Spencer Platt
In the summer of last year I concluded that CSX Corporation (NASDAQ:CSX) no longer was on rails. The company had seen a very strong 2021, yet saw headwinds which included volume declines, a softer economy, higher inflation, and higher fuel expenses.
With earnings growth hampered, or perhaps non-existent in 2022 (seen at the time), valuations have already reflected this to a major extent as the company in the end delivered on convincing earnings growth in 2022.
Real signs of a slowdown, and sequential impact on earnings, is seen in the second quarter of 2023, but with earnings posted at higher levels here, earnings power provides some support to the shares. That said, I require a further pullback before considering a position here.
Creating A Base Case
Pre-pandemic, CSX posted a 3% fall in its 2019 revenues to $12 billion, with the operating ratio of 58% and change suggesting that operating margins topped 41%, with net earnings of $3.3 billion resulting in earnings per share of $4.17 per share (as shares split on a three-for-one basis thereafter of course).
Revenues fell to $10.6 billion in 2020 but recovered nicely to $12.5 billion in 2021, as operating margins improved to 45% despite higher labor cost and fuel bills. Net earnings improved to $3.8 billion, or $1.68 per share (after the stock split. Net debt of $14 billion was stable, but as EBITDA improved to $7.0 billion, leverage ratios actually came down a bit to 2 times. With shares trading at $37, that resulted in a high multiple in the low-twenties.
With shares having fallen from $37 early in 2022 to a low of $29 last summer, I believed that the valuation multiple contraction from 22 to 17 times earnings priced in a lot of headwinds already, assuming that the company could maintain 2021 earnings into 2022. That made me cautiously upbeat, if not for the fact that operating margins were still very high on a historical basis, a situation which made me somewhat concerned if margins were to revert over time.
Rangebound
Since last summer, shares have of CSX have seen modest gains, having risen about 10% to $32 and change, as shares have been trading rangebound between $25 and $35 over the past year.
Forwarding to early this year, we have seen CSX post spectacular 2022 results in terms of the top line, aided by inflationary pressures. Revenues were up 19% to $14.9 billion, as this is entirely due to some pricing (and some more) with volumes down a percent. Agriculture, automotive and minerals were strong in terms of volumes, offset by weakness in fertilizers and chemicals.
Despite the inflationary pressure, the company managed to grow operating margins by 8%, with operating profits reported at $6.0 billion, with net earnings up 10% to $4.2 billion, as earnings per share were up sixteen percent to $1.95 per share, much better than I anticipated.
Net debt ticked up to $16.0 billion, due to buybacks and the fact that capital spending of $2.1 billion surpassed depreciation charges by more than half a billion, as well as some acquisitions pursued in 2022. This debt load is not really worrying as EBITDA came in at $7.5 billion, with interest expense hardly ticked in up just yet amidst long term fixed debt used to finance the operations.
In February, the company hiked the dividend in a modest fashion, increased by a penny to $0.11 per share on a quarterly basis. First quarter results were rather strong with sales up 9% to $3.7 billion, again driven by pricing as volumes were down a percent. Operating earnings rose by 14% to $1.5 billion, aided by lower fuel charges, as earnings per share were up by 23% to $0.48 per share, as the company continues to be a heavy buyer of its own shares.
In July, it became apparent that there is some kind of transportation crisis with second quarter sales of $3.7 billion being down 3% year-over-year, the result of a three percent point volume decline, amidst flattish pricing, after pricing has been such a strong driver in recent times. Operating earnings fell from $1.7 billion to $1.5 billion (although half of that is the result of lower gains on property dispositions). Amidst higher interest expenses, earnings fell 15% to $996 million, although that buybacks made that earnings fell just five cents to $0.49 per share.
And Now?
The reality is that I am not surprised to see shares up 10% over the past year as earnings trends in 2022 have been strong, as the company has been able to maintain the earnings power so far in 2023 (although that the second quarter results indicate that it will be challenging to maintain earnings per share for all of 2023).
That said, earnings power of around $2 per share only works down to a 16 times multiple here, although that net debt keeps increasing to $16.9 billion, with EBITDA trending at $7.5 billion, for a still manageable 2.2 times leverage ratio.
Right now, I am a bit cautious even as shares have fallen a bit in response to the second quarter earnings report, trading down from $34 to $32 per share. The issue is that CSX is clearly hit by slower growth, amidst continued volume declines but moreover the apparent end of the pricing strength. It seems that lower demand hurts the business from a volume perspective, although this is a near-term trend with the long-term fundamentals still being intact.
Given that CSX Corporation shares traded at lows of $28 per share as recently as April, I am not buying the latest small dips just yet, as I am waiting for an entry point in the higher twenties, in fact a re-test of the April lows. Based on earnings power of roughly $2 per share, such entry points would translate into a roughly 14 times multiple, for an earnings yield of around 7%. This is needed as there are some headwinds to the business which include lower volumes, lack of pricing seen in recent times, and the fact that buybacks will have to slow down from the current pace, without jacking unleveraged ratios too much here.