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CSX Preserves Margins Despite Plunge in Coal Volume

Keith Schoonmaker, CFA

CSX's (CSX) third-quarter coal carloads dropped 21% and are now down 29% year to date. Carloads declined broadly beyond coal as well, down 8% in both the quarter and the year thus far. Rail volumes really still look like a freight recession remains upon us. Consequently, revenue dropped 8% in the period and 11% this year, but we think margin preservation indicates that the rail has right-sized its network to match the demand the economy gives it. In fact, the quarter's 69.0% operating ratio marks just a 70-basis-point degradation from the prior-year period. It's like we've said: There's more to this rail than just coal, but adjusting to a low-coal book of business takes some time.

We expect coal contraction to continue, but intermodal growth to help offset this loss in part. However, this year intermodal is showing its cyclicality. Management indicates container volume 7% lower in the quarter and 3% lower year to date are due more to competitive losses of an international account and a slug of short-haul interchange traffic rather than to broad customer reversion back to trucking. We think intermodal will grow when fuel prices and container demand increases, but clearly this is not the year for that.

We decreased our projected 2016 intermodal contraction to negative 4% from negative 1%, but our projected 2016 OR still looks attainable (70.0% versus 70.3% year to date). Another positive: The rail improved same-store pricing 3.6% outside of coal and 2.3% including coal. These improvements are more modest than in the past five quarters, but still positive and above our long-term 3% per year expectation. Given that the rail must contend with a freight recession coupled with the erosion of its most lucrative commodity, coal, we think CSX is controlling costs reasonably well, demonstrating pricing discipline and power, and investing capital prudently for the future. We expect to maintain our fair value estimate and wide moat rating.

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