Rail freight giant CSX Corporation (NASDAQ:CSX) reported vigorous second-quarter earnings Tuesday after the markets closed, and its report was characterized by record operating efficiency metrics. The company is enjoying revived earnings and stock price momentum as a result of management's decision last year to do away with the railroad's hub-and-spoke rail plan, moving instead to a "scheduled railroad" model in which discipline, tight schedules, direct freight routes, and the optimization of assets are the foremost priorities. We'll scrutinize the variables that produced heightened results below, but first, let's take in the headline numbers.
CSX results: The raw numbers
|Metric||Q2 2018||Q2 2017||Year-Over-Year Change|
|Revenue||$3.1 billion||$2.9 billion||6.9%|
|Net income||$877 million||$510 million||71.2%|
What happened with CSX this quarter?
The company's nearly 7% revenue gain was achieved on a solid carload volume increase of 2%. Revenue per unit advanced by 4%. CSX was also able to secure firmer pricing across its segments, and it passed fuel recovery surcharges through to customers as fuel costs continued to rise.
The railroad set a company-record operating ratio of 58.6% during the quarter, and according to CEO James Foote, this number is also a record for a U.S. railroad. The operating ratio is determined by dividing operating expenses by revenue, and it measures a railroad's operating efficiency -- the lower the reading, the better. The ratio achieved in the last three months represents an improvement of 880 basis points over the 67.4% benchmark chalked up in the second quarter of 2017. Even after adjusting Q1 2017's operating ratio for nearly four percentage points due to a restructuring charge, the current quarter's metric still bested the prior-year period by 490 basis points.
As I discussed in my earnings preview, CSX's management had cautioned investors to expect a more moderate year-over-year improvement in second-quarter operating ratio, after a first-quarter 2018 jump of nearly seven percentage points. Clearly, the caution was unwarranted. CSX showed progress in most of its major operating statistics on a year-over-year basis. Average train velocity sharpened by 7% to 17.4 miles per hour, while average car dwell (idle) time decreased by 11%, to 9.7 hours -- both were record levels. Average train length increased by 13%, while active locomotive count dropped by the same percentage. CEO Foote lauded the company's discipline in avoiding the activation of any of 600 locomotives, previously placed in storage, even as volumes rose during the quarter.
The organization also controlled costs credibly. Most notably, labor expense decreased by 11% to $699 million, progress that management attributed in part to fewer crew starts due to implementation of the scheduled railroad strategy.
CSX repurchased $974 million worth of its own shares during the quarter. As I explained in my earnings preview, a recent $5 billion share repurchase authorization by CSX's board is targeted for completion in the first quarter of 2019. To meet this goal, the company will need to buy back about $1 billion of its shares on average in each quarter of 2018. CSX has purchased $1.8 billion worth of its shares on the open market so far this year, and over the last four quarters, it's reduced its average outstanding share count by 6%.
The railroad recorded $37 million in real estate sale gains during the second quarter, bringing the total amount of real estate gains on sales in 2018 to $69 million. CSX is shedding unneeded assets as it optimizes its business, and management is seeking to dispose of roughly $300 million in non-essential real estate in the near future.
What management had to say
During the company's earnings conference call, analysts pointed out that the extreme shaving of operating ratio should create a competitive cost advantage, and they asked management if this would lead to sustained lower pricing to drive volume. CEO Foote provided a balanced answer that addressed both the advantage of sending efficiency gains to the bottom line and the need to be opportunistic at times given a growing cost advantage over competitors:
I believe that the operating ratio is a reflection of the efficiency of our service, which, in my mind, means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio so that we can be the price leader in the marketplace. So, I think, as I said last time, we don't get stickers and bonus points for volume. Therefore, to the extent that we can sell our product as a superior product in the marketplace, we fully intend to do that.
Clearly, we have as much flexibility as we want to if there are unique opportunities in the marketplace where a customer to us is not interested in quality of service, but is only interested in price. And if makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So, we have all the flexibility in the world to pursue whatever business segments we want.
CSX doesn't issue detailed quarterly guidance, but management does provide a general outlook for the company's top line. Executives have raised the railroad's revenue target for 2018 from the low single-digits to mid-single-digit growth. This implies slightly faster expansion in the back half of 2018 versus the 3% revenue lift booked in the first two quarters of the year.