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How Is CSX Valued by the Market ahead of 3Q16?

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CSX, the fourth-largest US freight railroad

CSX Corporation (CSX) is the fourth-largest US freight rail system, accounting for 13% of originated railroad traffic. Intermodal accounts for 47% of CSX’s total originated traffic, while 53% comes from commodities.

It’s worth noting that on September 30, 2016, CSX shares reached a 52-week high, closing at $30.60. There’s been a considerable rise in volumes of CSX stock in recent trading sessions. Institutional investors such as Community Bank of Raymore, Cambiar Investors, and Huntington National Bank have recently increased their stake in the company.

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Forward price-to-earnings multiple

A forward PE (price-to-earnings) multiple represents the dollars payable today for every dollar of next year’s earnings per share. Historically, CSX’s valuation has been lower than its peers such as Norfolk Southern (NSC), Union Pacific (UNP), Kansas City Southern (KSU), Canadian National Railway (CNI), Canadian Pacific (CP), and Genesee & Wyoming (GWR)

CSX’s current forward PE multiple is 16.2x. The peer group’s forward PE multiple is 17.6x. This translates to a discount of 8%. Even against the S&P 500’s forward PE of 18.5x, CSX trades at a discount of 12.5%.

All the major railroads in the United States make up 6.5% of the portfolio holdings of the First Trust Industrials/Producer Durables AlphaDEX ETF (FXR).

Why is CSX’s valuation premium low?

Presently, CSX is a US Class I railroad that’s highly exposed to coal. The company ranks second, next to BNSF Railway (BRK-B), in terms of its share of coal revenues to total revenues. With coal’s 20% share in total freight revenues, CSX remains among the most levered rails to coal against the average share of 17% for other Class I railroads.

The growing use of natural gas as a substitute for coal will dampen the coal business going forward. However, the EIA (U.S. Energy Information Administration) expects the natural gas share of electricity generation in 2017 to fall to 33.3%. The coal share of generation is expected to rise to 31.0%.

On the other hand, lower oil prices are proving to be beneficial to truckload companies. This, in turn, is reducing intermodal business prospects in the medium to long haul lanes. CSX’s intermodal volumes have been falling in the mid-single digits in recent weeks. Even if intermodal grows, CSX’s margins are much less compared to other commodity merchandise margins.

Stock buybacks and savings from efficiency booster programs should result in CSX stock rising in the coming quarters.

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