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Sar Medoff

Mark Deluzio

CSX AT A GLANCE

P/E ► 14.1 AVG EV/EBITDA ► 8.31 AVG ROA ► 6.5% AVG ROE ► 13.5% AVG Debt to Equity ► 2.17 AVG Current Ratio ► 1.34 AVG Interest Coverage Ratio ► 4.33 AVG

 

 

 

 

 

 

CSX Corporation (NYSE:CSX) is one of the nation's leading transportation companies. CSX's 36,000 employees operate a rail network comprised of more than 37,000 miles of track, 3,800 locomotives, 101,600 freight cars, and nearly 45,000 intermodal units. The company transports everything from chemicals to automotive parts. Its main divisions are Merchandise, coal , Intermodal (a combination of rail and truck transportation), and Automotive.

Like its counterparts in the railroad industry, CSX is subject to economic cycles. When the economy is doing well, more goods tend to be shipped, and when the economy is doing poorly, fewer goods tend to be shipped. Moreover, the volume of goods being shipped by a particular industry tends to vary directly in proportion to the health of that industry. For instance as housing markets have declined, the demand for the transportation of housing related goods has also decreased. In 2006 CSX saw drops in volume in both automotive and forest products. Despite this historical correlation for railroad business, 2008 saw a new cycle affecting railroad volume- oil prices. As the price for a barrel of crude oil soared over 100%, diesel fuel and trucking became much more expensive. Rail prices are much less sensitive to fuel costs, and a massive movement to rail-based transport developed. Volume has exploded the last two quarters for this sector.

Although CSX has made progress in some areas, it still lags its competitors in key performance areas such as train speeds, on-time arrivals and departures, accidents, and re-crews. This is largely due to the complexity of CSX's rail road system. The company's current incarnation is the result of a merger of two separate railroads. CSX also acquired a significant interest in Conrail in 1997; the integration of these three networks results in more operational difficulties than its competitors. As a result of these operational lags to its competitors, hedge funds TCI and 3g Partners acquired large stakes in the company and launched a proxy battle to secure seats on the board of directors.

Surface Transportation Business

The CSX network consists of four main networks covering the Eastern United States.

• The Coal Network connects more than 130 mining operations in nine states, including three of the four leading coal-producing states.
• The Southeastern Corridor forms the western border of CSX's network and connects Chicago, Nashville, Birmingham, Atlanta, and Central Florida.
• The I-90 Corridor connects Chicago and New York
• The I-95 Corridor connects Miami, Charleston, Baltimore, Philadelphia, and New York

In FY 2006, revenue grew 11% to $9.6 billion, with an operating income increase of 38% to $2.1 billion.

Merchandise

Merchandise shipping accounts for nearly half of CSX's total revenue and approximately 38% of total volume. This sector includes "Forest Products" and "Metals;" the prosperity of the former is closely tied to construction and the housing market, the latter includes steel and other metals used in auto manufacturing.

• Chemicals - Total volume of chemical shipments decreased 1% in FY 2006, but revenue per unit increased 12% resulted in an 11% overall increase in revenue. The chemical industry is currently suffering from high raw material costs.

• Emerging Markets - This segment includes shipments such as municipal waste and military equipment and accounts for nearly 19% of all merchandise volume. Revenue increased 13% in FY 2006.

• Forest Products - The decline of the housing market and increased usage of digital media caused volume to drop 8% in FY 2006.

• Agriculture Products - Strong domestic demand and increased exports drove a 24% increase in revenue. In particular feed grain, soybean, and ethanol constituted a significant portion of the increase.

• Metals - In 2006, strong steel demand in construction was offset by a decrease in automotive demand; volume increased by 1%.

• Phosphates & Fertilizers - 2006 saw a significant increase in international phosphate production which resulted in less export demand and the closing of several domestic plants. Due to the downturn in production, volume fell 18%.

• Food & Consumer - A 2% decrease in volume didn't prevent 9% growth in revenue due to a significant increase in revenue per unit.

Coal

Strong demand for Appalachian coal has driven its growth as one of CSX's most important sectors. In 2006, total volume was up 5% and revenue per unit was up 9%. While consumer demand has stayed relatively constant, export demand increased and in FY 2006, many coal power plants took advantage of low prices to refill their inventories.

Intermodal

Intermodal combines more cost-effective rail transportation with the flexibility of short-haul trucks. Intermodal transportation is a particularly important link between the railroad and shipping ports. CSX is well positioned to capitalize on predicted future increases in traffic at East Coast ports, but domestic demand for intermodal transportation is currently on the decline. In FY 2006, intermodal volume and revenue saw a slight increase of 1% and 4% respectively.

Automotive

CSX is not immune to the woes of the domestic auto industry and has suffered as American auto manufacturers have sliced production. Recently, there has been a shift in production from domestic car companies to foreign car companies like Toyota. Although these companies manufacture a significant portion of their US vehicles domestically, they continue to bring large quantities of vehicles from overseas as well. As a result volume declined 5% in FY 2006. This was partially offset by a 6% increase in revenue per unit.

One Plan

In 2004, disappointed by years of increasing operating ratios and declining reliability and service metrics, CSX developed its One Plan. This new operating plan's main objective was to increase the efficiency and reliability of the CSX network. One major change was shifting the bulk of train traffic from an on-demand basis to more scheduled service. Theoretically, this shift should reduce the number and frequency of traffic jams at the major rail yards, while also increasing reliability as many trains followed a regular schedule. The benefits of this reorganization have yet to be fully realized. When the plan was developed in 2004, average train dwell times (the average time a car resides at the specified terminal location) were 13% longer than the previous year, on-time departures were down 21%, and on-time arrivals fell 28%. After beginning to implement the One Plan in 2005, average dwell times slightly increased, on-time departures increased by 4%, and on-time arrivals marginally decreased. In 2006, the One Plan's new strategies were clearly working, with average dwell times shortened by 14%, on-time originations improved by 49%, and on-time arrivals improved by 56%.

Hostile Takeover

Throughout 2007, hedge funds 3g Partners and TCI Fund Management began acquiring shares in an attempt to change the management and operations of CSX. After several attempts to collaborate with management, the companies began acquiring shares for a proxy battle to determine the control of the CSX board of directors. Their letter to the board illustrated the two funds' dissatisfaction with CSX management:

"It is our view that CSX management does not fully understand the economics of the business, is cavalier about potential risks, is undisciplined about spending, is unrealistic about future prospects, is complacent about operational under-performance and is unnecessarily adversarial towards labor, shippers and shareholders. We hold the Board accountable for these failings."

The two funds even collaborated to make a website dedicated to their vision for CSX's future: A Stronger CSX The basic thesis of the funds' new position is that CSX is in a great macroeconomic position, but current management is failing at effectively utilizing CSX's resources. The funds claim that they could achieve over $2.2 billion in productivity gains in just five years. ^[1] CSX is a laggard in almost every industry metric for operations:

CSX had their annual shareholders meeting on 25 June 2008 and voted on the company's board of directors. TCI and 3g had put five candidates up for election to invoke their agenda. Although the results will not be certified until July 25, preliminary voting results show that the funds have secured four seats on the board.^[2]

Other Sources of Revenue

Other sources of revenue for CSX include CSX Hotels, Inc., oversees operation of The Greenbrier, a resort hotel located in White Sulphur Springs, West Virginia; and CSX Real Property, Inc., a subsidiary responsible for the management, sale, lease, and development of properties owned by the company. These two units combined account for less than 1% of CSX's total revenue.

Risks

Fuel

As with all transportation industries, the price of oil and other fuels have a tremendous impact on CSX's bottom line. A decrease in fuel hedge benefits in 2006, coupled with higher diesel prices directly increased CSX's expenses. According to CSX, approximately 85% of its revenue is subject to fuel surcharges or price increases.

Derailments & Accidents

Derailments are a common expense for railroads but the magnitude of the accident can have a significant impact. CSX's train accident frequency decreased in 2006, but in early 2007, a serious derailment in Brooks, Kentucky cost the company $28 million. In addition, because railroads are required by law to transport hazardous materials, there is a possibility of future derailments of this magnitude.

Legislation & Regulation

Railroads are subject to various regulations from multiple government departments, all of which could significantly impact business should they choose to change any of the current regulations. Railroads, and the domestic transportation infrastructure in general, are vulnerable to terrorist attacks and as such, federal, state, and local governments are adopting legislation that will strengthen security. In conforming to new regulations, CSX would undoubtedly incur extensive expenses.

Network Difficulties

CSX is the product of a merger of two separate railroads and has also acquired a 42% economic interest in Conrail. Ensuring the compatibility of these three networks is a difficult task and a constant hindrance to improving train speeds and other operating metrics. The network is also subject to natural disasters, such as Hurricane Katrina, which resulted in more than $170 million in insurance claims. CSX currently spends an average 13%-14% of annual revenue on capital projects, primarily on track maintenance as opposed to expansion.

Unions

Most of the 36,000 employees belong to labor unions, making CSX's relationship with the unions of utmost importance. The rail industry has been fortunate in the past, almost always reaching an agreement during negotiations before a strike becomes necessary. In the last thirty years, there were only six days of work stoppage due to labor negotiations.

Competition

Like other rail lines, CSX directly competes with the trucking and shipping industries. Trains are three times more fuel-efficient than their trucking competitors, but have less short-haul flexibility. As shipping imports from Asia continue to increase, analysts expect increased volume at many East Coast ports because West Coast ports already experience heavy congestion. Higher volumes flowing through the Suez and Panama canals also seem to support this assumption. In the rail industry, CSX's main competitor is Norfolk Southern (NSC), another East Coast rail line. CSX maintains a larger rail network, but Norfolk Southern consistently tops CSX in two of the three the main operating metrics: Train speed and average dwell time (the average time a car resides at the specified terminal location); CSX consistently has more cars online. Norfolk Southern also has a significantly better operating ratio (operating expenses / operating revenue) than CSX - 72.8% vs. 77.8%.

References

1. ↑ Forbes
2. ↑ http://strongercsx.com/press/pr_071608.pdf