expected to repeat as prices pull back after a solid Q1. Investors are keen to see what Hunter Harrison can do going forward with cost cutting from implementing Precision Scheduled Railroading.

Investors need to keep in mind that the big EPS beat of $0.08 only brought the EPS figure to within a similar quarterly range as the last few years. The benefits from the legendary new CEO are due to significant cost cuts, whether part of the new railroad scheduling process or not.

CSX had a Q1 operating efficiency ratio of 69.2%, placing the railroad roughly 11 percentage points behind the 58.1% ratio of Canadian Pacific Railway (NYSE:CP) for the same quarter.

Prior to the Q1 report, analysts had a $2.07 EPS forecast for the railroad this year. Naturally, the stock is expensive based on these numbers, with a low likelihood of repeating the strong revenue metrics for the rest of the year.

The real question is how one values CSX based on whether Hunter Harrison can actually get the operating efficiency ratio down 1,000 basis points. The high analyst EPS estimate for 2018 is already at $2.85, with the average estimate up about $0.20 from the roughly $2.25 estimate about 90 days ago.

These numbers back my original estimates of a normalized EPS near $3, assuming that the efficiency ratio falls to that of Canadian Pacific. The stock trades at about 16x those EPS forecasts without any indication that the number is actually achievable or the time frame for that.

The key investor takeaway is that at nearly $50, the market is paying a current market multiple for CSX despite implementation risks and concerns that the age and health of Hunter Harrison impacts the ultimate plans.

Investors paying up for the stock escaped the downside risk of not having Harrison implemented as CEO, but one still has to question the upside potential in the stock at these levels.

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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.