Last week, CSX Corporation (CSX, Financial) reported third-quarter earnings results that were well ahead of Wall Street analysts’ estimates. However, shares aren’t cheap, and the company is seeing some headwinds in its business, even though many product shipment categories reported strong year-over-year growth. Is the business performance enough to justify the stretched valuation?
Earnings results
CSX reported its fiscal third-quarter earnings results on Oct. 20. Revenue surged 24.2% year-over-year to $3.3 billion, beating estimates by $230 million. Net earnings of $968 million, or 43 cents per share, compared favorably to net earnings of $736 million, or 32 cents per share, in the prior year. Earnings per share were also 6 cents better than analysts’ expectations.
The operating ratio improved 50 basis points to 56.4% and came in ahead of consensus estimates of 58.3%.
Every product category except for one showed growth from the prior year. Of these, all but one product type had at least a 10% gain year-over-year.
Total merchandise revenue, which includes most other product categories outside of coal and intermodal, grew 6% as gains in revenue per unit were offset by a 2% decrease in volumes. As was the issue for most companies in the transportation sector that have already reported quarterly results, supply chain issues were a headwind. This in turn impacted freight volumes and pricing throughout the quarter.
Automotive volumes fell 26% and revenue was down 23% from the prior year, largely due to the global shortage of semiconductor chips. Revenue per unit did grow 5%. Agricultural and Food Products had revenue of 2% as revenue per unit of 8% was offset by lower volumes due to difficult comparisons vs. the prior year.
Aside from these two categories, growth was abundant. Chemicals, the largest individual contributor to revenue, grew 10% from the previous year, primarily due to a double-digit improvement in revenue per unit. Fertilizers were up 14% even as volumes were flat. Pricing was a tailwind during the quarter. Forest products continued to see a benefit from housing starts as revenues were up 11%, with volumes growing 7%. Revenues for Metals and Equipment grew 30% on strong volume growth of 21%. Minerals were higher by 13%, driven by an 8% improvement in pricing.
Intermodal revenue grew 14% due to higher prices and better volumes as a result of increased international demand. The domestic business faced the headwind of container and truck shortages.
Coal was up 39% due to a nearly even contribution from both volume and pricing. Coal benefited from higher demand from all end-markets. U.S. demand was due to higher industrial and utility demand.
For the first nine months of the year, all categories have seen growth for total revenues. Automotive is the only category to see a decrease for volume and then at just -1%. For revenue per unit, metals and equipment is the only category to be lower than the prior year and the decline is just 1%. All other products have posted at least solid growth.
Year-to-date, free cash flow improved nearly a full $1 billion, or 49%, to $2.9 billion. The company also repurchased more than $1 billion worth of stock during the quarter and distributed $208 million of dividends.
Leadership reaffirmed guidance for the year with the expectation that it will see double-digit revenue growth in 2021 even before the impact of certain acquisitions.
Takeaways and valuation analysis
Revenue gains for the quarter came from nearly every product type. Demand was even robust for some products, such as coal, that had been weaker previously. CSX was facing its second weakest comparable period from 2020, but revenue was still more than 10% above levels reached in the third quarter of 2019.
Leadership did note that the company’s purchase of Quality Carriers, a leading provider of bulk liquid chemicals truck transportation in North America, did aid results. The acquisition, which was completed on July 1 of this year, contributed roughly a third of the overall revenue growth for the quarter. The remainder of the increase was due to organic growth.
CSX, like the other railroads, did have some noteworthy headwinds. The lack of truck chassis, containers and truck drivers put a ceiling on what CSX was able to transport during the quarter. Given the performance of the business, results could have been even better. Supply chain constraints also caused volatility to freight volumes and pricing as car loads and revenue per unit varied somewhat for different product types.
The company has taken steps to help alleviate some of the pent-up demand, such as adding more than a dozen overflow container yards and offering customers additional way to move their freight. CSX is in the process of developing select sites that can be used for shipping for those customers who are moving production and supply chains back to North America. The company also converted some of its intermodal terminals into grounded facilities to increase capacity. CSX’s hiring pipeline was up 300% as well during the quarter as the company attempts to expand its workforce to meet demand.
Even with these headwinds, business performed quite well. Revenue is already comfortably ahead of where it was in 2019 and expected earnings per share should grow by double-digits from pre-pandemic levels.
Shares of CSX are trading near $36, which is a new 52-week high for the stock. Using analysts' estimates for earnings per share for the year, CSX has a forward price-earnings ratio of 23.1. According to Value Line, the stock has averaged a multiple of 18.4 since 2016 and 16.4 since 2011. By either measure, shares are overvalued today. In fact, this would be CSX’s highest valuation since at least 2005 were the stock to average it for the entire year.
Applying earnings estimates for this year by these two average valuations results in a share price target of $25.42 to $28.52. Compared to the current price, CSX is overvalued by 20% to 29% against the medium- and long-term average valuations.
The GuruFocus Value chart also shows the stock to be overvalued.
With a GF Value of $27.93, CSX is trading at a price-to-GF-Value ratoi of 1.28. The stock would suffer a decrease of more than 22% were it to retreat to its GF Value. As a result, shares earn a rating of modestly overvalued from GuruFocus.
Final thoughts
Even with issues outside of its control limiting the service it was able to provide, CSX still turned in an excellent quarter that easily tops the comparable period in the prior year. Results were also better than pre-pandemic numbers.
The company has taken some steps to help meet the rising demand for product shipment, but this won’t fade away entirely until supply chain issues around the world have been corrected. The expectation is that this will be part of the business for some time, possibly even into late next year.
CSX has also been a shareholder friendly company. Buyback activity has been strong. The company has increased its dividend for the last 16 years and the compound annual growth rate is nearly 10% since 2011. This helps to make up for the paltry 1% yield that shares offer today.
CSX’s business looks good even under these conditions and the dividend growth rate is attractive, but the valuation leaves much to be desired. While I am a fan of the company’s business, I find the price-earnings ratio is too rich. I wouldn’t advocate selling the stock because the business is strong, but I am waiting for a better price before adding CSX to my portfolio.
