What's Going On? Quick Takeaways on CSX

“Talk to me, so you can see
Oh! What’s going on? Yeah, what’s going on? Ah, what’s going on?”
/Marvin

Greetings;

D’oh!

CSX slightly missed numbers late yesterday. So today they’re down 10% - on volume fears. People – we see volume numbers every single week! We stated only yesterday the 5 reasons traffic was lousy (economy/trade/(lingering) weather/truck overcapacity/PSR – and tough comparisons (tax cut, etc). 2019 estimates for the rails had already been coming down, and as we stated, the rails were going to have to back off their Q1/19 “Poor start of the year (due to Acts of God but we reiterate FY2019 Guidance” stance. If “reiterate” was the word of Q1, we knew that “capitulate” would be the phrase for Q2/19 – in the USA anyway. Just a day ago, CP reported a great quarter; retail sales numbers were “strong” and manufacturing output increased, and JBHunt’s earnings “signaled (that) the Transport Sector could be turning a corner” (WSJ); now, today, CSX’s statement (after the close yesterday) of the obvious causes investors to take profits in the best performing group in the sector, the railways.

So what is the big surprise? And CSX actually had a strong quarter despite the headwinds, outperforming the industry on the merchandise side (the PSR sweet spot), with most of the volume issues either strategic (de-marketing some intermodal) or simply cyclical/political (and thus not secular). So let’s quickly look at the CSX Q2/19 results and webcast highlights:

  • Volume declined 4% units (-3% RTMs) – and revenue declined 1% despite the mix hit coming from the 7% YOY drop in export coal

    • The Philadelphia refinery that exploded accounts for 1% of CSX usual annual volumes

    • However, within merchandise 5/7 commodities were up, and overall merchandise/car-load volumes were up 1% for the quarter – that’s actually a singular achievement in this environment (we look forward to the comparison with NSC next week)

    • Intermodal was down worse that I expected (volumes down 10%, revenues down 11%) but, remember, they planned to shed 7-8% if the business this year after shedding 7% last year – beginning in the fall, so lapping the de-marketing period at the end of this quarter will provide an optical boost; Foote said IM still enjoyed a 15-20% price gap to truck (which, along with JBHT earnings, should have been a healthy rejoinder to those that question intermodal’s future value proposition); in fact, CMO Mark Wallace – who, oddly, as with COO Ed Harris, was not on the prepared portion of the call but did take Q&A – said the secular growth rate for domestic intermodal might no longer be double-digit but was still GDP +2-300 bps; more time on the future of intermodal at CSX, the competitive challenges from truck and from rail (NSC), etc could have – and should have been spent. We’re getting to the point where another investor conference might be (is) warranted….

  • Yet earnings were up 7% YOY (consensus called for +10% but likely didn’t take into effect the export coal decline, inevitable, but early); CSX. CEO Foote noted it could still improve the OR by a point a year even with down volumes – and revenues….It is true that real estate gains were significant (1—bps in OR) but in this stage of CSX PSR transformation, it would be unfair to call that “unusual”….

  • Capitulate, not reiterate - And there it was….my thoughts when at the end of the prepared remarks Foote took down FY19 guidance from a revenue growth rate of 1-2% to a decline of a similar amount, without (above) any change in their OR guidance. Foote essentially said he almost felt compelled; he was bound by the SEC to do this – but remember its all volume-related – and that the biggest issue is the confusion stemming from “puzzling” mixed signals. Yes, it really wasn’t the direction (up or down), it was the uncertainty. Once it is clear that a recession has been reached (or not), CSX can quickly bring down variable costs accordingly (or not). This is, in fact, a historic railroad strong point; the key is how much of a lag is need to ascertain the actual economic trend. And for now, neither CSX nor their customers are forecasting a recession….

  • But the bottom line here was that despite the headwinds the OR improved by 120bps to an amazing 57.4% - crew starts were down 5%, more then the traffic decline, equipment rents were lower, etc

    • Operating metrics improved YOY, if not sequentially – velocity by 14% and dwell by 6%

    • O/T originations (88% and arrivals (still only 53%) followed a similar pattern

    • Safety showed remarkable improvement (P/I by 22% and train accidents by fully 54%)

  • Left unanswered: Why the absence of the key players on the (prepared or otherwise) call? That isn’t the PSR way, developed in part by Foote as the IR head during the CN (mothership) original “scheduled railroad” transformation. What about the recent turnover, and succession plans, etc? there was one reference in the Q&A to the new head of strategy, that was it. how is their current state of relationships with customers – and with the STB?

  • Still, why was July 17 the day Wall Street woke up to the economic/political near term challenges to rail volumes (and began to ignore operational reform and performance)? It does give one confidence in the rational thinker over the mob mentality….

Anthony B. Hatch
abh consulting
http://www.abhatchconsulting.com
abh18@mindspring.com