Amid the global push for increased digitization, cleaner technologies and even a renewed interest in a space race, rail transportation services may appear like a dinosaur industry.
Such biases are wholly misguided, as recent investors of CSX Corporation (CSX) have gleefully discovered. For the current month, CSX stock is up 7%-plus, with most of the bullishness culminating over a mere three-day span.
This is a sharp reversal of fortune for CSX, which lost 26% in the markets this year between the beginning of May and the end of August.
What Keeps CSX Rolling Along
Unlike high-tech companies focused on pioneering innovations, railroad companies like CSX Corporation consistently benefit from broadly supportive fundamentals.
Legislation that was passed in the 1980s allowed the railroad sector to abandon unprofitable routes. As a result of multiple reforms, railroads — above all other shipment platforms — carry the most cargo, and currently account for the movement of 40% of total U.S. freight, according to data compiled by the U.S. Bureau of Transportation. In addition, the railroad industry employs roughly 180,000 people, of whom 18% fall under CSX Corporation’s payroll.
However, the sector is not without its challenges, as evidenced by CSX stock’s year-to-date loss of 20%.
Perhaps the most conspicuous catalyst for the overall decline in railroad stocks this year — including CSX’s primary competitors Union Pacific Corp. (UNP) and Norfolk Southern Corp. (NSC) — is the persistent bear market in coal prices.
Representing a large chunk of revenue, the volatility in coal and other energy-related commodities has led to dramatically reduced rail volume. The backlash came in the form of UNP, NSC and CSX stocks all missing top-line sales forecasts in their respective second-quarter earnings reports for the current fiscal year.
Not willing to concede matters without a fight, CSX Corporation announced a new strategy to enhance efficiency and profitability in light of critical headwinds — increase the length of trains by up to twice the industry standard.
On average, CSX-branded trains are 10% longer than they were a year ago, typically enabling them to move as much in six days as they previously had in seven. Such improvements are likely to bolster investor confidence towards CSX stock while subsequently frustrating drivers — some of the trains, according to CSX chief executive officer Michael Ward, can be a couple of miles long.
Will these measures be enough to negate a 7% reduction in bulk freight for the first three quarters of 2015? The answer isn’t as clear-cut as the railroad industry would like everyone to believe.
Great Efficiency but Some New Headaches for CSX
CSX Corporation’s efficiency protocol has produced some unwanted consequences — namely, that their trains have seen a 12% reduction in average speed as compared to 2013.
This contributed to a worrying fall in on-time delivery rates — 54% of scheduled deliveries for Q3 FY2015, as opposed to 83% from two years ago.
In terms of the financials, CSX has combated a dip in revenue with cost-cutting efforts.
The upshot has been operating and net profitability margins that are well above industry averages. Earnings-per-share growth for CSX stock has also improved on a year-over-year basis for the first three quarters of 2015.
However, the magnitude of these improvements has gotten substantially smaller — the YOY gain for Q1 was 12.5% whereas for Q3, it was a meager 2%. Thus, a case could be made that CSX stock’s forward price-to-earnings ratio of 13.8 is a bit on the pricey side.
So far, that hasn’t tamed investors’ enthusiasm. Thanks to last week’s robust move in the markets, CSX stock was a mere 5% below its 200 day moving average on Friday.
Though encouraging, the bulls do have their work cut out for them. There will likely be significant upside resistance as shares make their way to $34 — roughly the average price of CSX stock between January and late June of this year.
Also, CSX shares have a problem with consistency. Only five times in 2015 has it posted consecutive bullish weeks, and the longest streak has been only three weeks in length.
Bottom Line
In many ways, CSX stock investors have the benefit of advantages not afforded to other industries. Overall demand for railroad services has only increased over the long haul, and the sector is flexible enough to adjust for the sudden drop in commodity prices.
And the earnings growth for CSX is there — no question about it. But whether it meets the expectations of Wall Street is an entirely different matter.
The recent surge in CSX stock is a small, but welcome confirmation that the bulls just might have the edge here.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
