CSX CORP CSX
March 19, 2012 - 11:22pm EST by
sfdoj
2012 2013
Price: 22.07 EPS $1.67 $1.81
Shares Out. (in M): 1,052 P/E 13.2x 12.2x
Market Cap (in M): 23,224 P/FCF 16.6x 17.4x
Net Debt (in M): 7,935 EBIT 3,418 3,600
TEV: 31,159 TEV/EBIT 9.1x 8.7x

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  • Railroad
  • Share Repurchase
  • Discount to Peers
 

Description

I am recommending a long position in the common stock of CSX Corp (CSX). I wrote most of this report prior to last Thursday and Friday’s +10% increase in CSX stock price off its low on Wednesday. I still think the stock is attractive here and based on the JPM conference presentation there should be increased confidence in CSX’s 2012 performance and therefore possibly lower downside in the stock. On the other hand we’ve missed that +10% move and the upside over any time period is thus reduced by that amount.

The only long railroad recommendations I can find on VIC are UNP from 2004 (+322%), reiterated in 2010 (+69%), and BNI from 2001 (+293%) and 2007 (+23%). Otherwise there is a short CP recommendation from 2011 with some good Q&A around railroad valuations and Capex vs. depreciation, revenue adequacy, and the probability of future regulation that will possibly hurt railroad profitability. The 2007 BNI writeup has some good background on the railroad industry as well. I mention this because the railroads are very solid businesses with seemingly permanent cost advantages relative to trucking, which is an industry perhaps 8-9x the size in terms of total revenues. Yet the high capital expenditures required to maintain the business likely turns off many investors. Still railroads produce a lot of FCF and CSX in particular appears to be undervalued as I discuss further below.

 

Investment Highlights

Wide moat from network effects, barriers to entry, economies of scale, and efficient scale—assets are impossible to replicate, costs are low relative to the major alternative, trucking.

Oligopoly with rational actors in combination with competitive advantages leads to significant pricing power—pricing has increased at a 6% CAGR since 2001.

Well run business that has improved dramatically over the past decade—operating margin has increased from 18% in 2002 to 29% in 2011.

High incremental operating margin—due to both operating leverage and pricing power incremental operating margins are generally above 40%. Yet CSX demonstrated a much more flexible cost structure than expected when revenue fell -20% in 2009 while operating income only dropped -17.5%.

Shareholder friendly management—bought $1.56B of stock in 2011 or about 6% of shares outstanding and cumulatively $6.8B and 29% of S/O over the last 5 years. Transparent and ambitious financial targets for 2015. Frequent communication with analysts. Clearly focused on shareholder returns.

Financially flexible—Net Debt/EBITDA of 2.1x including underfunded Pension and OPEB plans and capitalized operating leases; recently issued 30-year bonds at 4.4%.

Valuation is low relative to its history, the S&P 500, and UNP—19% below its L10Y mean P/E, 5% below its mean relative P/E to the S&P, and 18% below its mean relative to UNP. On an absolute basis the stock trades at a 5% FCF Yield (CFFO-CapEx), compared to a median of 2.9% from 2001-2005 and 4.6% from 2007-present. Dividend Yield is 2.2%.

 

Company History

The Company’s heritage dates back to the early nineteenth century when The Baltimore and Ohio Railroad Company (“B&O”) – the nation’s first common carrier – was chartered in 1827. Since its founding, numerous railroads have combined with the former B&O through merger and consolidation to create what has become CSX.  Each of the railroads that combined into the CSX family brought new geographical reach to valuable markets, gateways, cities, ports and transportation corridors. CSX was incorporated in 1978 under Virginia law. In 1980, the Company completed the merger of the Chessie System and Seaboard Coast Line Industries into CSX.  The merger allowed the Company to connect northern population centers and Appalachian coal fields to growing southeastern markets.  Later, the Company’s acquisition of key portions of Conrail, Inc. allowed CSX to link the northeast, including New England and the New York metropolitan area, with Chicago and midwestern markets as well as the growing areas in the southeast already served by CSX.  This current rail network allows the Company to directly serve every major market in the eastern United States with safe, dependable, environmentally responsible and fuel efficient freight transportation and intermodal service.

 

Business Description

CSX provides rail-based freight transportation services including traditional rail service and the transport of intermodal containers and trailers. CSX serves major population centers in 23 states east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec.  It has access to over 70 ocean, river and lake port terminals along the Atlantic and Gulf Coasts, the Mississippi River, the Great Lakes and the St. Lawrence Seaway.  The Company’s intermodal business links customers to railroads via trucks and terminals. CSX also serves thousands of production and distribution facilities through track connections to approximately 240 short-line and regional railroads.

Assets: 21,000 route miles (37,000 total track miles); CSX operates 4,116 locomotives, of which over 95% are owned by CSX, average age 20 years. In 2011, the average daily fleet of cars on line consisted of approximately 206,000; CSX owns 95,422 railcars.

CSX is one of two Class I (>$399mm in revenues) railroads with a network that covers the U.S. east of the Mississippi river, Norfolk Southern being the other. The biggest difference between their two footprints is that CSX’s tracks extend into Florida while NSC’s do not.

The U.S. demand to move more goods by rail is expected to rise along with the need to reduce highway congestion and greenhouse gas emissions. CSX and freight railroads are the best way to meet this demand while reducing environmental impacts. CSX can move a ton of freight almost 500 miles on one gallon of fuel and, on average, over three times more fuel efficiently than trucks.

CSX's network is positioned to reach nearly two-thirds of Americans, who account for the majority of the nation's consumption of goods. Through this network, the Company transports a diverse portfolio of products and commodities to meet the country's needs. These products range from energy sources like coal and ethanol, to automobiles, chemicals, building materials, paper, metals, grains and consumer products. The Company categorizes these products into three primary lines of business: merchandise, coal and intermodal.


Merchandise business—shipped 2.65 million carloads and generated approximately 54% of revenue and 41% of volume in 2011. The Company’s merchandise business is the most diverse market and transports aggregates, metal, phosphate, fertilizer, food, consumer (manufactured goods and appliances), agricultural, automotive, paper and chemical products.

Coal business--shipped 1.53 million carloads and accounted for nearly 32% of revenue and 24% of volume in 2011.  0.95 million of these carloads (62%) were to about 90 domestic utilities, about 24% of the carloads were exports, and the remainder (14%) shipped to industrial and steel plants. The Company transports utility, industrial and export coal to electricity-generating power plants, steel manufacturers, industrial plants and deep-water port facilities.  In 2011 37% of export coal (will be closer to 50/50 in 2012) and nearly all of the domestic coal that the Company transports is used for generating electricity. Export met coal contracts typically last 1 year; export thermal coal 1-2 years; export tariff rates are reset quarterly; and domestic coal contracts last 3-5 years.

Intermodal business—shipped 2.29 million carloads accounting for approximately 12% of revenue and 35% of volume in 2011. The intermodal line of business combines the superior economics of rail transportation with the short-haul flexibility of trucks and offers a competitive cost advantage over long-haul trucking.  Through a network of more than 50 terminals, the intermodal business serves all major markets east of the Mississippi and transports mainly manufactured consumer goods in containers, providing customers with truck-like service for longer shipments.

 

 

                                             

 

 

 

 

Fiscal Years

(Dollars and Shares in Millions, Except Per Share Amounts)

 

2011

 

2010

 

2009

 

2008

 

2007

Financial Performance

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

11,743

 

 

$

10,636

 

 

$

9,041

 

 

$

11,255

 

 

$

10,030

 

 

 

Expense

 

8,325

 

 

7,565

 

 

6,771

 

 

8,504

 

 

7,784

 

 

 

Operating Income

 

$

3,418

 

 

$

3,071

 

 

$

2,270

 

 

$

2,751

 

 

$

2,246

 

Net Earnings from Continuing Operations

 

$

1,822

 

 

$

1,563

 

 

$

1,128

 

 

$

1,485

 

 

$

1,227

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Ratio

 

70.9

%

 

71.1

%

 

74.9

%

 

75.6

%

 

77.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings Per Share: (a)

 

 

 

 

 

 

 

 

 

 

 

 

From Continuing Operations, Basic

 

$

1.68

 

 

$

1.37

 

 

$

0.96

 

 

$

1.23

 

 

$

0.95

 

 

 

From Continuing Operations, Assuming Dilution

 

1.67

 

 

1.35

 

 

0.95

 

 

1.21

 

 

0.91

 

 

 

Average Common Shares Outstanding

 

1,083

 

 

1,143

 

 

1,176

 

 

1,204

 

 

1,293

 

 

 

Average Common Shares Outstanding, Assuming Dilution

 

1,089

 

 

1,154

 

 

1,187

 

 

1,228

 

 

1,347

 

Financial Position

 

 

 

 

 

 

 

 

 

 

 

 

Cash, Cash Equivalents and Short-term Investments

 

$

1,306

 

 

$

1,346

 

 

$

1,090

 

 

$

745

 

 

$

714

 

 

 

Total Assets

 

29,473

 

 

28,141

 

 

26,887

 

 

26,154

 

 

25,417

 

 

 

Long-term Debt

 

8,734

 

 

8,051

 

 

7,895

 

 

7,512

 

 

6,470

 

 

 

Shareholders' Equity

 

8,468

 

 

8,700

 

 

8,768

 

 

7,985

 

 

8,612

 

 

 

Dividend Per Share (a)

 

$

0.45

 

 

$

0.33

 

 

$

0.29

 

 

$

0.26

 

 

$

0.18

 

Additional Data

 

 

 

 

 

 

 

 

 

 

 

 

Capital Expenditures (b)

 

$

2,297

 

 

$

1,840

 

 

$

1,586

 

 

$

1,784

 

 

$

1,806

 

 

 

Employees -- Annual Averages

 

31,344

 

 

30,066

 

 

30,202

 

 

33,348

 

 

33,977

 

 

 

Competition

CSX primarily competes with Norfolk Southern amongst the other regional and local railroads and motor carriers. Barges, ships and pipelines compete to a lesser extent. One major competitive advantage that trucking and water transport have over rails is that they utilize public rights-of-way that are built and maintained by governmental entities while CSX and other railroads must build and maintain rail networks largely using internal resources.

 

Management

Management is clearly focused on operational improvement and shareholder return. In their presentation they highlight improvements in operating income, operating margin, and earnings per share, and how these improvements since 2006 stack up against the rest of the S&P 500 (top 26%, 13% and 16%, respectively). I have never seen this type of comparison made; clearly management is focused on the company’s financial performance and is proud of the improvements they have made. Rather than simply discussing the share price, however, I like how they show that the underlying financial performance has been really good (and the implication is that shareholder return will eventually follow).

 

Ambitious 2015 targets

On May 18th of last year at its analyst day the company announced the following ambitious 2015 financial targets:

Operating ratio of 65%

Operating income of $5.5-6.0B (12-14% CAGR from 2010)

EPS of $3.09-3.36 (18-20% CAGR from 2010)

 

In 2011 the Operating ratio improved 20bps to 70.9%, Operating income grew +11% to $3.4B and EPS grew +24% to $1.67. So the operating ratio improvement is below the pace required, operating income is about on track, and EPS growth is better that expected. The targets are certainly ambitious but the company has said that despite the headwind that the large decline in utility coal shipments has created, they are still on track to reach these goals, although it will clearly be a lot more difficult than they expected when they set them one year ago.

 

Committed to stock buyback

In 2011, CSX repurchased a total of $1.56 billion of common stock, which includes $1.3 billion from the new share repurchase program announced in May 2011. As of December 30, 2011, the Company had remaining authority of $734 million under this new $2 billion program. CSX did not repurchase any shares in 4Q11. CSX expects to complete the remaining repurchase amount by the end of 2012. Since year end, the Company has completed $178 million of additional share repurchases through a trade date of February 15, 2012.

Shares repurchased by year:

2011: 67mm shares @ $23.20

2010: 80mm shares @ $18.14

2009: 0 shares

2008: 86mm shares @ $18.37

2007: 153mm shares @ $14.23

Cumulative L5Y: 386mm shares @ $17.50 for $6.8B or about 29% of shares outstanding at the beginning of the period. This compares to FCF of $5.15B (using CSX’s definition, which includes property dispositions which  have been significant in the last 3 years); so CSX has spent 131% of the last 5 years’s FCF buying back stock, a difference of $1.6B. But because operating income has grown so much over that period, leverage, as measured by Debt/EBITDA, has not increased. Perhaps more importantly, because interest rates have decreased, fixed charge coverage (EBIT/Interest expense) has increased from 5.03x in 2006 to 6.19x in 2011. CSX’s $9B of debt is comprised of more than 30 issues of bonds, 100% fixed, with a weighted average interest rate of 6.1% and a weighted average maturity of 14.5 years. They have $1.9B maturing over the next 3 years, which, if interest rates and their credit spread stays where they are today, would lower their average interest rate by 40bps. This will only increase EPS by about 2c, but it demonstrates the company’s increasing financial flexibility, even with significant debt.

 

With regard to 2012 guidance, the CFO recently said that even if utility coal volume continues to be down 25-30% YoY, CSX will still have a record year for earnings. Consensus EPS is $1.81 and 2011 EPS was $1.67.

 

Why is the stock mispriced?

I think there are two reasons the stock is trading at its current price, which is below fair value, in my opinion, both relative to the other railroads and on an absolute basis:

1)      Coal

There is a lot of concern around declining domestic coal shipping, and CSX has the highest exposure among the rails, possibly explaining why it is the cheapest stock among its peers (based on FCF Yield; NSC is cheaper based on EPS). One relevant point the CFO mentioned in his 3/15/12 conference presentation is that CSX carload volume declined by 882,000 from 2006 to 2011 and utility coal accounted for 530,000 of that decline—a -36% decrease—and yet operating profit increased +74% over that time frame. Coal powers about 39% of the country’s electricity today and the EIA expects the percentage to be comparable in 2035 but in absolute terms consumption will increase since our electricity production will increase over that period. So domestic coal shipping is not falling to zero any time soon, and in the meantime export coal will be flat in 2012 at 40mm tons, which was up 33% from 2010, mitigating the overall decline in coal revenues. YTD exports are up +5% so the forecast of flat volumes looks conservative thus far. There is also a positive mix shift here as export coal yields higher revenue per unit than domestic utility coal, so revenue will not fall as fast as total coal volumes. Export coal should have healthy demand for years to come due to rapid emerging markets growth and lower environmental standards.

From the 10-K:

Rapid economic growth in developing countries such as India, China and Brazil has generated a long term growth cycle in export coal demand. As a result of the increase in global steel production, demand for U.S. coal is expected to remain strong. Demand for coal used in electric power generation is also expected to remain high due to rising consumption as developing countries become more urbanized. These increases in global coal demand are expected to largely be met by export shipments with a considerable portion originating from the U.S. The Company is well-positioned to capitalize on this market growth through its network access to large U.S. coal suppliers and multiple port facilities.

 

Coal revenues as % of total in 2011:

CSX 32%, NSC 31%, BNSF 27%, UNP 22%

But the more important number is probably domestic utility coal revenues as a percentage of total revenues, because that is where the real weakness is, and for CSX based on the CFO’s recent remark that shipments are about 10% of volumes, that number is probably less than 15% on a run-rate basis. While 15% is not insignificant, weakness in that amount of the company’s business does not warrant a such a large discount as will be discussed later in the valuation section, particularly since every rail is experiencing some weakness, although not necessarily to the extent that CSX is.

 

2)      CSX has long had a reputation for being poorly managed

Based on current financial metrics this is simply no longer the case. Other service and operating measures might still lag but the financial metrics are what should matter most to investors and if CSX can translate subpar service and operating metrics into average to better than average financial metrics perhaps this indicates room for additional upside. Service measures such as on-time originations and arrivals have improved dramatically over the past four quarters to record levels for the company in 1Q12.

Operating Margin: Between 2000 and 2009 CSX’s operating margin averaged 5.2% below that of NSC. In the 1990s the gap was even wider, 9.2%. But since the beginning of 2010 CSX’s margin has averaged almost 1% higher than NSC’s. Similarly, CSX averaged an operating margin 3.5% below that of UNP in the 1990s. The gap widened to 6.5% from 2001-2004. But since 2005 CSX has actually averaged a 2% higher margin, although today they are about even. BNI had a similar advantage over CSX in the 1990s with a 5% advantage; the advantage increased in the early 2000s, averaging 6.7% until 2007. But since 2008 CSX has had the advantage by 2.2%.

Return on Invested Capital is another way to measure management quality within an industry. Since the current CEO assumed his post in January 2003, ROIC as Bloomberg defines it has improved from about 5% to about 12%. During those 8 years the average annual ROIC has been about 9.9%. Cost of capital is about 8.7% as I calculate it, so CSX has been earning far above its cost of capital in the last two years and should again in 2012, and has added value for the past 7 years. During the same 8 years UNP’s average ROIC has been 9.4%, NSC’s 10.5%, and BNI’s 10.7% (2004-2009). So CSX is middle of the pack on ROIC and leading on operating margin. Based on these financial metrics it doesn’t seem accurate to call CSX the worst managed railroad and to give it a large discount to its peers (all Class I railroads except NSC).

In terms of shareholder friendliness as measured by stock buyback, CSX has purchased $6.8B over the last 5 years (29% of S/O in January 2007) compared to $5.7B for UNP (15%) and $5.2B for NSC (22%). Dividend yield for NSC is 2.7% and 2.1% for UNP vs. 2.2% for CSX. So CSX appears to be returning more cash to shareholders than its two largest peers.

 

Finally, I think railroads have historically been viewed as regulated monopolies, like utilities, which seems to be only partially right. Here is Morningstar’s description of the industry:

“Heavy freight-hauling assets owned by North American railroads like CSX are practically impossible to reproduce. The costs and challenges of obtaining rights-of-way and building track erect a nearly insurmountable barrier to entry. Despite this powerful competitive advantage, railroads historically have failed to earn returns on investment greater than their cost of capital, due to heavy track reinvestment expenditures, government-mandated safety programs, some rate regulation, and competition from trucks in some commodities.”

While low ROICs were the norm in certain historical periods, (e.g. 1998-2004) this has not been the case in recent years as railroads have been able to increase prices above inflation. Morningstar also describes how powerful the moat is that railroads have established; and one benefit of their system is that the competitive advantage relative to trucking increases if the price of oil continues to rise. High CapEx is no doubt a permanent feature of railroad operations; but in spite of this the businesses have also produced significant free cash flow in recent years. CSX has averaged $1B over the last 5 years. Generally companies with nearly insurmountable barriers to entry and few substitutes that are growing EBIT at 12-14% per year do not trade at 6% FCF yields (CSX definition includes property dispositions which have been significant in the last 3 years), but that is where the stock trades if you believe their 2015 targets are achievable.

 

Valuation

L10Y TTM P/E Analysis

 

CSX

Mean: 16.3x

Low: 5.9x

High: 24.7x

Current: 13.2x

 

Relative to the S&P 500

Mean: 0.95x

Low: 0.54x

High: 1.32x

Current: 0.905x

 

Relative to UNP

Mean: 0.95x

Low: 0.59x

High: 1.5x

Current: 0.78x

 

Relative to NSC

Mean: 1.05x

Low: 0.63x

High: 1.5x

Current: 1.07x

 

BNI purchase by Berkshire Hathaway on 11/3/09:

19x TTM P/E

 

CSX is also trading at least 1 standard deviation below its historical average relative P/E to less comparable Class I railroads CP, CNI, and KSU.

 

Return forecasts and estimated probabilities:

Base case: $29, p=60%. Industrial production growth 1% + inflation 4% + pricing 1% = 6% growth.

Upside: $36, p=20%. IP growth 1.5% + inflation 3.5% + pricing 2% = 7% growth.

Downside: $19, p=20%. IP growth 1% + inflation 3% + no pricing = 4% growth, PTC cost $1.5B in present value.

Expected Value = $28, +28%

Base / Downside:  2 / 1

Upside / Downside: 4 / 1

 

 

Risks

  • Increasing cost of PTC— In 2008, Congress enacted the Rail Safety Improvement Act (the “RSIA”).  The legislation includes a mandate that all Class I freight railroads implement a positive train control system (“PTC”) by December 31, 2015.  The Association of American Railroads recently advised the Federal Railroad Administration on behalf of the industry that a nationwide interoperable PTC network cannot be completed by the December 31, 2015 deadline. Federal legislation introduced in both the House of Representatives and the Senate would, if approved, delay the final implementation of PTC from three to five years. CSX previously estimated that the total multi-year cost of PTC implementation would be at least $1.2 billion for the Company. This estimate is currently being re-evaluated due to upward pressure on these costs.
  • Legislation that limits fuel surcharges or price increases above inflation—fuel surcharges were first implemented in the early 2000s and have continued since that time which largely protects railroads from increasing locomotive diesel fuel prices. There have been various lawsuits filed against railroads alleging that fuel surcharges are illegal but thus far none have resulted in material fines or findings for plaintiffs. Prior to 2000 rail stock price movements correlated negatively (-0.4) with oil prices; between 2000-2006 the correlation was positive 0.9. If fuel surcharges were eliminated or minimized this would be extremely detrimental to CSX’s value.
  • Worse than expected utility coal volume declines—in the near term, 1-2 years, this would weaken the investment case for CSX as earnings would barely grow. Over the longer term, 3-5 years, as utility coal would shrink to an immaterial percentage of the business, this would not impact the value proposition.

Catalyst

  • Rising gas prices—because railroads use less fuel per mile of transported goods, rising fuel costs hurt them less than trucking companies.
  • New stock buyback authority—3 of the past 4 years CSX has bought back about $1.5-1.6B in stock and as of 2/15/12 it only has $556mm remaining on its current authority. A large new authority would indicate continued commitment to share repurchases and confidence in the company’s 2012 performance.
  • Legislation limiting or slowing natural gas fracking—this could increase the price of natural gas and limit further switching by utilities, thus stabilizing or driving up utility coal demand.
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    Description

    I am recommending a long position in the common stock of CSX Corp (CSX). I wrote most of this report prior to last Thursday and Friday’s +10% increase in CSX stock price off its low on Wednesday. I still think the stock is attractive here and based on the JPM conference presentation there should be increased confidence in CSX’s 2012 performance and therefore possibly lower downside in the stock. On the other hand we’ve missed that +10% move and the upside over any time period is thus reduced by that amount.

    The only long railroad recommendations I can find on VIC are UNP from 2004 (+322%), reiterated in 2010 (+69%), and BNI from 2001 (+293%) and 2007 (+23%). Otherwise there is a short CP recommendation from 2011 with some good Q&A around railroad valuations and Capex vs. depreciation, revenue adequacy, and the probability of future regulation that will possibly hurt railroad profitability. The 2007 BNI writeup has some good background on the railroad industry as well. I mention this because the railroads are very solid businesses with seemingly permanent cost advantages relative to trucking, which is an industry perhaps 8-9x the size in terms of total revenues. Yet the high capital expenditures required to maintain the business likely turns off many investors. Still railroads produce a lot of FCF and CSX in particular appears to be undervalued as I discuss further below.

     

    Investment Highlights

    Wide moat from network effects, barriers to entry, economies of scale, and efficient scale—assets are impossible to replicate, costs are low relative to the major alternative, trucking.

    Oligopoly with rational actors in combination with competitive advantages leads to significant pricing power—pricing has increased at a 6% CAGR since 2001.

    Well run business that has improved dramatically over the past decade—operating margin has increased from 18% in 2002 to 29% in 2011.

    High incremental operating margin—due to both operating leverage and pricing power incremental operating margins are generally above 40%. Yet CSX demonstrated a much more flexible cost structure than expected when revenue fell -20% in 2009 while operating income only dropped -17.5%.

    Shareholder friendly management—bought $1.56B of stock in 2011 or about 6% of shares outstanding and cumulatively $6.8B and 29% of S/O over the last 5 years. Transparent and ambitious financial targets for 2015. Frequent communication with analysts. Clearly focused on shareholder returns.

    Financially flexible—Net Debt/EBITDA of 2.1x including underfunded Pension and OPEB plans and capitalized operating leases; recently issued 30-year bonds at 4.4%.

    Valuation is low relative to its history, the S&P 500, and UNP—19% below its L10Y mean P/E, 5% below its mean relative P/E to the S&P, and 18% below its mean relative to UNP. On an absolute basis the stock trades at a 5% FCF Yield (CFFO-CapEx), compared to a median of 2.9% from 2001-2005 and 4.6% from 2007-present. Dividend Yield is 2.2%.

     

    Company History

    The Company’s heritage dates back to the early nineteenth century when The Baltimore and Ohio Railroad Company (“B&O”) – the nation’s first common carrier – was chartered in 1827. Since its founding, numerous railroads have combined with the former B&O through merger and consolidation to create what has become CSX.  Each of the railroads that combined into the CSX family brought new geographical reach to valuable markets, gateways, cities, ports and transportation corridors. CSX was incorporated in 1978 under Virginia law. In 1980, the Company completed the merger of the Chessie System and Seaboard Coast Line Industries into CSX.  The merger allowed the Company to connect northern population centers and Appalachian coal fields to growing southeastern markets.  Later, the Company’s acquisition of key portions of Conrail, Inc. allowed CSX to link the northeast, including New England and the New York metropolitan area, with Chicago and midwestern markets as well as the growing areas in the southeast already served by CSX.  This current rail network allows the Company to directly serve every major market in the eastern United States with safe, dependable, environmentally responsible and fuel efficient freight transportation and intermodal service.

     

    Business Description

    CSX provides rail-based freight transportation services including traditional rail service and the transport of intermodal containers and trailers. CSX serves major population centers in 23 states east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec.  It has access to over 70 ocean, river and lake port terminals along the Atlantic and Gulf Coasts, the Mississippi River, the Great Lakes and the St. Lawrence Seaway.  The Company’s intermodal business links customers to railroads via trucks and terminals. CSX also serves thousands of production and distribution facilities through track connections to approximately 240 short-line and regional railroads.

    Assets: 21,000 route miles (37,000 total track miles); CSX operates 4,116 locomotives, of which over 95% are owned by CSX, average age 20 years. In 2011, the average daily fleet of cars on line consisted of approximately 206,000; CSX owns 95,422 railcars.

    CSX is one of two Class I (>$399mm in revenues) railroads with a network that covers the U.S. east of the Mississippi river, Norfolk Southern being the other. The biggest difference between their two footprints is that CSX’s tracks extend into Florida while NSC’s do not.

    The U.S. demand to move more goods by rail is expected to rise along with the need to reduce highway congestion and greenhouse gas emissions. CSX and freight railroads are the best way to meet this demand while reducing environmental impacts. CSX can move a ton of freight almost 500 miles on one gallon of fuel and, on average, over three times more fuel efficiently than trucks.

    CSX's network is positioned to reach nearly two-thirds of Americans, who account for the majority of the nation's consumption of goods. Through this network, the Company transports a diverse portfolio of products and commodities to meet the country's needs. These products range from energy sources like coal and ethanol, to automobiles, chemicals, building materials, paper, metals, grains and consumer products. The Company categorizes these products into three primary lines of business: merchandise, coal and intermodal.


    Merchandise business—shipped 2.65 million carloads and generated approximately 54% of revenue and 41% of volume in 2011. The Company’s merchandise business is the most diverse market and transports aggregates, metal, phosphate, fertilizer, food, consumer (manufactured goods and appliances), agricultural, automotive, paper and chemical products.

    Coal business--shipped 1.53 million carloads and accounted for nearly 32% of revenue and 24% of volume in 2011.  0.95 million of these carloads (62%) were to about 90 domestic utilities, about 24% of the carloads were exports, and the remainder (14%) shipped to industrial and steel plants. The Company transports utility, industrial and export coal to electricity-generating power plants, steel manufacturers, industrial plants and deep-water port facilities.  In 2011 37% of export coal (will be closer to 50/50 in 2012) and nearly all of the domestic coal that the Company transports is used for generating electricity. Export met coal contracts typically last 1 year; export thermal coal 1-2 years; export tariff rates are reset quarterly; and domestic coal contracts last 3-5 years.

    Intermodal business—shipped 2.29 million carloads accounting for approximately 12% of revenue and 35% of volume in 2011. The intermodal line of business combines the superior economics of rail transportation with the short-haul flexibility of trucks and offers a competitive cost advantage over long-haul trucking.  Through a network of more than 50 terminals, the intermodal business serves all major markets east of the Mississippi and transports mainly manufactured consumer goods in containers, providing customers with truck-like service for longer shipments.

     

     

                                                 

     

     

     

     

    Fiscal Years

    (Dollars and Shares in Millions, Except Per Share Amounts)

     

    2011

     

    2010

     

    2009

     

    2008

     

    2007

    Financial Performance

     

     

     

     

     

     

     

     

     

     

     

     

    Revenue

     

    $

    11,743

     

     

    $

    10,636

     

     

    $

    9,041

     

     

    $

    11,255

     

     

    $

    10,030

     

     

     

    Expense

     

    8,325

     

     

    7,565

     

     

    6,771

     

     

    8,504

     

     

    7,784

     

     

     

    Operating Income

     

    $

    3,418

     

     

    $

    3,071

     

     

    $

    2,270

     

     

    $

    2,751

     

     

    $

    2,246

     

    Net Earnings from Continuing Operations

     

    $

    1,822

     

     

    $

    1,563

     

     

    $

    1,128

     

     

    $

    1,485

     

     

    $

    1,227

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Operating Ratio

     

    70.9

    %

     

    71.1

    %

     

    74.9

    %

     

    75.6

    %

     

    77.6

    %

     

     

     

     

     

     

     

     

     

     

     

     

     

    Earnings Per Share: (a)

     

     

     

     

     

     

     

     

     

     

     

     

    From Continuing Operations, Basic

     

    $

    1.68

     

     

    $

    1.37

     

     

    $

    0.96

     

     

    $

    1.23

     

     

    $

    0.95

     

     

     

    From Continuing Operations, Assuming Dilution

     

    1.67

     

     

    1.35

     

     

    0.95

     

     

    1.21

     

     

    0.91

     

     

     

    Average Common Shares Outstanding

     

    1,083

     

     

    1,143

     

     

    1,176

     

     

    1,204

     

     

    1,293

     

     

     

    Average Common Shares Outstanding, Assuming Dilution

     

    1,089

     

     

    1,154

     

     

    1,187

     

     

    1,228

     

     

    1,347

     

    Financial Position

     

     

     

     

     

     

     

     

     

     

     

     

    Cash, Cash Equivalents and Short-term Investments

     

    $

    1,306

     

     

    $

    1,346

     

     

    $

    1,090

     

     

    $

    745

     

     

    $

    714

     

     

     

    Total Assets

     

    29,473

     

     

    28,141

     

     

    26,887

     

     

    26,154

     

     

    25,417

     

     

     

    Long-term Debt

     

    8,734

     

     

    8,051

     

     

    7,895

     

     

    7,512

     

     

    6,470

     

     

     

    Shareholders' Equity

     

    8,468

     

     

    8,700

     

     

    8,768

     

     

    7,985

     

     

    8,612

     

     

     

    Dividend Per Share (a)

     

    $

    0.45

     

     

    $

    0.33

     

     

    $

    0.29

     

     

    $

    0.26

     

     

    $

    0.18

     

    Additional Data

     

     

     

     

     

     

     

     

     

     

     

     

    Capital Expenditures (b)

     

    $

    2,297

     

     

    $

    1,840

     

     

    $

    1,586

     

     

    $

    1,784

     

     

    $

    1,806

     

     

     

    Employees -- Annual Averages

     

    31,344

     

     

    30,066

     

     

    30,202

     

     

    33,348

     

     

    33,977

     

     

     

    Competition

    CSX primarily competes with Norfolk Southern amongst the other regional and local railroads and motor carriers. Barges, ships and pipelines compete to a lesser extent. One major competitive advantage that trucking and water transport have over rails is that they utilize public rights-of-way that are built and maintained by governmental entities while CSX and other railroads must build and maintain rail networks largely using internal resources.

     

    Management

    Management is clearly focused on operational improvement and shareholder return. In their presentation they highlight improvements in operating income, operating margin, and earnings per share, and how these improvements since 2006 stack up against the rest of the S&P 500 (top 26%, 13% and 16%, respectively). I have never seen this type of comparison made; clearly management is focused on the company’s financial performance and is proud of the improvements they have made. Rather than simply discussing the share price, however, I like how they show that the underlying financial performance has been really good (and the implication is that shareholder return will eventually follow).

     

    Ambitious 2015 targets

    On May 18th of last year at its analyst day the company announced the following ambitious 2015 financial targets:

    Operating ratio of 65%

    Operating income of $5.5-6.0B (12-14% CAGR from 2010)

    EPS of $3.09-3.36 (18-20% CAGR from 2010)

     

    In 2011 the Operating ratio improved 20bps to 70.9%, Operating income grew +11% to $3.4B and EPS grew +24% to $1.67. So the operating ratio improvement is below the pace required, operating income is about on track, and EPS growth is better that expected. The targets are certainly ambitious but the company has said that despite the headwind that the large decline in utility coal shipments has created, they are still on track to reach these goals, although it will clearly be a lot more difficult than they expected when they set them one year ago.

     

    Committed to stock buyback

    In 2011, CSX repurchased a total of $1.56 billion of common stock, which includes $1.3 billion from the new share repurchase program announced in May 2011. As of December 30, 2011, the Company had remaining authority of $734 million under this new $2 billion program. CSX did not repurchase any shares in 4Q11. CSX expects to complete the remaining repurchase amount by the end of 2012. Since year end, the Company has completed $178 million of additional share repurchases through a trade date of February 15, 2012.

    Shares repurchased by year:

    2011: 67mm shares @ $23.20

    2010: 80mm shares @ $18.14

    2009: 0 shares

    2008: 86mm shares @ $18.37

    2007: 153mm shares @ $14.23

    Cumulative L5Y: 386mm shares @ $17.50 for $6.8B or about 29% of shares outstanding at the beginning of the period. This compares to FCF of $5.15B (using CSX’s definition, which includes property dispositions which  have been significant in the last 3 years); so CSX has spent 131% of the last 5 years’s FCF buying back stock, a difference of $1.6B. But because operating income has grown so much over that period, leverage, as measured by Debt/EBITDA, has not increased. Perhaps more importantly, because interest rates have decreased, fixed charge coverage (EBIT/Interest expense) has increased from 5.03x in 2006 to 6.19x in 2011. CSX’s $9B of debt is comprised of more than 30 issues of bonds, 100% fixed, with a weighted average interest rate of 6.1% and a weighted average maturity of 14.5 years. They have $1.9B maturing over the next 3 years, which, if interest rates and their credit spread stays where they are today, would lower their average interest rate by 40bps. This will only increase EPS by about 2c, but it demonstrates the company’s increasing financial flexibility, even with significant debt.

     

    With regard to 2012 guidance, the CFO recently said that even if utility coal volume continues to be down 25-30% YoY, CSX will still have a record year for earnings. Consensus EPS is $1.81 and 2011 EPS was $1.67.

     

    Why is the stock mispriced?

    I think there are two reasons the stock is trading at its current price, which is below fair value, in my opinion, both relative to the other railroads and on an absolute basis:

    1)      Coal

    There is a lot of concern around declining domestic coal shipping, and CSX has the highest exposure among the rails, possibly explaining why it is the cheapest stock among its peers (based on FCF Yield; NSC is cheaper based on EPS). One relevant point the CFO mentioned in his 3/15/12 conference presentation is that CSX carload volume declined by 882,000 from 2006 to 2011 and utility coal accounted for 530,000 of that decline—a -36% decrease—and yet operating profit increased +74% over that time frame. Coal powers about 39% of the country’s electricity today and the EIA expects the percentage to be comparable in 2035 but in absolute terms consumption will increase since our electricity production will increase over that period. So domestic coal shipping is not falling to zero any time soon, and in the meantime export coal will be flat in 2012 at 40mm tons, which was up 33% from 2010, mitigating the overall decline in coal revenues. YTD exports are up +5% so the forecast of flat volumes looks conservative thus far. There is also a positive mix shift here as export coal yields higher revenue per unit than domestic utility coal, so revenue will not fall as fast as total coal volumes. Export coal should have healthy demand for years to come due to rapid emerging markets growth and lower environmental standards.

    From the 10-K:

    Rapid economic growth in developing countries such as India, China and Brazil has generated a long term growth cycle in export coal demand. As a result of the increase in global steel production, demand for U.S. coal is expected to remain strong. Demand for coal used in electric power generation is also expected to remain high due to rising consumption as developing countries become more urbanized. These increases in global coal demand are expected to largely be met by export shipments with a considerable portion originating from the U.S. The Company is well-positioned to capitalize on this market growth through its network access to large U.S. coal suppliers and multiple port facilities.

     

    Coal revenues as % of total in 2011:

    CSX 32%, NSC 31%, BNSF 27%, UNP 22%

    But the more important number is probably domestic utility coal revenues as a percentage of total revenues, because that is where the real weakness is, and for CSX based on the CFO’s recent remark that shipments are about 10% of volumes, that number is probably less than 15% on a run-rate basis. While 15% is not insignificant, weakness in that amount of the company’s business does not warrant a such a large discount as will be discussed later in the valuation section, particularly since every rail is experiencing some weakness, although not necessarily to the extent that CSX is.

     

    2)      CSX has long had a reputation for being poorly managed

    Based on current financial metrics this is simply no longer the case. Other service and operating measures might still lag but the financial metrics are what should matter most to investors and if CSX can translate subpar service and operating metrics into average to better than average financial metrics perhaps this indicates room for additional upside. Service measures such as on-time originations and arrivals have improved dramatically over the past four quarters to record levels for the company in 1Q12.

    Operating Margin: Between 2000 and 2009 CSX’s operating margin averaged 5.2% below that of NSC. In the 1990s the gap was even wider, 9.2%. But since the beginning of 2010 CSX’s margin has averaged almost 1% higher than NSC’s. Similarly, CSX averaged an operating margin 3.5% below that of UNP in the 1990s. The gap widened to 6.5% from 2001-2004. But since 2005 CSX has actually averaged a 2% higher margin, although today they are about even. BNI had a similar advantage over CSX in the 1990s with a 5% advantage; the advantage increased in the early 2000s, averaging 6.7% until 2007. But since 2008 CSX has had the advantage by 2.2%.

    Return on Invested Capital is another way to measure management quality within an industry. Since the current CEO assumed his post in January 2003, ROIC as Bloomberg defines it has improved from about 5% to about 12%. During those 8 years the average annual ROIC has been about 9.9%. Cost of capital is about 8.7% as I calculate it, so CSX has been earning far above its cost of capital in the last two years and should again in 2012, and has added value for the past 7 years. During the same 8 years UNP’s average ROIC has been 9.4%, NSC’s 10.5%, and BNI’s 10.7% (2004-2009). So CSX is middle of the pack on ROIC and leading on operating margin. Based on these financial metrics it doesn’t seem accurate to call CSX the worst managed railroad and to give it a large discount to its peers (all Class I railroads except NSC).

    In terms of shareholder friendliness as measured by stock buyback, CSX has purchased $6.8B over the last 5 years (29% of S/O in January 2007) compared to $5.7B for UNP (15%) and $5.2B for NSC (22%). Dividend yield for NSC is 2.7% and 2.1% for UNP vs. 2.2% for CSX. So CSX appears to be returning more cash to shareholders than its two largest peers.

     

    Finally, I think railroads have historically been viewed as regulated monopolies, like utilities, which seems to be only partially right. Here is Morningstar’s description of the industry:

    “Heavy freight-hauling assets owned by North American railroads like CSX are practically impossible to reproduce. The costs and challenges of obtaining rights-of-way and building track erect a nearly insurmountable barrier to entry. Despite this powerful competitive advantage, railroads historically have failed to earn returns on investment greater than their cost of capital, due to heavy track reinvestment expenditures, government-mandated safety programs, some rate regulation, and competition from trucks in some commodities.”

    While low ROICs were the norm in certain historical periods, (e.g. 1998-2004) this has not been the case in recent years as railroads have been able to increase prices above inflation. Morningstar also describes how powerful the moat is that railroads have established; and one benefit of their system is that the competitive advantage relative to trucking increases if the price of oil continues to rise. High CapEx is no doubt a permanent feature of railroad operations; but in spite of this the businesses have also produced significant free cash flow in recent years. CSX has averaged $1B over the last 5 years. Generally companies with nearly insurmountable barriers to entry and few substitutes that are growing EBIT at 12-14% per year do not trade at 6% FCF yields (CSX definition includes property dispositions which have been significant in the last 3 years), but that is where the stock trades if you believe their 2015 targets are achievable.

     

    Valuation

    L10Y TTM P/E Analysis

     

    CSX

    Mean: 16.3x

    Low: 5.9x

    High: 24.7x

    Current: 13.2x

     

    Relative to the S&P 500

    Mean: 0.95x

    Low: 0.54x

    High: 1.32x

    Current: 0.905x

     

    Relative to UNP

    Mean: 0.95x

    Low: 0.59x

    High: 1.5x

    Current: 0.78x

     

    Relative to NSC

    Mean: 1.05x

    Low: 0.63x

    High: 1.5x

    Current: 1.07x

     

    BNI purchase by Berkshire Hathaway on 11/3/09:

    19x TTM P/E

     

    CSX is also trading at least 1 standard deviation below its historical average relative P/E to less comparable Class I railroads CP, CNI, and KSU.

     

    Return forecasts and estimated probabilities:

    Base case: $29, p=60%. Industrial production growth 1% + inflation 4% + pricing 1% = 6% growth.

    Upside: $36, p=20%. IP growth 1.5% + inflation 3.5% + pricing 2% = 7% growth.

    Downside: $19, p=20%. IP growth 1% + inflation 3% + no pricing = 4% growth, PTC cost $1.5B in present value.

    Expected Value = $28, +28%

    Base / Downside:  2 / 1

    Upside / Downside: 4 / 1

     

     

    Risks

    Catalyst

    • Rising gas prices—because railroads use less fuel per mile of transported goods, rising fuel costs hurt them less than trucking companies.
    • New stock buyback authority—3 of the past 4 years CSX has bought back about $1.5-1.6B in stock and as of 2/15/12 it only has $556mm remaining on its current authority. A large new authority would indicate continued commitment to share repurchases and confidence in the company’s 2012 performance.
    • Legislation limiting or slowing natural gas fracking—this could increase the price of natural gas and limit further switching by utilities, thus stabilizing or driving up utility coal demand.

    Messages


    Subjectprb
    Entry03/20/2012 07:33 AM
    Memberheffer504
    i'm not a coal guy, but this dynamic seems wrong to me.  my understanding is the following: app coal is the highest energy, lowest sulfur.  prb coal is the lowest energy.  the price of prb coal is set so that the energy cost, including transportation, is equivalent to app.  as international coal demand increased, the coal that made sense to export is central app, as it is closest to ports and has higher energy content/volume.  if this demand decreases, then utilities will still buy all the central app they can get (at lower prices albeit) and cut down on the prb.  in fact, since utilities have all installed scrubbers to comply with clean air rules, they will likely shift more and more to midwest coal, which is high energy/high sulfur, and prb will get hurt as a result.
     
    no opinion on the rails though
     

    Subjectmy response
    Entry03/21/2012 11:44 PM
    Membersfdoj

    Great discussion, thank you to all who have written. Biffins, no need to apologize for disagreeing, I am sure it is educational for everyone here to hear your POV.

    A recent Credit Suisse report summarized this debate nicely, I think:

     

    Not surprisingly, there are two distinct views here:

    1. The Bears say… It’s game-over for the rails. Warm weather is just accelerating what is a long-term secular decline in one of the most profitable commodities moved by the rails. Cheap natural gas and pending EPA regulations will continue to squeeze coal volumes and neuter rail earnings growth.

    2. The Bulls say… Yes, recent coal volumes have been a disaster; and it may not get much better, given low natural gas prices and eventual EPA regulation changes. But even if we assume that coal volumes stay this weak all year, the stocks have been duly punished and the risk/reward profile again looks pretty

    compelling for the railroads. What’s more, other categories – such as automotive and metals – have been stronger than expected, and the rails still have solid pricing growth, which should allow for earnings growth even in the face of a sharp decline in coal. We find ourselves in this camp.

     

    I’d like to frame the discussion around what we can agree on and what we disagree on.

    Can we agree that:

    1)      Merchandise, Intermodal, and Other segments are growing nicely and should continue to have pricing power.

    2)      At current levels of profitability CSX is producing well over $1B of FCF per year and devotes it entirely to dividend and share repurchases.

     

    We disagree that:

    1)      Utility coal accounts for 50% of CSX EBIT—actually I don’t know the answer to this question but I’d like to see the analysis.

    2)      Utility coal volume will be "decmiated" (I'm not sure what that means so maybe we do agree . . .)

    3)      Export coal will not grow in volume or RPU

     

    I want to reiterate that the crux of the discussion is around utility coal, which is about 15% of CSX’s revenue. There is no doubt this is profitable business. I am still trying to get my hands on the Bernstein report. There is some disagreement on how profitable coal is. Some analysts estimate up to 40% of earnings. Apparently Bernstein says up to 50%. Credit Suisse believes incremental margins on coal are 65% versus 40% on everything else; and looking at incremental margins is the right way to calculate EBIT variability since no business is going to zero any time soon. Regarding the rest of their business, to answer gocanucks, between 2003 and 2011 RPU on Merchandise rose +7.5% per year. CSX has had and should continue to have very strong pricing power, particularly as oil prices continue to rise.

     

    Utility coal: The analyses I have read say the opposite of what Biffins says regarding the prevalence of CCGT plants in the East and their ability to switch from coal to natural gas. The last time natural gas prices fell this low, in 2009, you had about 40mm tons of coal demand disappear due to switching, out of a total of about 1 billion tons of consumption in the US per year. CSX is of course exposed to the high cost Appalachian coal (about 84% of their volume), and Appalachian coal production will certainly continue to fall, as it has generally over the past fifteen years. Biffins, if you have a detailed utility by utility analysis of how much switching is possible and how much you expect to occur I would love to see it. I don’t have this level of detail but the forecasts I have seen from the EIA and other analysts show a continued gradual decline in Appalachian coal, not a “decimation”. But clearly investors are worried due to the YTD performance, down 25-30%. I think the confluence of low gas prices and a historically warm winter is the culprit, so it is probably incorrect to extrapolate from the YTD performance. And I don’t think you need to make the argument that “coal will be back” in order to make this investment work. You just have to believe that utility coal volumes won’t decline 25% per year until they hit zero, and that while they are declining, everything else will perform as they have over the past decade. I agree with Nails and Rookie that CSX will not realize the 12% CAGR in RPU in coal that they have over the last 8 years. I don’t think they are selling export coal “at any price”. They reduced the tariff on one quarter of their export coal and expect export volumes to be stable this year. That doesn’t sound like a fire sale to me. If Biffins or anyone else has forecasts for utility and export coal volumes and RPUs I’d be curious to see them. I think rather than just saying that you expect them to be decimated it is important to quantify your expectations and then run the in the model to see what EBIT and earnings will be. I give one example further below. Although 1Q12 will be a terrible quarter for coal, and far worse than 4Q11 was, I will point out that 4Q11 total coal volume fell -8%, consistent with the annual decline over the past 8 years, and RPU grew +16%, somewhat better than trend, for a +6% increase in revenues.

     

    Export coal: Consider the following information: in 2011 CSX exported about 40mm tons of coal, the mix being 37/63 thermal/met. In 2012 the mix will be closer to 50/50. So CSX found buyers for an incremental 5mm tons of thermal coal, approximately. Met coal is priced higher than thermal so there will be a negative mix shift in 2012. But in my mind the more important factor is that there are plenty of buyers for CSX’s coal internationally. I don’t know the details on China’s Mongolia imports but I don’t think that is really key to CSX exports. The big 5 coal importers are Japan, China, South Korea, India and Taiwan; if CSX’s exports to China are proportional to China’s total imports relative to its neighbors, CSX exports to China might be about 6% of its total coal exports based on the following numbers: 2011 total US coal exports by destination were Europe 47%, Asia 22%, North America 16%, South America 12%, Africa 3%. According to Jefferies CSX ships about 50% to Europe, 30% to South America and 20% to Asia. The fact that CSX found incremental buyers for 13% of their export coal and volumes remained flat is an indication that export might not be doomed even if Chinese steel production only grows 4%/year for the foreseeable future and they begin importing a lot from Mongolia. If China is in fact only 6% of CSX’s coal exports then what happens there doesn’t worry me too much. As Nails pointed out, exports are a complicated thing to forecast with many moving pieces and I don’t think it is easy to make a call on this one. From 2006-2011 coal volume other than domestic utility increased at a 7.2% CAGR. I’m assuming a 1.2% CAGR from 2012-2016 in my downside scenario below. Most forecasts I have seen have US export coal growing, some at double digit CAGRs over the next 5 years. I actually think that coal exports will increase in the coming years due to growth in Brazil and India and also China, but you do not need to buy into a continued surge in exports or in RPU for this investment to work.

     

    Using the following assumptions, which I view an unlikely scenario but probably a worst case scenario for coal:

    Volume / RPU / Revenue CAGRs through 2016:

    Utility coal -25% / +0% / -25%

    Other coal +1% / +0% / +1%

    Merch +0.7% / +7% / +8%

    Intermodal +3% / +1% / +4%

    Total -0.5% / +3.4% / +2.9%

    And incremental/decremental EBIT margins of:

    Coal 65% (CS estimate)

    Merch 40% (CS estimate)

    Intermodal 20% (using something close to the Bernstein 17-18% IM margin)

    And $130mm per year of productivity gains, below the $145mm average over the past 8 years.

     

    EBIT growth is +3.7%. If the stock price grows in line with EBIT growth you get an annual return of about 6% factoring in the dividend. This is about 2% greater than what you should get in the stock market as a whole over the next decade (http://www.hussmanfunds.com/wmc/wmc120319.htm). But you also have to consider that CSX should generate over $6B of FCF during these five years and use most or all of it to buy back stock. That reduces S/O by about 15%, depending on the stock price over those years. The “exit” multiple is of course difficult to forecast, but for illustrative purposes if the EV/EBIT matches its historical multiple of 10.5-11x you’ll have a $37 stock which, when combined with the dividend will give you a total return of 13% per year over the next 5 years. If the multiple falls to 8x vs. its current 9x you get the aforementioned 6%, or a little better than a market return. If that is my worst case scenario I am happy to take that bet. EBIT under that scenario has hardly grown from last year’s $3.4B to about $3.8B and is therefore nowhere close to the company’s target of $5.5-6B, which would be a pretty incredibly large miss. If your bet is that they will miss that number, I think you are probably right. But the stock price already reflects a miss. To short the stock I think you need to have to view that stock performance will be worse than the overall market, and to get there you have to believe essentially that utility coal will be falling to zero within the next few years (vs. 4% of total volumes in my worst case 2016 forecast). That seems unrealistic to me. I can understand why you wouldn’t want to be long a stock that will miss company targets by so wide a mark. But I don’t think CSX is a short—in the sense that it will underperform the broader market over a multi-year period—under any conceivable scenario. Maybe EPS this year is closer to $1.67 than $1.81 current consensus, and maybe the stock ends the year lower than its current price. But 3-4 years from now I think CSX will turn out to have been a very solid investment from the current price.


    SubjectFCF Yield
    Entry03/22/2012 05:43 PM
    Memberoliver1216
    $1B FCF for CSX in 2012 is 4.5% FCF yield for this co. I think the yield ought to be higher, considering the earnings growth trend is slight over the next year (or more). Call it 7%, and you get a price below $15.
     
    As a comparison, FCF yields at WMT is over 5%, MSFT is over 10%.
     
    EV/EBITDA is a nifty comp tool, but when capex is over 2.5x D&A, EBITDA is less informative from a valuation standpoint.
     
    It's unclear to me why investors believe that rails can grow volume and pricing faster than GDP forever. There's a limit to how much share they can take from the roads, no?
     
    I get that this analysis is simplistic, but seems to me that CSX is getting credit for earnings/rev growth trends that aren't sustainable. Outperforming crappy expectations with some growth isn't going to cut it.
     
     

    SubjectRE: FCF Yield
    Entry03/22/2012 07:56 PM
    Membersfdoj
    I don't know what FCF in 2012 will be but it was $1.396B in 2011 and $1.49B in 2010 and has averaged $1.03B over the last 5 years. On 2011 that is a 6.3% yield. FCF/EBIT has fluctuated widely over the years probably due to CapEx fluctuations but has averaged 36% since 2003. If EBIT grows 3.7% per year over the next 5 years, my downside case, and FCF averages 36% of EBIT, FCF would be about $6.6B, or about $1.32B per year, for a 6% yield.
     
    WMT's consensus EBIT growth over the next 4 years is 4.6%, MSFT's is 6.1%. CSX has targeted 12-14% growth. At this point that looks like it will be difficult to achieve although they have not formally cut their targets yet. Still, the bet is that CSX will grow considerably faster than WMT or MSFT. WMT is 11% of all retail sales in the US. The entire railroad industry is barely 11% the size of the trucking industry. So there is plenty of share to take, although that is not the most important part of the investment thesis. But maybe WMT and MSFT are both cheap and will be good investments.
     
    Nothing can grow significantly faster than GDP forever. I don't need CSX railroad revenues to grow faster than nominal GDP forever, just for the next 5 or so years. Given the competitive advantages of this business and the high capacity utilization I don't see their pricing power changing in the Merchandise segment in particular. Keep in mind that pricing (revenue per ton-mile) is today 51% below what it was in 1980 before deregulation, adjusted for inflation. Moving commodities by rail is still quite cheap--roughly speaking CSX charges less than 5c to move a ton of coal one mile.
     
    I agree that EBITDA is not a very relevant metric when looking at railroads, that is why I don't look at it and haven't referred to it in this writeup or Q&A.

    SubjectRe: Re: Re: Re: Re: Re: Re: Re: Re: Anyone following?
    Entry06/11/2015 11:45 AM
    Memberspike945

    doesn't Ackman still have a position in CP (and has people on the board)?.  i would find it hard if he was able to build up a position in CSX and propose a merger.

    CP was basically begging for an activist to come into one of the 2 names (CSX/NSC).  

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