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[Updated: 5/28/2021] CSX Update

CSX Corporation (NYSE: CSX) has seen its stock price rise 36% over the last one year, in-line with the broader markets, with the S&P500 up 38%. The company shipped lower volume of carloads in 2020, owing to the impact of the Covid-19 pandemic on the overall demand. CSX reported its Q1 results last month, with revenue still down 1.4% compared to the prior year quarter. However, now that half of the U.S. population has received at least one dose of Covid-19 vaccine, the economy is expected to see a rebound, and it should bode well for CSX.

CSX is likely to see a pickup in demand across its segments – Merchandise, Intermodal, and Coal – over the coming quarters. While the overall rise in industrial production will bolster the demand for merchandise shipments, the expected increase in power consumption globally and a favorable comparison to the lows of last year will likely result in higher coal shipments over the coming quarters. Note that EIA forecasts 8% growth in the U.S. coal production in 2021.

Also, the trucking industry drivers shortage issue will bode well for railroad companies, such as CSX. Under intermodal transportation, trains are used for the long-haul portion of the shipment, while trucks are used to deliver goods to the originating intermodal terminal as well as the final destination, in case of domestic shipments. CSX’s intermodal business saw a solid 10% volume growth in Q1, a trend expected to continue in the near term. In another development, CSX recently announced its plans to acquire Quality Carriers, a bulk liquid chemicals transportation provider with North America’s largest tanker fleet. This acquisition will help CSX provide end to end transportation for chemical producers.

Although there are multiple positive developments for CSX, we continue to believe that the stock has only a little room left for growth, going by our CSX Corporation Valuation of $104 per share, based on expected adjusted EPS of $4.39 for full year 2021 and a P/E multiple of 24x. As such, it will be prudent for investors to wait for a dip to enter into CSX stock for better gains.

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[Updated: 3/31/2021] CSX vs. CP

We think that Canadian Pacific Railways currently is a better pick compared to CSX Corporation. CSX stock trades at about 6.9x trailing revenues, compared to around 6.4x for CP. While we notice that the difference isn’t large between both the companies, we believe that with the Canadian Pacific’s proposed acquisition of Kansas City Southern
KSU
, CP is a better pick over CSX stock. While business for both the companies has been hit during the pandemic, due to lower demand for power and oil & gas products, it is expected to see a rebound in 2021, with containment of the Covid-19 pandemic. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue growth as well as operating income and operating margin growth. Our dashboard CSX Corporation vs. Canadian Pacific Railway: CSX stock looks overvalued compared to CP stock has more details on this. Parts of the analysis are summarized below.

1. Revenue Growth

Between 2017 and 2020, CSX’s revenues declined by about 7% from $11.4 billion in 2017 to $10.6 billion in 2020. This can largely be attributed to the impact of the pandemic on the overall railroad demand. In fact, the 2020 revenue of $10.6 billion reflect a 11% y-o-y drop. Looking at Canadian Pacific, total revenue actually grew 17% from $6.6 billion in 2017 to $7.7 billion in 2020, though 2020 revenues were down by around 1% y-o-y. Barring 2020, CSX’s revenue growth was largely being driven by better pricing while volume has actually declined (including intermodal units). Canadian Pacific’s better revenue growth over the recent years can largely be attributed to its higher reliance on grain freight, which accounts for roughly a quarter of the company’s total revenues, and it has seen steady growth over the recent years, including 2020, offsetting most of the declines seen in some of the other segments, such as coal and energy.

2. Operating Income

CSX’s operating income grew from $3.1 billion in 2017 to $3.6 billion in 2020, as a drop in revenues was more than offset by improved margins, which grew from 27% to 34% over the same period. Looking at Canadian Pacific, the operating income grew from $2.3 billion in 2017 to $3.1 billion in 2020, led by both, revenue growth as well as margin expansion from 35% to 41%. In general, all railroad companies have been focused on reducing their operating ratio of late, which has boosted their bottom-line, a trend expected to continue in the near term.

The Net of It All

As we look into fundamentals, Canadian Pacific’s revenue growth (both 3-year and last twelve months), operating income, and operating margins, all compare favorably with CSX Corporation over the recent years. Still, CP stock trading at a lower multiple over CSX stock does not make sense. Now, we see that the difference isn’t big, but we believe that the valuation gap between CSX and Canadian Pacific will narrow going forward and CP stock will offer better returns for long-term investors.

Other than the fundamentals, there is more to CP stock. Canadian Pacific recently announced its plan to acquire Kansas City Southern, which is a step in the right direction for the company, in our view. The acquisition offer of $29 billion was made at a premium of 23% to Kansas’ stock value as of March 19, 2021. Canadian Pacific will also assume $3.8 billion debt of Kansas, included in the $29 billion offer. While the higher debt levels Canadian Pacific will have post Kansas’ acquisition is a concern, there are several positives associated with this deal. Firstly, the company expects synergies of $780 million, and the merger to be EPS accretive from the first year itself. Secondly, both the companies have an existing interchange in Kansas city, implying lower integration costs. Lastly, Canadian Pacific will become the first railroad to connect Mexico, the U.S., and Canada, implying better market reach. Overall, we believe that positives from this merger outweigh the concerns of higher debt levels for Canadian Pacific.

While CP stock looks like it can gain more, 2020 has also created many pricing discontinuities that can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Waste Management vs. Canadian Pacific.

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