Gary Yeowell
Summary
Following my coverage of CSX Corp. (NASDAQ:CSX), for which I recommended a buy rating given the strong business moat and positive volume outlook through 2024, this post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for CSX, as 1Q24 results proved my view that volume is trending in the right direction. The Baltimore Bridge incident impact was encouragingly lower than expected, and the impact could be lower since management is being conservative in their assumptions.
Investment thesis
CSX reported 1Q24 results yesterday, with sales and EPS in line with consensus expectations. For the quarter, CSX saw total revenue of $3.69 billion, down 0.7%, in line with consensus estimate of $3.66 billion. EPS came in at $0.46, also in line with consensus estimate of $0.45. Positively, total carloads were up 3%, supporting my previous view that January volume weakness was simply due to the weather. Operating ratio improved 90bps vs 4Q23 to 63.2%. Generally, the results were positive and I remain buy rated on the stock as valuation remains cheap. Below are some of my key takeaways and outlook for CSX.
I think the obvious concern that most investors would have is the impact of the Baltimore Bridge incident and whether it would impact CSX FY24 guidance. Encouragingly, Baltimore’s impact is less than feared, and the Army Corps of Engineers expects to reopen the Port of Baltimore by the end of May. I think the bigger takeaway here is how great CSX operation capabilities are (shifting volume to other export terminals), as it only expects to see a $25 to $30 million headwind per month (which translates to about ~$41 million headwind from mid-April to end-May).
This compares very favorably to Norfolk Southern Corp., which called out $50 to $100 million in drag on 2Q24 revenue. I believe the impact could be even smaller, as CSX does not assume the benefit of coal mines seeing better utilization in normal summer outages.
in terms of pent-up demand, there’s outages in the summer that happen for the coal miners, and we’ll see how they handle that with some of the, obviously, slowdown that we’ve seen. Is there opportunity to make up some of this volume in the third and fourth quarter? There is — that’s not in the plan right now. 1Q24 earnings results call
Cycling back to volume, rail volume growth trends in 1Q24 showed improvement from 4Q23, with February and March volume growth rebounding after the weather-affected month in January, further supporting my view of a turnaround in volume. The initial trendline for 2Q24 shows that total CSX carload growth was 5% y/y, indicating further acceleration.
Although there was some drag from the 2% growth in ex-intermodal volume vs. intermodal volume of 7% (which is very encouraging as it is accelerating), again, I think this is not representative of any volume weakness as it is mostly a function of disruptions related to the Baltimore Bridge collapse. With time, ex-intermodal should revert back to growth mode, and the downside impact is being actively managed by management’s diversion of volume to other terminals.
Regarding intermodal, I am still very optimistic about the outlook because international intermodal is witnessing strong consumer demand and more consistent inventory levels. While domestic intermodal business grew at a more moderate pace vs. recent quarters, the constraint to growth is not on CSX but rather due to the competitive pricing environment in trucking (as commented by J.B. Hunt (JBHT) management in the latest call), driven by the >20% excess capacity situation.
The way I see it, the pricing situation will only recover once the oversupply of capacity eases itself, and this should happen as consumer spending picks up with the upcoming rate cut. Once pricing becomes less competitive vs. domestic intermodal, CSX’s domestic intermodal revenue should see an uptick, as I believe rail is still a better logistical choice due to the cost savings.
Moving down the P&L, revenue growth acceleration should provide margin improvement tailwinds (operating ratio comes down). Though the debate here is that CSX has retained the elevated employee base built up post-COVID,. For reference, CSX currently has ~23k employees vs. FY19’s 21k employees, but the cargo handled is almost the same (6.14 million in FY23 vs. 6.22 million in FY19). This puts a lid on how much margin can expand; however, my counterargument is that it provides CSX with more capacity to drive growth, which should still lead to margin expansion nonetheless.
Model update
Own calculation
I still see attractive upside to CSX’s shares, with my updated price target reflecting 45% upside (vs. the previous targeted upside of 33%). I have gone in depth into how my model works in my previous post, so I urge readers to check it out for the model mechanics. What I have changed in this current model is to flesh out my expectations for revenue growth and FCF margin expansion and to bridge to FCF growth of 5% CAGR over the long term. 1Q24 results showed very strong evidence that volume is recovering well once we adjust for the Baltimore Bridge incident, and I expect this trend to continue, driving CSX revenue growth back to historical (past 10-years) levels of ~3%, followed by a gradual deceleration to 2% in the terminal exit year.
My FCF margin is probably conservative, as I expect CSX to revert back to pre-Covid margin levels over a 10-year period. These assumptions translate to FCF growing to $5.3 billion in FY33. Discounting the cash flows and terminal value by today’s value, I got an intrinsic share price of ~$50.
Risk
I have already noted the macro risk in my previous post, so I will not repeat it here, but I would note that continued weakness in coal prices could swing CSX near-term performance more than expected. Given that this is a commodity that is largely driven by macro-events that are outside of CSX control, it could lead to CSX missing growth expectations.
Conclusion
In conclusion, my rating for CSX is a buy rating. The Baltimore Bridge incident impact is lower than expected, showcasing CSX’s operational strength. Importantly, volume trends are positive, with intermodal seeing strong momentum. While employee headcount remains elevated, it provides growth capacity. 1Q24 results reinforced my belief that growth is on the right track back to historical levels, and along with that, margins should improve as CSX sees operating leverage.
