Buy, Sell or Hold: This is One Train You Don't Want to Miss

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Railroads have long been considered the veins and arteries of the economy.

As the railroads go, so goes the business of America.

That's why rail statistics have long been one of the signs most closely watched by prognosticators and economists.

Of course, that's not as true as it used to be. In fact, most railroads have actually done quite well lately – even in the face of a down economy. It's counter-intuitive but it's true.

One of them is CSX Corp. (NYSE: CSX). It's my favorite U.S. railroad stock.

Because even with the external weight of a delinquent U.S. economy strapped to its caboose, shares of CSX Corp. continue break out to new 52-week highs.

The question for investors now is whether or not this train has already left the station.

Here's my take on where CSX is headed from here…

Trouble in the Coal Business

Today, there are basically four major railway companies in the United States. CSX is the second largest with a market cap of $25.8 billion and operates 21,000 miles of track that cover two-thirds of the U.S. and Canada.

CSX's primary region is the Appalachian mountain range with its vast supply of coal. CSX is responsible for moving the heavy substance from the coal mines to the power companies.

The problem for CSX is that coal, for many good reasons, is an unquestionably unloved commodity. Putting aside the environmental aspects and coal's use as a political football, the other "good reason" coal is being hurt is that it is more expensive than alternatives such as natural gas.

Many of the utilities that CSX serves have switched to natural gas as a cheaper and cleaner alternative. The company recently reported that its coal revenues were down by 13% in Q1 2013, due to 10% drop in volumes.

CSX management also estimates that coal volumes in the U.S. will decline 5% to 10% in 2013 due to the utilities having to burn through their excess supply of coal.

But all is not lost, once coal prices stabilize, CSX's Chairman, President and CEO Michael Ward said. "The underlying strength of our business continues, even with the transition that is taking place in the domestic coal market," Ward said.

With these two negative factors in motion – the slow economy and the lack of demand for coal – how did CSX manage to beat analysts' expectations in Q1 2013 by reporting a profit of $459 million or 45 cents per share?

Not All Demand is Grinding to a Halt

One significant aspect to note from CSX's most recent quarterly report is that if the company were to exclude coal revenues the total for all other revenues would be up 5%.

So while demand for coal may be down, much of the company's revenues have been compensated for by the demand for its other products such as chemicals.

Ironically, an 11% growth in CSX's chemicals business was driven by the need for alternative energy types such as crude oil, gas and fracking sand.

What we can broadly extrapolate from CSX's revenues is that consumption of these commodities is not going to stop regardless of how the economy is doing. There will always be a necessity to ship items that people need (like energy) rather than what people may want.

One of the beautiful things about the rail business is that as the landscape changes and new products come to the forefront, a railway like CSX can adapt to meet the needs of these new consumers quite adeptly.

Delivering these needs by rail is still the most cost-efficient way to do so – ahead of costly trucks and bureaucratic stuck-in-the-mud pipelines. Is it any wonder that Warren Buffett's Berkshire Hathaway (NYSE: BRK-A) owns Burlington Northern Santa Fe Railway?

As for CSX, it is one efficient, well-oiled machine. The company trimmed down costs and streamlined its processes. CSX began the year estimating it would have $130 million in productivity savings but has now raised its estimates to $150 million for 2013. This is on the heels of $200 million in productivity savings in 2012.

Along with chemicals, CSX is seeing a nice 4% increase in the need for intermodal transport (containers that are delivered partly by truck or ship). This is taking some of the business away from the costlier trucking companies.

Buy This One for the Long Haul

Now imagine if the U.S. economy were to somehow manage to speed up growth, this will be a huge boon for a company like CSX.

Or better yet, what if there is resurgence in coal? Currently, the price of natural gas is creeping higher and utilities might be looking at switching back to coal (at least partially) yet again.

But in the meantime, while the economy is still down and natural gas is still the energy of choice, CSX continues to just chug along.

In fact, the company is expecting a compounded annual growth rate of 10% to 15% through 2015. It continues to trim down costs and is targeting a high-60s operating ratio by 2015. CSX is also buying back $1 billion worth of shares over the next two years and pays out a healthy 15 cents per share, or 2.4%, dividend yield.

That's why I am a BUYER of CSX Corp.

Unfortunately, the word is out on CSX and its share price is making new 52-week highs almost daily.

The stock has gone up over 28% year-to-date and it looks as if it has already "left the station."

Normally, I would like to see a pullback on a stock that is making 52-week highs. But I don't want to miss this bullet-train.

That's why a better approach may be to purchase a portion now and wait for a pullback before adding the remainder of the position.

Either way, CSX has all the makings of a great long-term play.

[Editor's Note: If you have a stock you would like to see us analyze in a future issue, leave us a note in the comments below and we'll add it to our list.]

About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.

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  1. Bill Cowart | May 20, 2013

    Please consider reviewing PDLI

  2. peter baird | May 26, 2013

    I would like to know your analysis on healthcare provider amedysis

  3. Wim Dunk | May 26, 2013

    Please analyze Mosaic (NYSE:MOS) for me.
    Thanks

  4. Jade | May 27, 2013

    Please analyze sandstorm gold (SSL) and tinka resources (TK), thank you!

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