Results Come in South of its Competition
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors have many less options for investment in the railroad sector than they used to. In the past, there were many choices like Conrail, Union Pacific (NYSE: UNP), CSX (NYSE: CSX), Norfolk Southern (NYSE: NSC), and Burlington Northern. However, in the last several years, Conrail was split and bought out by Norfolk and CSX, and Burlington Northern was acquired by Berkshire Hathaway. At this point there are really only three direct investment options, and they are the companies listed above with stock symbols. The great thing about railroads is they give investors an inside look at multiple industries, and they can also be good investments on their own. With CSX recently reporting earnings, investors get yet another chance to look at the overall heath of the economy, and to see how this individual company is doing.
The good news for CSX investors is, some of the company's underlying performance metrics improved. The bad news is, though the company improved its performance this didn't translate to big gains in earnings. In fact, the company reported revenue down 2%, and EPS increased just 2%. CSX increased on time originations and arrivals to 90% and 80%, which were both improvements over last year. The company's dwell hours decreased from 25.5 to 23.2 meaning less time in the station and more time on the rails.Another positive was the company's train velocity increased from 20.6 mph to 22.6 mph. Since the key ways for a railroad to increase performance is less time in the station, faster train speeds, all while maintaining safety, these are all positives for the company.
That being said, CSX still has room for improvement. The company's train speed of 22.6 mph compares unfavorably to Union Pacific, which managed a 26.1 mph average train speed. Unfortunately, Norfolk Southern doesn't release train speed so we can't compare how they are doing. However, Union Pacific's performance just shows that CSX can improve even further. When it comes to CSX's financials, we find a similar mixed bag of results.
One thing that investors need to be careful of is assuming that a company's reported increase in the EPS is the same thing as an increase in cash flow. Clearly this was not the case in the current quarter at CSX, as EPS increased 2%, but over the first nine months of the year the company's operating cash flow was actually down nearly 11%. On a positive note, the company has repurchased enough shares to retire almost 3.5% of its diluted share count. However, there is still room for improvement as a company's operating margin does not hold up to its peers. CSX's operating margin was 29.51%, compared to 32.5% at Norfolk Southern and 32.02% at Union Pacific. When your two major competitors both carry a higher operating margin, this tells investors that CSX's management can squeeze more costs out of the business.
Industry Cheat Sheet
One of the best things about a railroad's earnings is, the fact that it gives investors so much information about other industries. Looking at CSX's results, there are a few important takeaways for different industries that investors should be aware of. First, in an ongoing area of strength the Automotive industry showed another double-digit increase in volumes with an 18% drop in the current quarter. The company specifically stated that this was due to head up demand as the average age of vehicles in the U.S. hit record highs. Needless to say, this is a positive for a company like Ford Motor, which rely on sales in the United States for its profits.
The strength has not been limited to just CSX, as in the last few earnings reports from both Norfolk Southern and Union Pacific, both showed similar strong demand for autos. Another area of strength was Phosphates & Fertilizers which showed a volume increase of 5%. This would suggest that companies like Mosaic and other fertilizer and phosphate companies are benefiting from strong demand. This makes sense as there was an equivalent increase in volume in Food and Consumer, showing that the increase in phosphates and fertilizers is being used to increase food production.
The perennial loser among the industry groups has continued to be the coal industry with volumes down 17%. CSX specifically noted lower natural gas prices and high utility stockpiles as reasons for the decrease in volume. However, in a positive note indicating strength at companies like Peabody Energy, the company also said that it saw higher export volumes of thermal coal. As you can see, almost no matter what industry you follow, there is some information to be gained from reading a railroad's earnings report.
Looking at the overall performance at CSX, the stock looks like it represents a decent value. However, until management can more consistently manage costs and raise their operating margin to a level closer to their competitors, better opportunities lie elsewhere. For instance, Norfolk Southern offers a higher yield (3.02%), and similar growth and valuation versus CSX. Norfolk also has beaten earnings estimates each of the last four quarters, and has the highest operating margin of the three major railroads.
The class of the industry still seems to be Union Pacific, and though their yield at about 2% is lower than CSX or Norfolk Southern, the railroad has the highest expected earnings growth rate, at over 14% in the next few years. Since Union Pacific consistently beats earnings estimates, the company may do better than even analysts expect. Though Union Pacific isn't as cheap as its peers, the company has reported more consistent earnings growth, and appears to warrant a premium. For CSX shareholders, the stock isn't a bad choice, but it's not the best of the bunch either.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.