Thursday, April 20, 2017

CSX 1Q financials suggest an upside

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CSX President and CEO E. Hunter Harrison CSX President and CEO E. Hunter Harrison

CSX Corp.’s first quarter 2017 non-adjusted net earnings of $362 million and a adjusted operating income of $712 million, yielded net earnings per share of $0.39 up from net earnings of $356 million, or $0.37 per share, in the same period of last year.

Excluding a $173 million restructuring charge in this year’s first quarter results, adjusted EPS was $0.51. The adjusted operating ratio, based on adjusted operating income of $885 million and adjusted net earnings of $472 million, was 69.2%. Including the restructuring charge, the OR was 75.2%.

Revenue for the quarter increased 10%, reflecting volume growth across most markets, overall core pricing gains, increased fuel recovery, and what CSX termed “favorable mix.” The $173 million restructuring charge drove a 13% year-over-year increase in expenses for the first quarter, but based on such factors as headcount reduction and hump yard closures, the railroad “delivered strong efficiency savings of $123 million. Looking forward, CSX is making adjustments throughout the company to improve asset utilization, achieve greater operations efficiency and reduce its cost structure.”

“Working together, we are going to make this company the best North American railroad, capable of consistently meeting and exceeding the expectations of our customers and our shareholders," said President and CEO E. Hunter Harrison. “As the business environment continues to improve and we implement Precision Scheduled Railroading, CSX will realize these objectives while driving volume growth and achieving a new level of financial performance.”

At the same time, CSX announced an 11% increase in its quarterly dividend, a new $1 billion share repurchase program and “strong financial guidance” as it applies Harrison’s Precision Scheduled Railroading model to its operations.

“Although we are just in the beginning phase of making changes to our network, we are off to a great start,” said Harrison. “These changes are critical to driving strong, sustainable service for our customers and superior value for our shareholders.”

“By focusing on these principles, CSX expects to realize record efficiency gains and a step-function improvement in its key financial measures for the year given continued economic growth and stable coal markets,” the company said. “Adjusting for restructuring charges in 2017, these actions are expected to drive a full-year operating ratio in the mid-60s, EPS growth of around 25% off the 2016 reported base of $1.81, and free cash flow before dividends of around $1.5 billion.

“Recent changes to the company’s operations have already begun to deliver strong returns and are expected to accelerate in the coming quarters. Given this momentum, the CSX Board of Directors approved an increase in the quarterly dividend from $0.18 to $0.20,” payable on June 15, 2017 to shareholders of record at the close of business on May 31, 2017.

In addition, the Board also approved a new $1 billion share repurchase program, which management expects to complete by the end of the first quarter of 2018. “This follows the successful completion of CSX’s previous repurchase plan, during which the company bought back $2 billion worth of shares since April 2015,” CSX said. “In line with the company’s balanced approach in deploying capital, CSX now expects to invest $2.1 billion in 2017, including approximately $270 million for Positive Train Control. Of the 2017 investment, more than half will be used to sustain core infrastructure with the balance allocated to projects supporting profitable growth, efficiency initiatives and service improvements.”

Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl comments:

“CSX’s 1Q17 adjusted EPS of $0.51 beat our and consensus expectations of $0.43. All-in same store sales pricing was up 3.9% y/y, it’s strongest growth since 4Q15, but intermodal and merchandise SSS pricing continues to moderate. Headcount reductions and operational changes are under way.

“While we do expect Hunter Harrison to speak to his initial assessment of the business and discuss some immediate changes taking place, we are not expecting to hear definitive operating ratio targets and timelines. We think Harrison and management will likely need some more time to analyze the business.

“765 people were laid off in March, or about 3% of the total workforce and a number of hump yards were shut down. We expect to hear of further cost reduction efforts in the coming months.

“All-in SSS pricing grew solidly in 1Q17, at 3.9%. That’s the fastest rate of growth since 4Q15 and was largely due to better pricing conditions in CSX’s export coal business, which is about 40% of the company’s total coal tonnage.

“Merchandise and intermodal pricing continues to be under pressure given recently negotiated contract renewals, which is driven by an oversupplied truckload market. Merchandise and intermodal (69% of revenue) pricing moderated to +2.5% from 3.2% in 4Q16, 3.6% in 3Q16, 4.0% in 2Q16 and 4.0% in 1Q16.

“The $173 million restructuring charge, or $0.12 per share, was taken during the quarter resulting in adjusted EPS of $0.51, better than our and consensus’ $0.43 estimate. The company’s 69.2% adjusted OR was over 200bps better than our 71.4% forecast and consensus’ 71.9% expectation. CSX noted $123 million worth of efficiency savings during the quarter. Previously, the company had said it would achieve more than $150 million of efficiency gains for the year, so the 1Q17 result suggests upside.”

Following CSX's earnings call, Seidl added:

"Newly raised 2017 guidance of a mid-60s operating ratio and around 25% EPS growth implies about $2.25 to $2.30. That's roughly 9% above current consensus expectations and is a key reason for the stock's reaction to the release and conference call (It shot up 8%). Harrison's comments on the call were more robust than we expected, but management noted that a more detailed discussion of the multi-year strategy and guidance will be conveyed sometime in the second half of the year. The new CEO needs more time to evaluate the business. Harrison pointed out a few things:

"There are no structural issues at CSX that will keep the company from achieving industry leading margins, which implies a CN-type operating ratio in the mid-50s range. We think that implies around $4.00 in EPS over the next 4-5 years, but we are not forecasting that yet. CSX does a good job in the intermodal area (15% of revenue), but significant improvements can be made in the merchandise segment (53% of total company revenue). Focus will be on a more balanced network over 7 days a week, a reduced number of locomotives and railcars with significantly less average terminal dwell time from ~26 hours to the high-teens range. The ultimate result should be improved service levels for customers.

"CSX's 9 divisions are likely to be cut to 'a couple.' Some of the most recent terminals that CSX has built were in the 1980s (one in Galesburg, Ill.), which suggests Harrison thinks the company has been slow to evolve the network as times have changed. Like most rails, CSX has too many facilities due to all of the mergers in its history.

"The OR guidance does not include real estate sales, but it sounds to us like there is plenty of opportunity to divest some property. Genesee & Wyoming could be positioned well to benefit from that. M&A has nothing to do with his plan at CSX and he does not expect any deals to take place at the railroad during the duration of his 4-year contract.

"The company expects to achieve a record level of structural cost reductions in 2017, topping 2016's record of $420 million. In 1Q17 alone, CSX says it recorded savings of $123 million. Previously, the company expected to achieve at least $150 million in savings for 2017.

"All-in SSS pricing grew solidly in 1Q17, at 3.9%. That's the fastest rate of growth since 4Q15 and was largely due to better pricing conditions in CSX's export coal business, which is about 40% of the company's total coal tonnage. That trend is unlikely to continue for the rest of the year. Merchandise and intermodal pricing continues to be under pressure given recently negotiated contract renewals, which is driven by an oversupplied truckload market. Merchandise and intermodal (69% of revenue) pricing moderated to +2.5% from 3.2% in 4Q16, 3.6% in 3Q16, 4.0% in 2Q16 and 4.0% in 1Q16.

"Estimate changes: We are raising our 2017 and 2018 EPS estimates to $2.30 and $2.60, respectively. That's up from $2.07 and $2.50 to reflect the better than expected results in 1Q17 and the company's change to guidance. We are raising our price target to $54 from $48 as we apply the same 19x multiple on 2018E EPS. We think it is important to note that the strong 1Q17 results had very little to do with Hunter Harrison. The impact from the impending changes he is likely to make are yet to come."

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