CSX Stock: Buy on the Dip?

A look at the recent earnings from the East Coast railroad and its outlook for 2022.

A look at the recent earnings from the East Coast railroad and its outlook for 2022.

The decline in railroad stocks in 2022 has created an exciting buying opportunity in the sector. However, stocks usually decline for a reason. In the case of East Coast-focused railroad CSX ( CSX -4.90% ) and others, there’s a fear that supply chain constraints and labor issues might negatively impact the company.

Moreover, volumes might be weaker on the demand side, given any economic slowdown. Does it all add up to make CSX a buy or not? Here’s a look at what the latest earnings report can tell us about the company.

A freight train.

Image source: Getty Images.

CSX’s first-quarter earnings

Investors well received the earnings, and for good reason. A substantial increase in revenue (up 21% year over year) led to a 16% increase in operating income. Turning to the key metric in the railroad sector, namely the operating ratio (OR), there was some mixed news.

The OR represents operating expenses divided by revenue, so a lower number is better because it means a higher operating profit margin. In recent years, the big story coming out of the railroad sector has been all the major U.S.-listed railroads driving to reduce the OR via implementing precision scheduled railroading (PSR) management techniques.

PSR aims to run the same amount of volume while using fewer assets. Its practitioners seek to achieve this by improving operational metrics, for instance, increasing train velocity and reducing terminal dwell (the time a carload stays idle at a terminal location), increasing train length, and other measures.

CSX’s operating ratio

Unfortunately, CSX’s OR increased (remember, a lower number is better) to 62.4% in the first quarter compared to 60.9% in the same period last year. Superficially, that’s not good news, and it supports the view that the railroads will struggle to lower the OR in 2022. However, there are three reasons why that may not be the case.

First, during the earnings call, CEO James Foote said the OR “increased by 150 basis points to 62.4%, but remember, this rate includes approximately 250 basis points of impact from Quality Carriers and the impact of higher fuel prices.”

Fuel prices are unlikely to rise forever, and the increase in the OR from the acquisition of Quality Carriers (bulk liquid chemicals truck transportation) in 2021 will drop off in the future.

Second, in common with other transportation companies, such as Delta Air Lines, CSX ended the quarter a lot stronger than it started. Foote noted the negative impact of severe weather and the omicron variant at the start of the year and then said, “as we moved into March, operating conditions began to gradually improve, and we do see indications that this momentum is continuing.”

Third, management spent a lot of time on the earnings call, highlighting its efforts to add crew resources to meet volume demand and provide good service. Foote candidly spoke of the need to hire engineers and conductors, and management disclosed that it had an average of 561 employees in training in the first quarter, compared to just 108 in the same period last year.

Moreover, CSX made 303 conductor promotions in the first quarter, compared to just 35 in the first quarter and 156 in the fourth quarter of 2021.

All told, there’s reason to believe CSX’s OR is going to improve in the future, and the company will meet its service objectives while improving its key PSR metrics.

Freight trains.

Image source: Getty Images.

Volume demand

Generating revenue increases through increased pricing and fuel surcharges is one thing, but CSX still needs underlying volume growth. Unfortunately, CSX’s overall volume did decline 2% in the quarter.

At the start of the year, management expected volume growth to outpace gross domestic product growth, but as Foote noted, “there is a number of new moving parts going on right now.” For example, the downgrade to automotive production expectations is undoubtedly going to have a negative impact (automotive volume was down 10% in the first quarter) on CSX. Moreover, any economic slowdown is likely to negatively impact CSX’s end markets, including chemicals, minerals, and metals.

On the other hand, executive VP Jamie Boychuk noted that the war in Ukraine and the lack of supply of commodities and steel products from Russia and Ukraine to Europe could lead to increased volume flows of U.S. commodities/steel products through the East Coast and on into Europe.

A stock to buy

The underlying OR improvement is good news, and CSX has good trading momentum and is preparing to improve its service capability and meet potential volume demand. However, there’s no denying that automotive production will be lower than expected in 2022, and global economic growth expectations have also been nudged down due to the ongoing conflict. CSX’s volume growth, as a result, might not be as strong as expected in 2022. That’s cause for caution.

Read this article on Motley Fool

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