CSX: Better Results Rolling Down the Line

It might sound crazy to suggest that a company with worse performance than its peers could represent the best buying opportunity of the group. However, that seems to be exactly what CSX (NYSE: CSX  ) offers investors. This railroad is underperforming its peers in a couple of ways, but there are encouraging signs that results will improve in the future.

Two challenges that could spell opportunity
Union Pacific (NYSE: UNP  ) may be the best performer in the railroad industry. It has also been fairly clear that both CSX and Norfolk Southern (NYSE: NSC  ) have a lot of work to do if they hope to take the crown of top publicly traded railroad.

However, where some might see problems, long-term investors may see opportunity. Most people know that the challenges surrounding the coal industry have caused CSX a lot of pain in the last several years. As demand for coal has ebbed, the company has struggled to generate significant growth in revenue. Part of the issue is, CSX relies more heavily on coal revenue than either of its two big competitors.

In fact, in the most recent quarter, CSX reported that 24% of its revenue was derived from coal. By comparison, Norfolk Southern generated less than 23% of its revenue from coal, and Union Pacific came in at just over 20%. In the short term, CSX's heavier reliance on coal is hurting the company, with coal revenue down 9%, but this could become an opportunity in the future.

According to the U.S. Energy Information Association, the expectation is that coal production will actually return to growth in 2014 as inventories stabilize. If this projection is correct, CSX would stand to benefit the most, as its higher reliance on coal would provide a boost once demand recovers.

A second challenge facing CSX today is that the company carries the lowest operating margin of its peers at just over 28%. Using Norfolk Southern and Union Pacific as gauges, both companies reported margins of more than 30%, with Union Pacific's margin coming in north of 35%.

This again is a case where the situation today is hurting CSX, but in the future this margin could improve. First, CSX has been steadily improving its train speed and dwell time numbers. In the current quarter, the company reported a 3% increase in train velocity, and a 6% improvement in dwell time. The more efficient the company is in getting its trains from point A to point B, and the less time trains are sitting idle in the yard, the less cost to maintain the fleet.

Higher efficiency means CSX can operate with fewer cars in operation, which means lower maintenance costs, and less overhead. Given that this is the second quarter in a row where CSX reported an improvement in both train speed and dwell time, the company is obviously focused on running its network more efficiently.

CSX is attempting to turn the train around
While CSX is lagging its peers when it comes to reliance on coal and operating margins, the company is taking concrete steps to improve its financial position in the future. The railroad business requires a consistently high level of capital expenditures to keep the fleet moving, buy new trains and cars, and service tracks and ports. With a high level of expenditures understandably comes a level of debt.

On an overall basis, Union Pacific carries the least relative debt with a debt-to-equity ratio of just 0.46. Norfolk Southern and CSX carry much higher levels of debt with ratios of 0.92 and 0.87. That being said, CSX is taking steps to cut its debt. In fact, the railroad cut its net long-term debt by more than 6% on a year-over-year basis.

Relative to CSX's improved balance sheet, Union Pacific cut its net long-term debt by just 2%, and Norfolk Southern's net long-term debt actually increased by more than 5% versus last year.

In addition, CSX investors are being offered a decent valuation at the present time. With a yield of roughly 2.3% and an expected EPS growth of more than 11%, investors are being offered an almost 14% combined expected return. With shares selling for a forward P/E of about 14, the shares look like a decent value.

As you can see, CSX stands to benefit from the recovery that is coming in coal, which in turn could improve the company's operating margin as well. With the company putting a focus on paying down debt, and improving train speed and dwell hours, CSX is ready to deliver better results for shareholders down the line.

Investors and pundits alike are skeptical about future growth
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