Anemic Growth

One of the enduring ideas found in Dow Theory is that transportation companies can provide insight into the overall health of the US economy. As more goods are manufactured, more ore and coal mined, more corn farmed and cattle raised, the transport company’s business expands as they bring these goods to market. Even though we no longer have the same manufacturing based economy we did when Dow Theory was first embraced, it still provides clues as to the state of many parts of the economy.

Directionally, top line growth for CSX and the entire railroad industry has been in decline. CSX generates 15% of its revenue from Coal, slightly better than the 17% exposure for Norfolk Southern.  Not only are coal prices down, but CSX has also had to compete with low natural gas prices. Unfortunately it doesn’t look to abate anytime soon; rail traffic is a forerunner of economic activity and the global economy is worse than the powers that be would have you believe.

Amid anemic revenue declines, a key measure will be how efficient the company is with the revenue it can generate. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) of $1.0 billion was 11% less than the $1.1 billion generated in the year earlier period. CSX got some pick up in fuel costs which fell from 9% of revenue to 6% of revenue this quarter. Of note,  labor costs rose slightly to 30% of revenue from 29% last year. Management cut headcount by roughly 4,000 over the past year, and will likely cut more jobs going forward.

The CSX (NASDAQ:CSX) network covers two-thirds of the US population and 60% of US manufacturing. So what do they have to say about the health of American industry? At a glance, it doesn’t look good. Revenue in the first quarter fell 14% compared to the previous year, operating income by 16%, and earnings by 19%. Volumes are down. As a consequence, overcapacity triggered a 9% contraction in revenue per unit. Management has stated macroeconomic headwinds intensified in 2015 and this is expected to continue in 2016. The strong dollar and low commodity prices are a theme in explanations CSX’s poor performance. To deal with the tough times CSX is focusing on cost cutting and efficiency gains. They plan to reduce headcount in operations and general and administrative areas. There have been 2,200 train and engine workers furloughed. There are also capacity cuts underway with 400 trains going into storage and unprofitable segments (for instance, those leading to shuttered coal mines) closing down.

By streamlining operations and closing facilities within its Coal network, management claims to have generated $130 million in efficiency gains. CSX expects $250 million in efficiency gains for the full year. Cost cuts mirror those being initiated by Norfolk Southern and Canadian National. It appears competitors are attempting to close the gap between their EBITDA margins and the 49% margins generated by Canadian Pacific.

 

 

This article is written of my own opinion and information gathered from various financials, and CSX’s own first quarter earnings report.