CSX 1Q18 financials: Records broken, but where is volume growth?

Written by William C. Vantuono, Editor-in-Chief
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CSX on April 17 posted record earnings and an all-time low operating ratio—based almost entirely on cost-cutting measures, headcount reductions, rate increases and stock buybacks, not volume growth.

CSX first-quarter 2018 net earnings of $695 million, or $0.78 per share, were substantially higher than the $362 million, or $0.39 per share, in the same period last year. The operating ratio for the quarter improved 950 basis points to 63.7% from 73.2% in the prior year.

Compared to 2017 first-quarter adjusted operating results, which excluded restructuring charges, this represents an operating ratio improvement of 570 basis points and a 53% increase in earnings per share, year over year.

Revenue for the first quarter remained relatively flat at $2.88 billion, while expenses declined 13% year over year, or 8% when excluding prior-year restructuring charges. Operating income for the quarter increased 36% to $1.04 billion when compared to $769 million in the same period last year, or 19% when compared to the adjusted operating income of $879 million reported in the first quarter of 2017.

Volume declined or was flat, however, in all categories except export coal and international intermodal:

Chemicals: “Volume declined as a result of reduced fly ash shipments, sustained challenges in energy markets and inventory shortages caused by plant outages reducing plastic shipments.”

Automotive: “Volume declined primarily due to a reduction in North American vehicle production and the industry’s strained autorack fleet.”

Agricultural and Food Products: “Volume declined due to losses in the ethanol market as well as challenges in the domestic and export grain markets.”

Forest Products: “Volume was flat due to gains for panel products from southeastern origins, which were offset by a decline in lumber shipments.”

Minerals: “Volume declined due to the prior year’s mild winter weather, which allowed producers to ship ahead of the typical shipping season.”

Metals and Equipment: “Volume declines were driven by a decrease in scrap metal shipments resulting from shifts in the global marketplace and declines in transportation equipment moves.”

Fertilizers: “Volume declined primarily due to the closure of a customer facility impacting short-haul rail shipments.”

Coal – Domestic: “Utility coal volume declined reflecting strong competition from natural gas. Coke, iron ore and other volume declined, primarily driven by sourcing shifts as producers focused shipments toward the export market.”

Coal – Export: “Volume increased as global supply levels and elevated global benchmark prices supported continued demand for U.S. coal exports.”

Intermodal – Domestic: “Volume declined as rationalization of low-density lanes in late 2017 more than offset growth with existing customers due to tightening truck capacity.”

Intermodal – International: “Volume increased, driven by new customers and strong performance with existing customers, which more than offset losses from the rationalization of low-density lanes in late 2017.”

COWEN INSIGHT

“CSX’s 1Q18 results were better than our above-consensus forecasts,” said Cowen and Co. Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “Early on in [CEO Jim Foote’s] tenure, the company is showing the ability to operate efficiently as a smaller railroad with fewer employees and assets. Investors are likely going to have increased confidence in the company’s goal of achieving a 60% OR by 2020.

“CSX’s 1Q18 beat is likely going to give investors additional confidence that the 60% OR (or better) goal by 2020 is much more achievable than previously appreciated. Excluding coal, sequential price improvement (overall yields were up about 4%), an incremental $30 million of real estate gains, $71 million of additional demurrage, detention and incidental payments vs. 1Q17 and a leaner cost structure helped drive the beat. A roughly 100bps more-favorable tax rate also added about $0.01.

“We are not expecting the typical seasonal OR improvement (500-plus bps) from 1Q to 2Q this year, given management commentary and significant structural improvements that took place in the first quarter. However, we continue to expect an improved operating environment in 2Q18. Management did not change its guidance for a 60% OR by 2020 or for a 4% CAGR (compound annual growth rate) in revenue in 2019 and 2020. We have slightly raised our expectations as a result of the solid results in 1Q18.

“We continue to expect that CSX will become a more nimble, dynamic railroad in the coming years, as many layers of management have been reduced. The company has consolidated its structure into four operating regions from nine. The number of hump yards (‘where railcars go to die’) has been cut by two-thirds to four, from twelve. There could be more to go on that front. Decentralization of operational decision-making will likely prove to be a key component to customer service improvement and employee retention over time.

“As we saw in 1Q18, the railroad’s footprint (labor, real estate, track) is likely to shrink in the coming months. The company expects to sell at least $300 million worth of real estate between now and 2020 (and this could be a conservative estimate). In 1Q18, CSX recorded $32 million worth of gains on sales of real estate. We think CSX’s strategy could provide an opportunity for Genesee & Wyoming (already a huge interchange partner of CSX), always one to assess asset sales from the Class I’s, to acquire complementary infrastructure. CSX management noted the high demand for assets in the market today.

“We have raised our 2018 EPS estimate from $3.08 to $3.30 to account for the 1Q beat and improved OR outlook for the remainder of the year. Our 2019 estimate is now $3.55, up from $3.50 prior on a slightly better OR expectation. We are now expecting a sub-60% OR result in 2020. We are applying a 20x multiple on our 2018 EPS estimate of $3.30 to arrive at our new price target of $66 (prior $62). This implies approximately a roughly 18x multiple on our 2019 estimate.”

RAIL ECONOMIST INSIGHT

“CSX’s announced first-quarter 2018 net earnings of $695 million, or $0.78 per share, is a huge 53% improvement per share,” notes railroad economist and Railway Age Contributing Editor Jim Blaze. “Much of that is a result of billions spent to reduce outstanding shares by a buy-back. The operating ratio improved 19.8%—mostly by cost-cutting. Revenue was relatively flat, year over year. The biggest revenue growth appeared to be from price leveraging and fuel surcharge increases.

“On the traffic side, my analysis is a bit more negative for those expecting a shift toward a larger rail vs. truck mode change. That’s not occurring for CSX, not from the numbers shown below:

“Traffic unit growth has stalled, vs. the long-expected increases when and if truck driver shortages and electronic logging, etc. problems finally occur—which they have. Intermodal volume remained unchanged percentage-wise at just 1,000 intermodal units over the 90 days. That’s about 11 system-wide units per day as truckers struggle. Who saw that competitive outcome? Domestic intermodal growth was negative. That outcome isn’t in any stated railroad plans, is it?”

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