CSX Sticks With Harrison's Plan To Cut Jobs, Reduce Trains

Summary

• CSX's new CEO will stick with Hunter Harrison's plan to cut jobs and reduce trains.
• Amid management's rightsizing, CSX has experience train derailments and service problems.
• I also believe the upside from efficiency gains could be priced into the stock already.
• Avoid CSX.

CSX (NASDAQ:CSX) recently affirmed it would stick with former CEO Hunter Harrison's plan to cut jobs and rail cars, and slash capital spending:

U.S. railroad operator CSX Corp said on Thursday it would stick with a plan started by former Chief Executive Hunter Harrison, who died in December, to boost profit through cutting jobs and rail cars, and would also slash capital spending.

CSX shares, which ended the trading day up about 1 percent, have surged about 50 percent since January 2017 and about 12 percent since March 2017, when Harrison took over as CEO following a push by activist investor Paul Hilal of investment fund Mantle Ridge LP.

Harrison died in December at the age of 73. Jim Foote took over as acting CEO. Harrison was known as a turnaround artist. He turned Canadian National Railway (CNI) into one of the most-efficient railroads in the world. Harrison brought his pixie dust to Canadian Pacific (CP), rightsizing the organization and creating efficiency gains only rivaled by Canadian National. Harrison and Canadian Pacific attempted high-profile hostile takeover attempts of CSX and Norfolk Southern (NSC) but were rebuffed.

Harrison attempted to apply his turnaround skills to CSX. A major question was whether new CEO Jim Foote would continue his cost-cutting strategy. That question has just been answered.

Will Efficiency Gains Come At The Expense Of Service?

Key to Harrison's strategy was cutting cost, reducing downtime, and getting higher utilization from CSX's existing railroad fleet. Harrison lengthened trains, closed rail yards, mothballed certain trains that were considered underutilized and cut overtime pay for hundreds of workers. Last summer, critics suggested the rapid changes came at the expense of safety measures:

A signal maintainer spoke of a dangerous change in hump yard operations at Avon Yard, in Indianapolis, Indiana, "One of the big problems is that management was actively being encouraged to disregard safety standards, and being threatened with their jobs if dramatic changes didn't occur. They increased the speeds of the cars that go down through the retarder. Normally those cars take 5 seconds, but management said they should take 2 seconds to pass through [meaning, they roll at higher speeds].

"During this time, there were more derailments than I've ever seen in that yard, and I worked there for five years. If you are working in the yard, this is dangerous, and if something were to happen there are only two ways in and out for emergency services. One of those entrances is constantly blocked by trains, and the other often is as well."

Bottlenecks and customer delays dogged CSX amid Harrison's cost-cutting plan. Harrison blamed the service problems on internal mistakes and the closing of too many rail yards. Foote must now convince customers that service problems are issues of the past. CSX must also deliver on those promises. Two days ago, a CSX train derailed on a bridge in Maryland. The cause of the incident is still under investigation.

If derailments and service problems persist, then CSX could be vulnerable to truckers and competing railroads using its service record against it when competing for new business.

Lastly, Foote must also help maintain employee morale amid sizeable layoffs. The railroad wants to bring its expense ratio to 60%, down from its current ratio of 67-68%. Canadian Pacific has consistently delivered an expense ratio below 60%. A big advantage is that Canadian Pacific's labor ratio has been lower than CSX's by 7-8%. That implies more layoffs at CSX if Foote wants to achieve a 60% expense ratio.

Is The Good News Already Priced In?

Rumors began to swirl in January 2017 that Harrison and CSX were in talks for him to take the helm at the railroad. Market chatter suggested he would rightsize CSX or position it for a sale to Canadian Pacific. CSX bulls stood to reap a potential windfall. Since January of last year, CSX is up over 40% while the S&P 500 is up about 20%. CSX currently trades at over 11x run rate EBITDA. When I first started evaluating the stock a few years ago 8.0-8.5x was a normal trading range. It implies that the good news of layoffs and efficiencies gains is likely priced in already.

Secondly, major efficiency gains could be predicated on CSX maintaining or even growing its top line. Its Q4 railroad revenue of $2.9 billion was off 6% Y/Y, and that was on an 8% decline in volume. It may not get much better as industry railcar traffic has been stagnant. For the first eight weeks of the year, total combined U.S. rail traffic was up 1% Y/Y. Investors should keep in mind that rail traffic and overall business activity have been buoyed by accommodative central bankers around the globe. If they remove the punch bowl, then it could create slight headwinds for CSX and other railroads.

Conclusion

CSX's new CEO will continue Hunter Harrison's plan of cost cuts to drive its expense ratio lower. I believe the good news is already priced into the stock. Investors should avoid CSX.

Analyst’s 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. I have no business relationship with any company whose stock is mentioned in this article.