Rail-based freight transportation provider CSX Corporation (NASDAQ:CSX) reports second-quarter 2018 earnings Tuesday after the close of trading. Shares have ascended more than 15% since the company's successful first-quarter report in mid-April, due in part to management's focus on leaner operations and improving efficiency. Below, let's delve into an earnings preview, by way of four items with the potential to either support the current positive trend, or catalyze a bout of profit-taking.
1. The relationship between revenue and volume
Last quarter, CSX recorded $2.87 billion in revenue -- an essentially flat result against the first quarter of 2017. Yet volumes declined by 4%, paced by weakness in the company's three biggest segments: chemicals, automotive, and agricultural and food products. CSX offset much of the volume-driven revenue weakness through "other revenue." This category surged by $71 million, or 96%, to $145 million, as the company enforced contractual incidental charges to customers that did not meet minimum volume commitments.
Supplemental revenue aside, CSX's top line each quarter is ultimately dependent on the strength of domestic economic activity in its major transportation categories. Continued soft volumes can compress operating income, while higher shipping demand will of course create the opposite effect.
Judging by rough weekly data supplied by CSX on total carload volumes, Q2 2018 may exhibit stabilization against the prior sequential quarter. CSX has reported a total carload increase of 1.9% for the second quarter, per its June 30 weekly carloads report. Over the last three months agricultural, auto, and coal shipments have chalked up positive volume versus the prior year, while carloads of chemicals remained soft. We'll get a more complete picture when the company releases its results on Tuesday, but on a first read, the recent volume trend appears stable.
2. Gauging the state of the operating ratio
CSX surprised investors last quarter with an adjusted operating efficiency ratio of 63.7%, which represented a nearly 6-percentage-point decrease over the prior-year quarter. Defined as total operating expenses divided by revenue, the operating ratio is perhaps the most widely recognized benchmark of rail company performance. A declining ratio denotes increased operating efficiency; with this metric, lower results are prized.
CSX's long-term goal is to reach an operating ratio of 60% or better. Rail companies improve the operating ratio by shortening average car dwell (idle) time, increasing average train length, boosting train velocity, and making similar transport-specific gains. Yet controlling labor and other key expenses also positively affects the ratio.
CSX management is examining every aspect of its business in its quest to boost performance. For example, the supplemental revenue mentioned in the preceding section represents a decision to enforce liquidated damage clauses, and other penalties for customer-induced delays which the railroad has previously ignored. On the company's first-quarter earnings conference call, CFO Frank Lonegro observed that CSX isn't interested in bulking up other income through customer penalties. Rather, it's trying to influence customer behavior as part of its effort to craft a more disciplined operating schedule.
Investors probably shouldn't expect quite the 600-basis-point improvement in operating ratio which the company booked in the first quarter of 2018. The second quarter is up against a strong showing in its comparable 2017 period, as CSX shaved 250 basis points off its ratio, which landed at 67.4%. A reasonable expectation for the current period is at least a 100- to 200-basis-point improvement from this level, to approximately 66.5% or 65.5% -- within the neighborhood of the 63.7% reading achieved in the first quarter of 2018.
3. Update on asset sales
Alongside optimizing operations, CSX's overall strategy calls for its divestment from unneeded or underutilized assets. As I discussed earlier this summer, CSX management believes the company can realize $800 million in proceeds by disposing of rail lines worth $500 million, and real estate valued at $300 million. During the second quarter, CSX put 650 miles of rail up for sale in North Carolina, Kentucky, West Virginia, and New York. The marketing of these noncontiguous track segments is in addition to 150 miles of track in Georgia and Alabama already in the process of being sold.
Disposing of nonperforming rail segments is particularly advantageous as a railroad not only receives cash, but gets relieved of repair, maintenance, and general and administrative expenses tied to the track mileage. Management is likely to update shareholders on the status of rail segment dispositions, and any real estate sales in the works, during the company's earnings conference call.
4. Brute-force share repurchases
In February, CSX took advantage of its relatively clean balance sheet and added $2 billion of debt to its liability total. As I explained last quarter, the borrowings will be utilized to fund share repurchases. In October of 2017, CSX extended its $1.5 billion share-buyback authorization to $5 billion.
Since November of last year, the railroad has repurchased nearly $1.1 billion of its shares on the open market, including $834 million in the first quarter of 2018. Management has signaled that the current program will be completed by the end of the first quarter of 2019.
That puts CSX on pace to repurchase a massive $1 billion in shares in each of the next four quarters. Investors can anticipate finding a number close to this run rate over the last twelve weeks, when the corporation issues its filing after the closing bell on Tuesday.