One good barometer for how the economy is performing are railroad companies. In the weak portions of the economic cycle, railroads tend to underperform. In strong economic environments, they often do well as the products they ship are in high demand. Today, unemployment remains low, which means consumers are likely carrying more cash than they normally would. This has led to strong performances among many of the railroads. One of my favorites in this space is CSX Corp. (CSX, Financial).
Company background
CSX has been in operation since 1827, when it was known as the B&P Railroad. Initially, the company operated just 13 miles of track. CSX now has 21,000 miles of track that covers 23 states in the eastern portion of the United States. CSX has a market cap of more than $64 billion and generated $11.5 billion in sales last year.
Recent earnings results
CSX last reported earnings results on July 17. The company earned $1.01 per share during the second quarter, topping analysts’ estimates by 14 cents. This was a massive 58% increase from the prior-year quarter. A new lower effective tax rate of 23.3% helped drive some of this increase. Revenue grew 5.8% to $3.1 billion, the company’s best results since the fourth quarter of 2014. Revenue totals were $100 million higher than the market expected.
The rail’s operating ratio, the percentage of revenue used to maintain operations, improved nearly 5% to 58.6%. Among all North American railroads, CSX’s operating ratio trailed only Canadian National Railway’s (CNI, Financial) during the second quarter.
CSX’s expenses fell 8% year over year. Lower employee head count resulted in a cost savings of more than $80 million, which helped to offset a 36% increase in fuel expenses. Train dwell, the amount of time a train is stationary, improved 11% from the prior year and train velocity increased 7%. Overall, CSX had a 34% increase in operating income.
Almost all of the products CSX transports saw at least mid-single-digit revenue growth, with revenue per unit growing 7% company-wide. Even though volumes for chemicals were flat, strong demand for industrial chemicals and energy shipments led to 7% revenue growth. Several other rails saw demand for autos decline in the quarter, a trend CSX was able to overcome. Higher volumes for truck and SUV shipments resulted in 7% automotive revenues. Forrest products, metals and equipment revenues increased 11% as heightened demand for building materials drove higher volumes. International demand for intermodal shipments helped to offset lower volumes of domestic shipments.
Coal, which has been a major headwind for the rails in general and CSX in particular, saw a 6% volume increase. While domestic shipments did decline 11% due to lower demand from power plants, coal exports increased almost 40%. A little less than half of the coal volumes moved by CSX were to international customers.
CSX forecasts a midpoint for earnings per share of $3.30 for 2018. If achieved, this would represent 43% growth from last year.
Dividend history and valuation
CSX has increased its dividend for the past 14 years, second among all railroads to Canadian National Railway. The company has increased its dividend:
- By an average of 7.4% annually over the last three years.
- By an average of 7.6% annually over the last five years.
- By an average of 15.8% annually over the last 10 years.
As you can see, dividend growth has fluctuated over the last decade. The rail increased its dividend 10% for the payment made last March. CSX generated more than $1.3 billion in free cash flow for 2018, almost double the total for the same time period last year.
CSX is scheduled to pay 88 cents per share in dividends for this year. Given the company’s earings per share guidance of $3.30, the expected dividend payout ratio is 26.7%. The average payout ratio over the last 10 years is 30.5%. Most of the railroads have low payout ratios due to the very cyclical nature of their business, but CSX has one of the lowest. This leaves the company with plenty of room to offer dividend increases going forward. This is especially true if the lower operating ratio is sustainable and the free cash flow growth is consistent.
Shares of CSX currently yield 1.17%. This is below the dividend yield of the S&P 500 (1.74%). Investors likely don’t hold shares for the yield, but for the capital gains. The stock price has increased more than 36% year to date and has more than doubled since the start of 2017.
Based off of the midpoint for 2018 earnings and Wednesday’s closing price of $74.99, CSX trades with a price-earnings multiple of 22.7. From 2008 through 2017, the average price to earnings multiple was 15, meaning the stock is overvalued by its own historical valuation. Compared to the price-earnings ratio of the S&P 500 (25.3), CSX’s stock is slightly undervalued.
Conclusion
Shares of CSX have more than doubled in less than two years, driving the company’s stock price to new highs. With low unemployment, demand for exports for shipments, a lower tax rate and impressive operating ratio, CSX finds itself in a very positive business environment. While shares are overvalued compared to their own history, they are attractively valued against the market as a whole. Investors who think this positive business environment is likely to continue should consider owning shares of CSX.
Disclosure: I am not long any stocks mentioned in this article.
