What CSX’s Valuation Indicates
Railroad industry and valuation tool
The transportation sector (XTN) is cyclical in nature, and railroads aren’t immune to the oscillations, so cash earnings are significant for these companies. Thus, we have used the forward EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple to value CSX along with its US Class I railroad (XLI) peers.
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Enterprise value is calculated by subtracting cash and its equivalent from the sum of a company’s market value and debt. Since the forward EV-to-EBITDA multiple isn’t affected by capital structure mix, it’s extensively used to compare companies with different leverages.
CSX versus peers’ forward EV-to-EBITDA multiple
A close look at the above graph suggests that among the major US railroads, Canadian National Railway (CNI) has the highest multiple of 12.3x. This may be due to the company’s industry-leading operating margins. Plus, the lowest exposure to coal (revenue and carload-wise), as well as the strong intermodal business backed by industry-leading weekly volume growth in 2017, also supports CNI’s valuation.
CNI is immediately followed by CSX (CSX) with a forward EV-to-EBITDA multiple of 11.5x. The latter has similar operating margins compared with arch-rival Norfolk Southern (NSC). However, a significant premium has resulted from the company’s precision schedule railroading technique, which is expected boost margins significantly on a sustained basis.
Next, comes Canadian Pacific (CP) with a multiple of 11.2x. CP’s margins have improved significantly over the last four to five years. The company has operating margins just below those of its prime competitor, Canadian National. Union Pacific (UNP) has the lowest multiple at 10.4x, whereas Norfolk Southern has a forward EV-to-EBITDA ratio of 10.6x.
Investors should be cautious about CSX. If operating margins don’t improve as per market expectations, then the stock’s valuation may tumble.