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Economic Headwinds Will Keep CSX Stock Depressed

Faisal Humayun

CSX Corporation (NASDAQ:CSX) stock witnessed a sharp decline after missing second quarter estimates. In addition, a weaker guidance for 2019 accelerated the decline. However, after touching a near-term low of $64.4, the stock is again higher by 12.4% to current levels of $72.4.

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I do believe that CSX is a fundamentally strong stock, but I remain bearish on the stock for the coming quarters. I am of the view that the stock can again trend lower and this coverage will elaborate on the concerns.

Economic Concerns Will Weigh on CSX Stock

The rail-based freight transportation is sensitive to economic fluctuations and CSX is likely to feel the impact in the coming quarters.

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To put things into perspective, the following data on the economy points to a meaningful slowdown:

  • The U.S. manufacturing sector is in recession for the first time in three years with the ISM manufacturing index reading below 50.
  • The probability of recession as indicated by Treasury spread is currently at 37.9%, which is the highest level since the financial crisis.
  • U.S. GDP growth for 1Q19 was 3.0% and it declined to 2.0% for 2Q19. According to GDPNow indicator, growth for 3Q19 is likely at 1.8%. Clearly, growth is decelerating and I expect weakness to sustain. The trade war impact on growth will be felt in the coming quarters.

Clearly, the economy is weak and the impact will be felt by CSX in the form of lower revenue, potential margin compression, and decline in cash flows.


Rail Traffic Trend Remains Sluggish

According to data from the Association of American Railroads, the rail traffic trend has remained depressed into the third quarter. Further, for the first 36 weeks of 2019, the total combined (carload and intermodal) traffic has declined by 3.7% as compared to the prior year.

For the same period, CSX has witnessed a decline of 3.1% in total combined traffic. The good part is that CSX has outperformed the industry. The concern is that weak earnings will sustain and it remains to be seen if the downturn is relatively prolonged.

In a recent report, Moody’s analyst opines that the railroad sector can face $5 billion in lost revenue in the next decade as coal shipments decline. For 2018, CSX generated 18.3% revenue from coal. While the impact is not immediate, this is a long-term concern and adds to negative stock sentiments.

Correction Will Provide Opportunity to Accumulate CSX Stock

I do believe that CSX stock price is headed lower in the coming quarters. However, any decline in the stock is an opportunity to accumulate.

CSX is a fundamentally strong stock and worth holding to in your portfolio. To elaborate, the company reported an operating cash flow of $2.3 billion for the first half of 2019. Further, the free cash flow for the same period was $1.6 billion. This implies an annualized OCF and FCF of $4.6 billion and $3.2 billion respectively.

Even if the company witnesses some margin squeeze amidst economic concerns, free cash flow will remain robust. In addition, the company has a cash buffer of $1.7 billion as of June 2019.

The point I am making is that CSX stock has an annualized dividend of 96 cents and I see smooth dividend payments through the downturn. CSX is also positioned to create incremental shareholder value through share repurchases considering the free cash flow and liquidity buffer.

It is worth noting that CSX Corporation has almost $16 billion in balance sheet debt. However, with annualized EBITDA in the range of $5.5 to $6 billion, debt servicing is likely to remain smooth. Interest coverage will remain robust even if EBITDA declines on a relative basis in the coming quarters. Clearly, CSX Corporation is well-positioned from a credit perspective to navigate challenging times.

Final Thoughts on CSX Corporation

CSX stock sharply trended lower after second-quarter earnings. But the stock has bounced back and I believe that weak earnings for 2019 are discounted in the stock.

However, CSX stock price can trend lower if weakness sustains into 2020. That’s one reason to avoid the stock at current levels.

Overall, CSX is a quality company in terms of balance sheet fundamentals and cash flow. Any renewed correction would be an opportunity to accumulate.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.

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