The Real Story Behind CSX's First-Quarter Results

One of North America's leading railroads, CSX (NYSE: CSX  ) , released its first-quarter results last week. The market was unimpressed. Though it subsequently recovered much of the initial losses, CSX stock opened down 3% during the first day of trading after results were announced.

Compared to the same period a year earlier, revenue and volume grew 2% and 3%, respectively. However, operating income declined 16%, to $739 million, and earnings of $398 million, or $0.40 per share, is a 14% decline from the $462 million, or $0.45 per share, in the first quarter of 2013.

Weather, predictably, was blamed for many of the ills that affected CSX during the quarter. In the 17-page Form 8-K filed with the Securities and Exchange Commission, the term "weather" appears 18 times – "severe weather," "harsh weather," and "weather disruptions."

Here are three important takeaways from CSX's latest earnings release, and what it means for investors.

Stubbornly high and deteriorating operating ratio
The measure of every great railroad can be found in its operating ratio. A railroad's operating ratio is its operating expenses expressed as a percentage of revenue -- the lower the better. A low operating ratio means more revenue flows to the bottom line as profit, and gives the company added flexibility to be competitive in terms of pricing.

CSX, however, has proven its inability to make meaningful, sustained improvement in this area. Its operating ratio was 71.1% in 2010, basically the same operational performance achieved last year. During the first quarter of 2014, CSX's operating ratio deteriorated a frightening 520 basis points, to 75.5%. Compare that to Canadian National's (NYSE: CNI  )  industry-leading operating ratio of 63.4%.

Not surprising, and with some justification, CSX blamed the poor operational performance on weather. But such a large deterioration is a concern, and hopefully not a sign of things to come for subsequent quarters.  

Coal's deterioration continues
In 2010, coal accounted for 31% of CSX's revenue. In 2013, it slipped to 24%. The decline continued into this latest quarter, and is likely an indication of a structural shift in how CSX generates revenue.

During the first quarter, coal revenue declined 9% from the same period in 2013, though volume fell by just 1%. The disproportionate decline in revenue is a result of the dramatic deterioration in coal exported to the lucrative, but declining, global market -- shipments destined for export markets fell by 15%. If this trend persists, CSX will experience continued pressure on earnings.

Optimism for grain and intermodal growth
Strength in grain and intermodal revenue, growth of 18% and 4%, respectively, are reasons for optimism, at least during the short term. Western Canadian farmers harvested a record 80 million tonnes of grain and oilseed last year, a crop 27% above the previous 2008-2009 record. And in the U.S., the yield was well above its five-year average. But much of that crop hasn't made it to market due to a lack of rail transport, and will likely take much of 2014 to clear the backlog.

CSX's intermodal segment has been another key growth engine, driven by highway-to-rail conversions. According to CSX, the opportunity for its intermodal business is significant as it tries to convert an estimated 9 million truckloads in the East to intermodal movements -- a trend CSX and other Tier 1 railroads are trying to capitalize on to grow revenue in 2014. 

Foolish bottom line
CSX surpassed the market's expectations for first-quarter earnings per share by $0.03. But that positive surprise was overwhelmed by some of the other facts that came to light in the quarter, including continued weakness in export coal, and a sharply deteriorating operating ratio.

CSX is coming off a strong 2013, where its stock rose nearly 43% compared to the 36% gain in the Dow Jones U.S. Railroads Index. But 2014 looks much less certain for CSX, and caution should be exercised by those considering an initial investment. Existing shareholders can take comfort in CSX's ongoing commitment to return cash to shareholders. Its dividend has increased 11 times during the past eight years, equating to a 20% compound annual growth rate. And with its recent announcement to raise the dividend by 7%, to $0.16 per share, CSX's stock provides investors with a yield of 2.10%.

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