CSX Has Likely Peaked

Summary

• CSX's top line continues to grow.
• Total rail traffic is slowing, which signals the economy has peaked.
• CSX remains a sell.
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Source: WSJ

There is a lot of debate over whether the economy is strong or whether we are already in the throes of a recession. Recessions are difficult to predict because no one knows when the government will stop providing low interest rates or tax cuts. One metric that could predict the next recession is rail traffic. For the month of May, U.S. rail traffic and intermodal units were down 4.1% Y/Y. Through the first 22 weeks of 2019 combined U.S. traffic and intermodal units were down 2.4% Y/Y. Industrial output has fallen. Another factor in declining rail traffic could be economic uncertainty pursuant to trade tensions with China.

Nonetheless, CSX's (NASDAQ:CSX) revenue is growing by mid-single digits. In Q1 2019, the company generated revenue of $3.0 billion, up 5% Y/Y.

Revenue growth was based on an increase in price and volume. Total volume was up 4% Y/Y while revenue per unit rose 5%. On a product basis, revenue growth was broad-based with Construction-related products leading the way, up by double-digits. Revenue from Coal and Agricultural products both rose by 7%.

Construction was driven by Forest Products which experienced increased volume due to export demand for pulp and building products. Construction revenue could stay strong as long as interest rates remain low. Agricultural experienced volume increases from domestic and export grain markets. I expect this to change by the second half of 2019 if China stops purchases of soybean and other agricultural products. Coal increased due to domestic steel production.

The Industrial segment represents over 35% of CSX's revenue and its future growth (or lack thereof) could drive the narrative. It also commands the highest price at $346 per unit. The segment also includes Automotive products, which could be hurt by a decline in auto sales if consumers become worried about the future.

Has EBITDA Peaked?

CSX's operating ratio improved by 400 basis points to 60% from 64% in the year earlier period. An operating ratio below 60% is best-in-class, in my opinion. The operating ratio was 59% in Q3 2018 and Q4 2018. To achieve such low ratios, the company embarked on a cost-cutting program that involved laying off thousands of workers. The fact that the operating ratio ticked up slightly versus Q4 2018 could signal it is difficult to sustain long term.

EBITDA was $1.5 billion, up 13% Y/Y. The EBITDA margin was 51%, a 300 basis point improvement versus the year earlier period. If cost cuts have been fully-realized by management, then more EBITDA improvement could be difficult to come by sans more scale. That said, I believe EBITDA has peaked.

This is important, as CSX currently trades at over 12x run-rate EBITDA (Q1 2019 EBITDA annualized). This is very robust for a cyclical name. I would prefer something in the 8x range for a company whose revenue ebbs and flows with the economy. In a market driven by sentiment, fundamental analysis may not matter much. However, unless EBITDA improves, it may be difficult to justify buying CSX at this level.

Conclusion

Talks of rate cuts could spur financial markets and CSX in the short term. CSX is up over 15% Y/Y. Long term, CSX's prospects will likely fall with the economy. Sell CSX.

Analyst’s Disclosure: I am/we are short CSX. 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.