CSX Resets Timing Target for Mid-60s Operating Ratio


CSX improved operating income 2% to a record firstquarter level despite continuing coal weakness. Management pushed out the 2015 target for achieving a 65% operating ratio. The rail conceived the prior margin improvement timeline a couple of years ago, before the full emergence of natural gas sufficiently cheap to displace material utility coal volume. Now weighing the latter with greater visibility, the firm targets a high 60s OR by 2015 and mid-60s longer term. We already projected performance resembling this revision (67.5% in 2015 and 66% long run), thus we maintain our fair value estimate.

The rail’s attainment of record first-quarter EBIT amid coal malaise supports our narrow economic moat rating. Even if income declines as a result of soft demand in some commodities, we believe the rail boasts powerful barriers to entry that guard against competitive intrusions on its (albeit possibly somewhat diminished) economic profits. Weak coal weakens earnings but does not destroy CSX’s future; indeed, CSX has set income and margin records throughout much of the recent period of coal volume decline (from peak 1.9 million carloads in 2006 to 1.3 million in 2012).

This period, coal carloads and tonnage declined 10% from the year-ago period, revenue declined 13%, and revenue per unit declined 3%. Tonnage slid 14%-15% in domestic and export thermal markets and dropped 18% in coke, iron ore, and other, but improved 11% in export metallurgical.

Management expects 5%-10% declines for full 2013 coal volume. We posit that the rail can move costs in line with volume, as during the recession, in some quarters better than in others. This period CSX reduced coal crew starts 16%, exceeding the 10% volume decline and 6% coal revenue ton mile decline in part due to longer trains.

CSX improved core pricing (76% of business) by 0.3%, or 4.1% excluding export coal, the latter similar to prior quarters and importantly, still exceeding railroad inflation. Earnings per share were in line with guidance of flat to down slightly; $3 billion in sales was flat with last year. Reported $0.45 EPS includes a $0.02 benefit from take-or-pay coal contracts, $0.01 tax benefit, and $0.01 property sale gains; normalized EPS of $0.41 declined $0.02 from the prior-year period.

The reported 70.4% OR degrades to around 72.1% excluding nonrecurring property sale gains, but this is just 1 percentage point worse than in the first quarter of 2012. The announced $1 billion share-repurchase agreement for the next 24 months is slightly more aggressive than we modeled, and as such will be value-accretive if made at share prices below our fair value estimate, as at present. Management projects a 10%-15% EPS compound annual growth rate through 2015 off this year’s base and EPS this year to be flat to slightly down from 2012.


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