The Dow Jones Transports Average went bananas from Monday to Thursday of this week, rising more than 6% in four trading sessions, Despite a slight pullback in Friday trading the DJT still posted post a 5.9% gain for the week. The DJT was founded in 1884, pre-dating its cousin the Dow Jones Industrials, and shares the same conceptual flaw, in that it is a price-weighted, equal-weighted index. There's no constructive bias that explains away a 6% weekly gain, though. The transports are simply red-hot, and the question for market-watchers is: are the transport stocks jumping because the market is more optimistic on their prospects, or is the market more optimistic on the transports because the stocks are jumping? Yes, in this top-down ETF world it can be very difficult to separate the chicken from the egg.
I revisited CSX (CSX) in light of this week's action. I went back and re-read a column I wrote on CSX and the other railroad stocks on October 13th. That column was based on a pre-earnings check-up for CSX and the group, and I predicted few fireworks from CSX on their post-earnings conference call with some caution as the company is still reworking its logistics structure. As of October 13th, earnings estimates for CSX were $2.23 and $2.70 for 2017 and 2018, respectively, and as of today, those estimates sit at $2.22 and $2.68. So, as I predicted, earnings were a non-event for CSX, and as of this Monday, CSX shares had fallen about 5% since the column was published.
Then, as if by magic, CSX shares began a stirring run-up Tuesday, It's a sign of the times that a 10% move in a four days in a railroad stock barely registered, but with a $50 billion market cap, it should not be ignored. The market clearly liked the presentation by CSX CEO Hunter Harrison -- a legend in the North American railroad sector -- at a Credit Suisse conference in Palm Beach on Tuesday, but it is hard to believe that alone propelled the stock in the latter half of this week.
No, CSX shares are moving because tax reform is looking more certain. Companies that generate most or all of their revenues domestically will be the major beneficiaries of tax reform. It stands to reason, as the tax burden on U.S. companies is among the highest in the world. That's not politics, that's just fact. I recently had the CFO of a regional bank -- with 100% of operations in the U.S. -- tell me at a conference in a conspiratorial tone "if tax reform passes that all drops straight to the bottom line." Yes, it will, and that should be no secret.
It is true that the key indicators for the North American railroad industry are trending upward, and American Association of Railroads data show an even faster rate of growth thus far in 2017 than they did when I published my RM column on October 13th. But earnings estimates for the sector haven't budged, and, as mentioned above, CSX's have actually declined slightly since mid-October.
So, the market is re-valuing CSX based on the potential for greater after-tax cash earnings. If the Republicans are successful in lowering corporate tax rates, shareholders of North American -focused companies should benefit in some way. CSX's yield of 1.3% is puny even compared to that of the S&P 500, and a higher dividend is one way that shareholders could be rewarded if CSX's effective tax rate does indeed decline.
I believe, however, the potential for improved cash flows due to lower corporate tax rates is fully reflected in the Dow Transports' 16.8% total return in the past 52-weeks. That's a strong gain by historical standards, and looks puny in comparison to CSX stock's massive total return of over 63% for that time period.
"Priced to perfection" is a phrase often used to define high-flying stocks, and at 20.95x 2018 EPS estimates, I just don't see any upside for CSX's valuation multiple. If analysts raise EPS estimates for CSX that could provide that next catalyst for the stock, but, barring that, I believe tax reform is priced into CSX shares at these levels, and other industrial stocks offer more compelling values.