CSX Earnings - Beyond The Headlines

By Chad Henage - April 25, 2012 | Tickers: CSX, UNP | 0 Comments

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CSX Corporation (NYSE: CSX) recently reported earnings that beat analyst estimates, that much you might already know. I'm aware though that we are all busy, and sometimes it's easy to just read the headline earnings, skim the rest and move on. I know that earnings reports can be full of valuable information, and transportation companies can be particularly interesting because they can tell us about other industries. Let's dig into the most recent CSX report in a little more detail and see what we can find out.

Revenue

First, the headline numbers, revenue was up 6%, EPS was up 23%. When it comes to revenue this 6% increase was driven by 3 primary factors: $26 million in increased volume, $64 million in increased prices, and $66 million from lesser fuel costs. While the increased volume and increased prices are good to see, the lesser fuel costs aren't something I would bank on going forward. Without this, revenues would have increased about 3-4%.

Expenses

The other part of the earnings increase was expenses were down 4%, versus last year. Expenses would have fallen further, except for a 10% increase in fuel costs. Without this 10% increase in fuel costs expenses would have dropped about another 2%.

Net Earnings and EPS

While the number most will focus on is the 23% increase in EPS, net earnings actually grew by 14%. The difference was made up from share repurchases. There is a trend here that I would worry about if I were a long term shareholder. CSX seems to have a problem with spending cash flow it doesn't have. Look at the last four quarters:

This is not a good sign. CSX's free cash flow in the last four quarters has gone from over $500 million positive to a negative number. You can see this shows up on CSX balance sheet in its cash and long term debt from four quarters ago.

These are not sustainable trends. The fact that CSX is not only running now negative free cash flow, but has also weakened its balance sheet, by about $1 billion in the last year is a problem. For point of comparison, Union Pacific (NYSE: UNP) has shown relatively consistent $400 - $600 million in free cash flow over the last four quarters. In addition, Union Pacific's cash level has stayed flat, while the company retired over $400 billion in long-term debt. CSX management needs to realize they can't buy earnings growth forever. If free cash flow stays negative, this could jeopardize further stock repurchases after the current authorization runs out.

2^nd Q outlook

CSX sees positive trends in volumes in autos, steel, consumer packaging, phosphate, and fertilizer. (Note to shareholders of companies that operate in these industries, this is a good sign of things to come for your stocks.) Most of their other markets such as chemicals and agricultural, they see flat volume growth. Something that should not be a surprise to anyone is, they see unfavorable volumes in utility coal in the U.S. That being said, the company does have a brighter outlook for coal volumes in the 3^rd and 4^th quarters. CSX specifically said after their 53% margin in the current quarter, they expect margins to drop in the second quarter and then turn around in the second half of the year as, “utility coal headwinds moderate”.

The company expects capital expenditures to be about $2.25 billion. in 2012, this compares to the $2.29 bil. in capex. for 2011. Given the above issues with free cash flow and the balance sheet, I was a little surprised to hear that the board was going to review a potential dividend increase in May. Considering in the last two quarters, the company used up $156 million in cash and $384 million in short term investments, a dividend increase doesn't make a whole lot of sense. Out of the $540 million the company used from the balance sheet, about $251 million went to dividends, and the remainder paid down short and long term debt. The problem is CSX cannot do this every quarter and maintain a healthy balance sheet.

Conclusion

If I'm a long term shareholder the two main things I want to see turn around are CSX's free cash flow, and their policy of borrowing to repurchase shares. It's one thing for the company to use free cash flow to repurchase shares, as it increases future EPS with no damage to the balance sheet. What CSX is doing however, is manufacturing EPS growth from money they now no longer will have. This hurts shareholders longer term, because the company has less of a cash cushion and more net debt. While the 23% EPS increase looks good on paper, it looks at least in the short term, that CSX has gone off track.

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