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CSX took too heavy a beating
CSX Corporation (CSX +0.05%) saw a steep decline in its stock price in mid-September, falling almost 10% when its competitor Norfolk Southern (NSC +0.24%) announced that its third quarter earnings will be approximately 25% below analyst estimates. Since the decline, the company's stock has traded below our current price estimate of $22 and is currently trading around $20.


While we think the concerns surrounding railroads are justified in the uncertain macroeconomic environment, CSX's stock price has taken a hit far beyond what is warranted. We think the company has been proactive in controlling costs and improving efficiency which, combined with automotive and intermodal revenue growth, provide the base which supports our $22 valuation.


Improving efficiency to help control costs

In our opinion, CSX's management has done a good job especially compared to Norfolk Southern in cutting costs to tackle the slowdown in freight volumes. For example, during the third quarter, CSX's operating income declined 3% on 2% revenue decline while Norfolk Southern's operating income declined 22% on revenue decline of 7%.


What encourages us is CSX's ability to hold costs down over the long term by improving its operating efficiency. Key metrics such as one-time originations and arrivals increased to 90% and 80%, respectively, during the third quarter. Additionally, terminal dwell decreased to 23.2 hours from 25.5 hours and average train velocity increased to 23 mph from 21 mph year-over-year.


We expect CSX's management to maintain, if not improve on, these efficiency gains. Hence, we expect CSX's EBITDA margins will remain flat in the coming quarter and into next year but will start to grow as economic conditions improve.


Intermodal, automotive growth will drive revenue

Intermodal services help freight customers to take advantage of multiple forms of shipping. Customers can leverage the flexibility of truck pickups with the price benefit of long haul rail freight to efficiently manage their supply chains. Their preference for this mode of transportation is evident by the fact that intermodal carloads increased approximately 4% year-over-year in October.


CSX's management, to its credit, sees intermodal freight as a lucrative opportunity. It has spent heavily on assets such as the National Gateway which support or expand its intermodal operations. Additionally, the company is attempting a double-stack initiative where one container can be stacked on top of another, which will further help to cut costs.


In addition to intermodal freight growth, we think automotive freight will also help offset declines in other segments. CSX's third quarter automotive freight revenues increased 18% because of higher vehicle production, which saw increases to meet pent up demand created by the high average vehicle age in the US.


However, the automotive industry is cyclical in nature and could be affected by a deeper slowdown in overall economy. Additionally, as individuals continue to replace old vehicles, we might see growth in this segment moderate going forward as vehicles are not a commodity purchased by customers on a recurring basis.


Conclusion

Overall, we think that CSX has done well in recent quarters to improve efficiency and keep a check on its operating ratio. We expect growth in CSX's overall revenues will be muted but should be helped by increases in automotive and intermodal freight volumes. If management is able to maintain efficiency gains, the overall volume weakness should not have a drastic impact on the firm's bottom-line.

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