The State Of The Economy In One Earnings Report

By Chad Henage - July 23, 2012 | Tickers: CSX, NSC, BTU, UNP | 0 Comments

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Most people looking at CSX's (NYSE: CSX) recent earnings report, are likely looking at how the company itself did. However, investors in multiple industries really should keep tabs on how the railroads are doing, as they give sort of a cheat sheet for multiple industries future results.

CSX Earnings:

Where CSX itself is concerned, revenue and volume were essentially flat while earnings per share increased 7% year-over-year. The company's CEO, Michael J Ward said, “CSX delivered its 10^th straight quarter of year-over-year earnings growth despite significant headwinds in its utility coal business.” When the CEO points out one particular industry as a major challenge to the company's earnings growth, investors in that industry should pay close attention. Setting this concern aside for a moment, the company saw fuel costs increase 5%, and this increase was almost directly offset by CSX retiring almost 6% of outstanding shares year-over-year. There is really no question that without the share repurchases, the company would have reported very different earnings-per-share results. Where the company's financials are concerned, a few adjustments are necessary to fully understand how much cash flow the company generated. CSX appears to have experienced a decline in its operating cash flow. However, the company contributed $275 million to its pension plan, and also took $215 million worth of other adjustments. Stripping out these one-time items, operating cash flow would have increased by 12.37%. However, capital expenditures growth far outpaced cash flow, with a 29.42% increase. The bottom line for CSX investors is, their dividend appears safe with an adjusted free cash flow payout ratio of about 48%. Before we get to individual industry results, let's quickly compare CSX to its largest competitors to see how the company is valued relative to its industry peers.

Competition:

If the analysts that follow the major railroads are correct, the economy should recover quite nicely over the next few years. With the three largest railroads all expected to see earnings growth of at least 12.5% longer-term, this will only occur if the economy continues to recover. Because railroads are generally cyclical in nature, investors should definitely consider having some exposure to this industry. As the U. S. comes out of one of the worst recessions that most people have ever seen, railroads should benefit. CSX, which we've already mentioned, Norfolk Southern (NYSE: NSC), and Union Pacific (NYSE: UNP), all sell for a P/E ratio near or below their respective growth rates. Of the three, Norfolk Southern appears to be the best value, as the company is expected to grow at almost 14%, and yet sells for about 12.55 times 2012 earnings. While Union Pacific has the highest respective growth rate, the stock also reflects this higher expected growth with a forward P/E ratio of 14.53. CSX sits somewhere in the middle with a P/E ratio of 12.50 and expected growth of 12.5%. Each of the three companies pays a dividend, but at this moment, Norfolk Southern's yield of 2.55% is just slightly higher than CSX.

Industry Cheat Sheet:

As I mentioned before, we can learn a lot about different industries based on CSX results. I'll highlight just a few industries that showed a significant change in their shipping volume. Agricultural volumes for instance were down 7%, primarily due to reduced shipments of ethanol and corn from reduced gasoline demand. While this already occurred, lower shipments of ethanol and corn would directly affect oil refiners such as Valero Energy and Chevron. As two companies that are directly affected by ethanol production, investors in both should take note of future developments in this shipping division.

For the second consecutive quarter, automotive volumes increased significantly. This quarter, automotive volumes were up 27%. This increase was driven by North American vehicle production increasing 25% year-over-year. For auto companies that benefit directly from their U.S. based sales such as Ford and General Motors, this should be very good news. In theory, this increase production is meant to meet increased demand going forward.

One final example is, the much-maligned coal industry. As low natural gas prices have driven down demand for coal tremendously. CSX does investors a favor by breaking out what percent gain or loss the company observed in both utility coal and export coal. Utility coal showed a huge 37% decrease in volume year-over-year. This was attributed to the fact that utilities have current stockpiles above their target levels, combined with low natural gas prices. On the complete opposite end of the spectrum, export coal volume increased by 41%. This huge increase should directly benefit companies that have significant international coal operations. One name that immediately comes to mind is Peabody Energy (NYSE: BTU). The company has been investing heavily in its Australian mining operations, and has made a particular point to increase its coal exports over the last few years. With the company selling at less than 9 times 2012 earnings, and expected to grow at about 9% in the future, the stock could be attractive. Beyond reading up on Peabody, investors should keep a close eye on the trend in coal shipments with each earnings report by the major railroads.

Conclusion:

As you can see, not only does CSX's earnings report give investors insight into the railroad's operations, it also gives investors in other industries a glimpse of what has been going on. Given the expected future strength and earnings at the three major railroads, investors need to keep a close eye on each company. Not only could each of the railroads be potential investment ideas, but each of their earnings reports can give investors an “insider's edge” into other industries for investment ideas. As you can see, a railroad's earnings report is almost like a, “status of the economy” all in one place.

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