Corporate earnings are rolling in. For certain cyclical industries, the results have not been very good. CSX reported Q2 revenue of $2.26 billion, down over 25% Y/Y. The decline in revenue was not unexpected. The coronavirus has brought the economy to a practical standstill, causing revenue and business activity to free fall. For the first 28 weeks of the year, total combined U.S. rail traffic fell by double digits.
CSX’s Q2 rail traffic and average selling price fell Y/Y by 20% and 7%, respectively.
Each of the company’s major product categories experienced a decline in revenue. The Industrial, Coal and Intermodal segments were hardest hit. Industrial revenue fell 31% on a 34% decline in volume and 5% increase in ASP. Coal fell 48% on a 44% decline in volume and 8% decline in ASP, while Intermodal fell 18% on an 11% decline in volume and an 8% decline in ASP.
CSX’s total rail traffic fell 20% Y/Y. Volume for the Industrial segment fell 34%, as automotive vehicle production fell due to plant closures and industrial production was negatively impacted by COVID-19. Coal volume declined due to competition from natural gas, and Intermodal was negatively impacted by a decline in global economic activity. Q2 GDP fell over 30%, which portends railroads could face more headwinds going forward.
CSX enjoyed price hikes last year that helped mask the decline in rail traffic. With the economy in the doldrums, it may be difficult to pass price increases along to customers. CSX’s top line growth could falter for the rest of 2020.
Operating Ratio Deteriorates
CSX was one of the U.S. railroads leading the charge on cost take-outs and becoming more efficient. The company had consistently reported an operating ratio below 60%. With the decline in scale CSX’s operating ratio deteriorated to 63%, up from 57% in the year-earlier period. Total operating costs were $1.4 billion, down 19% Y/Y. However, operating costs fell less than revenue, causing the company’s operating ratio to deteriorate.
Labor costs were $507 million, down 22% Y/Y. At 36% of total operating expenses, labor costs were CSX’s largest expense item. The amount included about $10 million of severance costs during the quarter, which should lead to future cost savings:
In addition to these efficiency improvements we had $39 million of lower incentive compensation expense in the quarter primarily reflecting lower projected payouts on existing plans.
Finally, the quarter included $10 million of severance costs resulting from a management restructuring to align our resources and improve efficiency. From these actions we expect $25 million in ongoing annualized savings.
Cutting into labor costs could have the biggest impact on the company’s operating ratio going forward, yet it could potentially hurt employee morale. Fuel costs and material costs fell 61% and 9%, respectively. Fuel costs could continue to decline due to low oil prices and declining volume.
The fallout was that EBITDA of $1.2 billion fell 29% Y/Y. EBITDA margin was 52%, down 200 basis points versus the year-earlier period. Margins could remain compressed until the economy fully reopens, which may not occur until the end of 2020.
CSX Remains Overvalued
The Dow Jones (DIA) has bounced over 45% off its March lows. The Federal Reserve and policymakers have stepped in to provide stimulus to financial markets, corporations and small businesses. Animal spirits have returned to financial markets despite the fact millions of Americans remain at home amid shelter-in-place policies. CSX has an enterprise value of $71 billion and trades at over 12x last 12 months (“LTM”) EBITDA. However, it likely does not reflect the headwinds facing CSX and the railroad industry.
CSX is up over 50% versus its 52-week low set a few months ago. Its share price may have gotten ahead of its earnings fundamentals. CSX remains a sell.
I also run the Shocking The Street investment service as part of the Seeking Alpha Marketplace. You will get access to exclusive ideas from Shocking The Street, and stay abreast of opportunities months before the market becomes aware of them. I am currently offering a two-week free trial period for subscribers to enjoy. Check out the service and find out firsthand why other subscribers appear to be two steps ahead of the market.
Pricing for Shocking The Street is $35 per month. Those who sign up for the yearly plan will enjoy a price of $280 per year – a 33% discount.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.