There’s not a lot of mystery at the moment when it comes to railroad operator CSX Corporation (NASDAQ:CSX). CSX news of late has been disappointing, thanks to a soft second-quarter earnings report. That report has pulled the CSX stock price down more than 10% — and trade worries have kept the pressure on.
CSX unquestionably is a solid company — and, at the moment, the premier railroad operator in North America. That alone creates a strong “buy the dip” argument with the CSX stock price now down 17% from its highs.
But there are two key questions here. The first is whether even a 17% pullback is enough given factors outside of CSX’s control. The second is whether the “buy the dip” case for CSX stock applies just as well to other, cheaper cyclical plays.
From here, the answers to those questions are somewhat of a split decision. I’d wager the CSX stock price will start climbing again. But I’d bet, too, that other stocks — maybe even some in the railroad industry — will do better.
CSX News Doesn’t Change the Long-Term Case
Short-term weakness aside, CSX still has been a star performer. The CSX stock price has almost doubled since the 2016 United States presidential election. Even after the selloff, it has seen the biggest gains of the seven major railroad stocks that comprise the Dow Jones Railroads Index. The 132% increase dwarfs the 104% gains at second-place Norfolk Southern (NYSE:NSC).
The company has been excellent at controlling expenses. Its 2018 operating ratio — operating expenses divided by revenues — was the lowest in that index, at 60.3%. The two Canadian operators, Canadian National Railway (NYSE:CNI) and Canadian Pacific Railway (NYSE:CP), come in next — at a full point higher.
To top it off, after the disappointing CSX news, the stock now is the cheapest of the group. The forward price-to-earnings ratio sits at 14.5x, slightly lower than NSC. It’s possible that multiple will rise — some analysts may still lower 2020 earnings estimates — but at the least, CSX is valued in line with the peers it’s currently outperforming.
Given all these positive factors, the selloff looks like an opportunity. And it’s not as if the Q2 earnings report was truly that bad. The company did cut full-year revenue guidance, but it left itself room to outperform if second-half demand strengthens. Operating income still increased 2% year-over-year. This wasn’t a disaster, but some investors seemed to treat it as such.
The Concerns Going Forward
The performance of CSX stock so far raises one key and seemingly counterintuitive concern. There simply may not be much room left for improvement.
Again, CSX’s operating ratio is a full point better than that of every other major railroad play. It’s three points better than that of Kansas City Southern (NYSE:KSU), and a full five ahead of Norfolk Southern. Is CSX that much better than the rest of its sector? Or is there more room for rivals to catch up — and drive earnings growth in the process?
That concern becomes more important amid the current cyclical fears. Operating expenses for railroads, like those of any business, can be leveraged by revenue growth. But CSX isn’t seeing revenue growth coming in the second half of the year. The obvious worry is that declines may continue if the macroeconomic environment in the U.S. weakens. CSX stock already has a headwind from coal shipments, which may not come back. Its CEO, on the Q2 conference call, called the macro picture “puzzling.”
If the economy turns, revenue growth may head south for more than just a couple of quarters. And it may be CSX whose growth and share price lags, as rivals find more room to cut costs in the new environment.
Is CSX Stock the Best Play?
Those concerns are real. But at 14x-15x forward earnings, they look priced in. At this point, the declines do seem like they’ve gone too far.
But, again, the other important question is whether CSX stock is the best play. And that’s a tougher case to make. Cyclical stocks across the board generally have struggled since the beginning of last year, even though many have rallied somewhat so far this year. And many are downright cheap.
Caterpillar (NYSE:CAT), for instance, trades at 10x forward earnings. Many other stocks in industries like construction, boating and automobiles look even cheaper. The risks in those sectors are higher — but so are the rewards. If an investor has the stomach to make a contrarian bet against the current macro worries, there are options that go beyond CSX and beyond railroads.
So from here, the case for CSX stock looks solid but also a bit narrow. It’s for investors who are willing to take on cyclical risk — but only a little. Long-term, the selloff is an opportunity. But the same factors that drove the selloff could open up intriguing opportunities elsewhere.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
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