CSX Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

CSX Corporation is a leading transportation company in North America that provides rail-based freight transport services and, through an intermodal business, connects rail to other transportation modes.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

CSX operates a vast rail network, spanning more than 20,000 route miles across the eastern United States and parts of Canada. The company provides a crucial link in the North American supply chain, transporting a wide range of goods, including:

Merchandise: Chemicals, agricultural and food products, automotive, metals, equipment and other commodities, accounting for 43% of revenue in 2023.
Intermodal: Consumer goods carried in containers that connect the railroad network with other modes of transportation, making up 17% of revenue in 2023.
Coal: Exported and domestic coal for power generation, steel manufacturing, and other industries, accounting for 14% of revenue in 2023.
Other: Includes revenue from trucking operations, real estate sales, and other non-core services, accounting for 4% of the revenue.

The business’s main revenue sources are derived from the transportation of freight as performance obligations that arise from its contracts with customers and the revenue is disaggregated by market as this best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.

Industry Trends

The railroad industry in North America is relatively consolidated, with a few major players dominating the market. It is a capital-intensive business with high fixed costs, making economies of scale a significant factor in competitive positioning. However, companies that can leverage their infrastructure and geographic reach to connect customers with various end markets, especially in the eastern United States, are more likely to succeed.

The industry is sensitive to macroeconomic factors, such as economic growth, commodity prices, and trade policies. In 2023, the company saw a decline in total revenues and profits due to lower export coal demand, lower merchandise volume and the impact of price declines in some commodities, higher fuel prices and interest rates.

These changes in trends are expected to continue in 2024.

The demand for intermodal transportation has been rising because of its flexibility, cost-effectiveness, and the ability to connect rail with trucking and other modes of transportation. Trucking revenue, despite accounting for a smaller share of CSX’s revenue, is an area of growth where better pricing discipline and utilization are being emphasized.

Sustainability is becoming a major focus in the transportation sector, and companies are increasingly under pressure to lower carbon emissions and operate more efficiently and environmentally consciously.

These sustainability efforts include increased efficiency of fuel use, investments in electric charging infrastructure, and promoting less polluting options.

Competitive Landscape

CSX faces competition from other major railroads, such as Norfolk Southern and Union Pacific. It also faces competition from other modes of transportation, like trucking and shipping. However, a few factors allow CSX to stay highly competitive:

Extensive network: CSX’s expansive network makes it easy to transport goods to many destinations
Intermodal capacity: With large intermodal volumes, they are able to offer flexibility to clients.
Strategic Location: The company’s focus on the Southeast has a large market that can be consistently tapped.
Investment: The company is continuously investing in its network and infrastructure to maintain its high quality and efficiency.
Partnerships: The partnerships and business connections the company has built over decades gives it strong competitive positioning.

Financial Deep Dive

Let’s analyze some of the most recent reports from the company. First, let’s go to CSX Corporation’s 10Q report for the three months ended on March 31, 2024.

Revenues: Total revenue decreased by 1% to $3.68 billion in Q1 2024, mainly driven by lower merchandise and intermodal volumes, although these decreases were partially offset by pricing gains.
Operating Income: Operating income was $1.38 billion, a decline of 8% compared to the same quarter of 2023.
Operating Margin: Operating margin was 37.8% down from 39.8% in Q1 2023.
Net Earnings: Net earnings were $885 million.
Diluted EPS: Earnings per diluted share were $0.46, which is up 5% year over year as a result of fewer outstanding shares due to share repurchases.
Expenses: Expenses increased by $180 million or 9%, YoY. The increase in operating expenses was driven primarily by increased labor and fringe costs, increased purchased services and other costs, increased equipment and other rents, and partially offset by a drop in fuel costs.
Free cash flow: was -$115 million for the three months of 2024.
Working Capital: Was $1.1 billion.
CapEx: Planned capital investments for 2024 are expected to be approximately $2.3 billion.

The latest 10-Q report shows a very challenging quarter for the company. Operating income and margin declined substantially, however, they did produce positive net income and increased their earnings per share by 5%.

Now let’s take a look at the latest CSX Corporation 10Q report for the three months ended on September 30, 2024

Revenue: Total revenues increased 1% year-over-year to $3.819B in the 3rd quarter of 2024.
Operating Income: Operating income increased 7% year-over-year to $1.4B.
Operating Margin: Operating margin increased to 37.4%.
Earnings per Diluted Share: Increased 12% YoY to 0.68$ per share.
Expenses: Expenses increased 7% YoY to $2.27B, driven mostly by labor and material costs.
Free cash flow: Increased from $130 million in 3Q23 to $590 million in 3Q24.
Working Capital: The working capital is $1.13 billion, which has slightly decreased YoY.
Capital expenditures: Are forecasted to be approximately $2.5 billion for 2024.

The latest 10-Q shows better performance by the company. A mix of a higher volume of products and price increases improved the revenue and profitability year-over-year. While expenses still rose, they were not enough to offset increased profitability. Moreover, the free cash flow was positively impacted.

CSX’s MOAT Rating: 3 / 5

CSX possesses a narrow economic moat, underpinned by several factors, yet limited by market forces and competition. Here’s a breakdown:

While the moat is not a huge advantage, the consistency and sustainability of the business gives it more weight.

Scale and Distribution: Its extensive rail network provides economies of scale, enabling the company to operate at lower costs per unit compared to smaller competitors. The geographic reach gives a logistical advantage. However, it is limited to the eastern side of the US and parts of Canada.
Switching Costs: For customers that have direct rail connections, the switching cost might be pretty high.
Some Niche Moats: Parts of their Intermodal and Trucking businesses enjoy a limited competition in their areas that give them a slight advantage.

Despite these factors, the moat is not very wide as competition is still fierce in the industry. The company can’t increase prices substantially due to regulatory restraints in most parts of its business. The company also has to continually compete with substitutes like trucking companies.

Legitimate Risks to the Moat and Business Resilience:

Competition: There is significant competition with other major railroads and other modes of transportation like trucks.
Macroeconomic Factors: Economic downturns, fluctuations in commodity prices, and changes in trade policies can significantly impact the company’s business performance. As seen in 2023, the industry is susceptible to changes in the economic climate.
Regulatory Changes: New regulations and changes in existing rules for the railroad industry could affect operations, costs, and the profitability of the business. This is something that is not totally within control of the management.
High Capital Expenditure: The industry is inherently capital intensive, requiring large investments in infrastructure and equipment. Any increase in CapEx can have a material impact on the Free Cash Flow.
Technological Disruption: Innovation and new technologies could disrupt existing processes and erode competitive advantages. As new technologies appear, it will be harder to be on top of the industry.
Labor issues: As a unionized industry, strikes and labor disputes can cause major disruptions.
Geopolitical Risks: Global market conditions, wars, political stability and other factors can severely impact trade volume, prices, and the business of the company.

Despite those risks, the company is well-established and has a wide variety of products and services. They also benefit from their strong network and infrastructure, and strategic position that will make them more resilient during economic downturns.

Understandability Rating: 2 / 5

The railroad business model seems very simple on the surface—transport goods from A to B, but the dynamics are very complex. Here is a list of difficulties that make the company hard to understand and hence give it a low understandability rating:

Complex Financial Statements: The complex relationships of many subsidiaries and the high number of intangible assets on the balance sheet make it difficult to understand the fundamentals of the company. The different types of revenues, from various business segments, are also difficult to grasp and need deeper analysis.
Industry Dynamics: The economic dynamics of the industry can be hard to understand. There are many moving parts in the supply chain of a commodity-based company like CSX and those are hard to keep track of. The company is exposed to commodity prices and is subject to various regulations that add to the complexity of the business.
Economic Factors: The company is heavily reliant on the economic climate of the region in which it operates, and the company’s financials are deeply impacted by macroeconomic conditions that make forecasts difficult.
Government and Regulation: Different governing bodies regulate all the key aspects of the business, from transportation safety to fair pricing for commodities. Changes in regulatory structure could negatively affect profitability.
Cyclical and Long-Term Nature: Companies in cyclical industries are more difficult to value, as earnings fluctuate more than in other industries. A complete business cycle can take more than a decade to complete, which makes it harder to predict future earnings and cash flows. The long-term trends, market share, and ROIC, that are the fundamental aspects of value creation, are also difficult to track during such periods.
Heavy Infrastructure: A lot of the business relies on the infrastructure and its associated maintenance costs. While these can be planned ahead, any unplanned event may result in substantial costs.

Balance Sheet Health Rating: 4 / 5

CSX demonstrates good balance sheet health, characterized by reasonable debt levels, high liquidity, and a positive equity ratio. This strength allows the company to successfully navigate economic downturns and invest in future growth initiatives. Here is a detailed explanation:

Liquidity: The company’s liquidity position is very strong. As of the most recent report (3Q 2024), it has cash and cash equivalents of $1.48B with access to a revolving credit facility.
Debt: The company’s Long-term debt is $18.5B, with low interest rate obligations and credit ratings.
Tangible Book Value: It is not necessarily an indicator of the company’s value, but it is a good indicator of the assets that the company owns. From the numbers, the net tangible assets are more than 1/3 of the market cap, indicating that the company has good and tangible assets that are not just intangible items.

Overall, the company’s balance sheet looks quite healthy with ample liquidity, manageable debt levels, and a positive equity ratio.

Recent Concerns, Controversies and Management Commentary

The company has been consistently stressing their focus on efficiency and improving service, as well as building partnerships and customer relations. This was echoed in a variety of earnings calls where management focused on the turnaround time for cargo and improving operational efficiency.

They have been consistently addressing the issue of lowering costs, both through operations improvements and better supplier relationships.

As a response to the problems faced over the last year, the company has been cutting costs, and improving operations. In their Q3 report and earning calls, the management has repeatedly mentioned the positive effects of the implemented turnaround plans. There has been an overall focus on reducing costs and improving operations as well as improving profitability and long term outlook. They are focused on “pricing for value” and improving margins through that.

Management was positive about the future, seeing positive changes because of their turnaround plans and improved economic forecasts.

To conclude, CSX is a stable company that has faced some challenges over the last couple of years but is now poised for growth. The company shows good moat strength due to its strategic location and the high barriers of entry, but could have a wider moat in case of higher demand for the industry. Financials are fine and the balance sheet is reasonably healthy. The management has taken steps to improve its margins, and the stock is likely to yield good results over the next few years.