CSX Stock: Keeping the Growth Engine Running (NASDAQ: CSX)

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Investment thesis

CSX Corporation (NASDAQ:CSX) is one of the 5 largest North American railroad companies and has been the backbone of the US economy for the past 100 years. CSX and South Norfolk (NYSE: NSC) operate essentially as a duopoly in the East. This dominant market share and network effect provides a distinct advantage competitive advantage, and CSX has long been a very profitable and cash-generating business. They reported a strong quarter with substantial increases in revenue, operating profit and EPS, and I expect that to be the case for the foreseeable future. In addition, they have just announced an increase in the dividend. I believe CSX is a great stock for the long-term investor because:

  • CSX released a strong quarterly report with a 21% YoY increase in revenue, a 12% YoY increase in operating profit and a 27% YoY increase in EPS.
  • Their 2021 results reiterated the railroad’s efficiency and environmental sustainability, and their economic moat will be maintained going forward.
  • There are signs of easing supply chain disruptions, which will positively contribute to CSX’s growth and profitability going forward.

Top 5 Largest North American Railroads

Top 5 Largest North American Railroads (Sound Maps)

Still good quarterly results

Overall, CSX had a very strong 4Q 2021. Revenue was up 21% YoY. Most of the segments (Chemicals, Agriculture, Minerals, Coal, etc.) contributed to the revenue growth, except for Automotive due to the persistent chip shortage problem. Operating profit rose 12% to $1.3 billion for the quarter, and EPS rose 27% to $0.42 per share.

Highlights of 4th quarter results

4th Quarter Earnings Highlights (CSX Investor Relations)

Due to ongoing labor shortages and inflation, overall operating expenses increased quite substantially from $1.6 billion in Q4 2020 to $2.0 billion in Q4 2021. However, CSX management has done an excellent job of controlling costs where possible (e.g. maintaining a strong hiring pipeline, targeted investments to drive fluidity, etc.) and passing the cost on to customers. Operating margin declined (i.e. operating ratio increased by 310 bps), but EPS increased significantly from $0.33/share in Q4 2020 at $0.42/share in Q4 2021.

Change in operating expenses

Change in operating expenses (CSX Investor Relations)

Reflecting this strong financial performance, CSX announced a dividend increase of 7.5%. This is the 17th consecutive year of dividend growth and demonstrates the strong cash-generating nature of their business. In addition, they have been very favorable to shareholders. Outside of 2020, they’ve invested at least $1 billion a year in share buybacks since 2016. They just bought back $2.9 billion worth of common stock in 2021. profitability and operating cash flow, I expect the generous returns to shareholders to continue. .

Economic gap, energy efficiency and sustainability

In 2021, CSX demonstrated that rail is the most fuel-efficient form of ground transportation and that CSX is committed to minimizing carbon footprint. CSX was the most fuel-efficient Class 1 railroad in the United States and helped reduce carbon dioxide emissions by 11 million metric tons. This is equivalent to the electricity consumption of 1.9 million homes for one year or 2.3 million passenger vehicles driven for one year.

Given the growing interest in reducing the carbon footprint, I expect railroads in general and CSX in particular to maintain their advantage over other transportation (eg trucking). Additionally, being the most fuel-efficient among the railroads will give CSX a competitive edge and better market share. Therefore, I think CSX will maintain its already strong economic moat going forward.

Energy efficiency and sustainability

Energy Efficiency and Sustainability (CSX Investor Relations)

Mitigate supply chain disruptions and growth potential

Supply chain disruption has created problems for everyone in almost every industry for the past two years. Automakers are still struggling to get chips and parts to make new cars, and electronics makers are struggling to put their products together. This shortage has pushed up the prices of various products and aggravated inflation. It’s been a pretty tough few years. Reflecting these challenges in the supply chain, railway volume is struggling to gain momentum even with the economic recovery.

The good news is that as Covid-19 infection rates drop and travel restrictions ease, experts are seeing improvements in the supply chain. During the latest earnings call, CSX’s CEO mentioned that the expected easing of supply chain disruptions will put CSX in an excellent position for future growth. He also mentioned that the demand for their service is only increasing, which bodes well for their steady growth trajectory.

Global Railway Market Growth

Global Railway Market Growth (Tech Navio)

Estimation of intrinsic value

I used the DCF model to estimate the intrinsic value of CSX. For the estimate, I used EBITDA ($6,643M) as the cash flow indicator and the current WACC of 7.5% as the discount rate. For the base case, I assumed 5% EBITDA growth (5-year average) for the next 5 years and zero growth thereafter (zero terminal growth). For the bullish and very bullish case, I assumed EBITDA growth of 6% and 7%, respectively, for the next 5 years and zero growth thereafter. With supply chain issues easing and the economy picking up, 6% and 8% growth looks achievable.

The estimate revealed that the current share price represents an upside of 10-15%. With a recovering economy and a loosening supply chain, I expect CSX to achieve this upside and maintain growth going forward.

Price target

Upside down

Base case

$37.13 7%

Bullish case

$38.64 11%

Very bullish case

$40.19 16%

The assumptions and data used for the price target estimation are summarized below:

  • WACC: 7.5%
  • EBITDA growth rate: 5% (base case), 6% (bullish case), 7% (very bullish case)
  • Current EBITDA: $6,643M
  • Current stock price: $34.66 (2/21/2022)
  • Tax rate: 25%

Risks

The railway sector is a very capital-intensive and energy-intensive industry. Railways, locomotives and wagons need continuous repairs and CAPEX to sustain activity. Therefore, the increase in raw material costs (e.g. steel) and labor costs will negatively impact the business. In addition, the increase in oil prices will reduce the operating margin. However, CSX has been investing in improving energy efficiency and operational efficiency and effectively managing competing risks for a long time. I don’t expect this time to be any different. The 2021 financial result demonstrates their ability to manage risks.

While I expect the odds to be slim in the near future, there is always the possibility of industry-disrupting technologies emerging. For example, Google (NASDAQ:GOOG) and JB Hunt (NASDAQ: JBHT) are working on the development of self-driving freight trucks, which would significantly improve efficiency and reduce costs for the trucking business. However, this technology is still in the development stage and it is far from being commercialized.

Conclusion

The railroad has been the backbone of the American economy for over 100 years. CSX has been an industry leader for a long time. Their operational efficiency, energy efficiency and environmental sustainability prepare them well for future long-term growth. The result for the 4th quarter of 2021 (and overall for 2021) clearly demonstrates their financial and operational solidity. Global inflationary pressures and supply chain disruptions may test their business, but I expect them to be able to resolve these issues to sustain future growth. I expect a 10-15% upside from here, as well as an annual dividend increase.


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