CSX's Discount Won't Last Forever

 | Jul 16, 2013 | 9:00 AM EDT
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CSX (CSX), a railroad that operates primarily in the eastern U.S., will reports second-quarter earnings after the close today, and the consensus is that the company earned $0.47 a share, compared with $0.49 a year ago, a very respectable result considering the significant year-over-year decline in utility coal volumes. The company's exposure to utility coal has weighed heavily on the share price, which has significantly underperformed its railroad peer group over the past year.

After terrible relative stock market performance in 2012, when its shares were down 19%, CSX has bounced back this year, gaining 24.2%. But even after this year's rebound, CSX is trading at a big discount to its peer group and to the market. At 13.8x  2013's earnings estimates and 12.2x next year's estimate, and a 2.45% dividend yield, the shares offer good value today with a chance for multiple expansion and earnings growth as the economy improves and coal volume comparisons get easier.

Apart from the decline in the utility coal business, there is much to like about CSX's business outlook. The company has a very diverse business mix. Merchandise and intermodal make up 80% of company revenue. CSX offers broad exposure to an improving economy. Chemicals, automotive, agriculture, phosphates and forest products each represent 5% or more of CSX's volume. The housing market drives nearly 6% of CSX's business.

CSX has been able to deliver solid results despite the sluggish economy and declining coal business, in part because it manages its business so efficiently. The company has an excellent safety record, and its on-time performance is at record levels. In the past six years, the company's operating margin has increased by 710 basis points, from 22.3% to 29.4%. The company is on track to meet its $150 million target in efficiency savings this year, and it's targeting a high-60s operating ratio by 2015.

Earnings have increased at a 12% annual growth rate over the past six years. The decline in the coal business will lead to a flat earnings year in 2013, but growth should resume next year, and the company expects to show 10% to 15% in annual earnings growth through 2015.

Finally, the company recently increased its dividend by 7% to $0.60 annually (a 2.45% dividend yield) and announced a $1 billion share-repurchase program over the next two years.

CSX is a well-run railroad trading at a very reasonable price. Investors looking for a way to participate in an improving U.S. economy should hop on board before the train leaves the station.

One caveat: We would wait for today's earnings release after the market and tomorrow's conference call and consider starting the position on Wednesday.

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