Railroad industry valuations
On July 5, 2017, CSX Corporation’s (CSX) stock reached a 52-week high of $55.3 per share. But the true test of investor euphoria won’t come until July 18, 2017, when CSX announces its 2Q17 results.
Railroads are an extensively capital-intensive industry. Roughly half of companies’ capital expenditures go into maintaining existing infrastructure, and the remaining capital investments go to procuring rolling stock and track expansion. For this reason, to value CSX among its US Class I railroad (XLI) peers, we’ve used the forward EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple.
CSX’s forward EV-to-EBITDA multiple
Enterprise value is calculated by deducting cash and cash equivalents from the market value of company’s equity and debt. For highly capital-intensive companies like railroads, this multiple makes the most sense because EBITDA can’t be manipulated compared with earnings, and so we get a clearer valuation picture.
The forward EV-to-EBITDA multiple compares the overall value of a company relative to its cash profits. Since this multiple is capital-structure neutral, it’s widely used to compare companies with different debt levels.
CSX versus peers
Among US Class I railroads, Canadian National Railway (CNI) has the highest forward EV-to-EBITDA multiple of 12.9x. CSX’s multiple is 11.7x, while Union Pacific’s (UNP) is 10.1x—the lowest. Norfolk Southern (NSC) has a multiple of 10.3x.
CNI’s performance so far in 2017 has been the best in the entire Class I group in terms of volume. CNI also leads the pack in operating margins, and its EBITDA margin is the highest among peers.
Notably, for CSX, the market is betting on significant margin gains from its implementation of precision schedule railroading. Hunter Harrison, CSX’s new CEO (chief executive officer) is expecting CSX to deliver a free cash flow before dividends of nearly $1.5 billion in 2017.
Investors interested in exposure to industrial stocks can consider investing in the First Trust Industrials/Producer Durables AlphaDEX Fund (FXR). Major US railroads make up 5.3% of FXR.
Expectations are thus running high for CSX. But investors should still be cautious about the stock. Any less-than-expected margin improvement could wipe out the huge premium placed on the company’s stock.