Prepared by Tara, Senior Analyst at BAD BEAT Investing
CSX Corporation’s (CSX) stock has been chugging along as the company is working to get back on track. While things are definitely improving economically, the company is still facing some headwinds, most notably in its coal volumes, and not from general economic pressures. Rail data certainly appears to be improving but overall rail traffic still is down. The stock has had a strong rebound in shares off of the lows, and an impressive overhead ratio, but we have concerns that if COVID really does spike again this winter, we will see further contraction.
CSX just reported earnings, which we will discuss here. We had been anxiously awaiting this report, and we want you to be aware of the progress on the key metrics we follow for the stock. All things considered, performance remains solid, and we are excited for the shareholder-friendly nature of the company and the moves being made there. We remain overall neutral on the name and think it will continue to market-perform. The third quarter showed some key strengths and weaknesses. Let us discuss.
Operational efficiency dipped
There was once again weakness in coal shipments, and that is expected to continue in the rest of 2020 as well. That said, performance was actually pretty decent in Q3, but not strong. The murky outlook we saw for 2020 has continued, and this has us still concerned. But a concern here is that CSX’s operational efficiencies back in Q2 saw a reversal which caught our eye. The economy is still questionable right now, and we continue to actively monitor the data for signs of economic strength or lack thereof. The rail shipping data (subscription may be required to view this) week to week has also been very concerning. The company’s operating ratio set a Q1 record of 58.7%. But in Q2 it rose to 63.3%. That had us nervous. But we were so excited to see efficiency improve in Q3, and to match Q3 2019’s record-setting 56.9%. Excellent. That said, the results from CSX suggest slowdowns are still occurring, but not as bad as we thought would occur. Still, there is no doubt that revenue is suffering. Overall, the results were mixed.
Revenue pressure
Let us be clear, the company had delivered slow and steady growth for years, but revenues have started to contract. The trend of contracting revenues has continued the last few quarters. The top-line revenue figure came in at $2.65 billion, which was down 11% year over year. This reversed recent growth in the last few Q3s, but was a sequential improvement from Q2.
We expected that revenues would be down, but they were below expectations by $30 million. It was a rough quarter, but in fairness, handicapping the results was immensely difficult. We had expected an 8-12% drop in revenues, so this was within our expectations. We saw great international volumes, but once again we saw a negative mix from coal market headwinds, and lower fuel surcharge revenue.
Expense management helps earnings
While revenue was down 11%, CSX managed to slash expenses rather significantly as well. Expenses declined 11%. This type of expenditure control is once again a testament to strong management and strong discipline of the company to stick to its spending plans. We really have to say that operationally, the company has never run better. With the pain from reduced coal, and lingering pressure from COVID-19, the massive volume increases were a big surprise, but the lower coal and merchandise volumes weighed. But with reduced volumes, we were happy to see reduced expenses. Expenses were $1.51 billion, much better than the $1.54-1.57 billion we thought we would see.
This efficiency was driven by continued efficiency gains and volume-related savings. This was the reason the operating ratio was just so favorable. This really boosted earnings. With an expected drop in revenues, we were expecting EPS to fall to $0.90-0.93. It came in at $0.96 thanks to that expense management and improved operating ratio.
As you can see, earnings were better than expected. However, there was no growth here. Earnings per share were down from last year by $1.08, even if they surpassed consensus by $0.03, and surpassed our expectations. The trend of growth was broken for Q3, but was not surprising. While the results for the quarter were better than expected, it is clear that the trend suggests the pace of earnings growth has ceased, reinforcing our belief that 2020 would see no growth, and in this case, start to decline. Given that for the full-year 2020 CSX is going to see earnings contraction, it is tough to buy the stock here after the rally with the market. One positive set to drive the stock higher is that management has decided to reauthorize a $5 billion buyback. That is winning. We love that.
2020 outlook
As we enter Q4 2020, the story of CSX has certainly changed. Economic activity has slowed down but is rebounding nicely, with strong volume gains, particularly internationally. We do note the company’s liquidity position is extremely strong with nearly $2.5 billion of cash and short-term investments. For the year 2020, we are projecting revenues of $10.5-11.0 billion, a decline from last year. With a reduced share count and a favorable operating ratio, we think earnings will contract. We see EPS of $3.90-4.10. This lack of growth in earnings makes a buy here tough. Still, the big repurchase authorization is bullish. Overall, we think the name simply performs with the market, and rate it a solid hold.
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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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.