North American railroad CSX Corporation (NASDAQ:CSX) continued to benefit from operational changes undertaken over the last 20 months, as a jump in third-quarter 2018 revenue was enhanced by wide productivity gains, leading to an earnings surge. Let's review highlights and details from last week's earnings report to grasp the underpinnings of CSX's recent success.
CSX results: The raw numbers
|Metric||Q3 2018||Q3 2017||Year-Over-Year Change|
|Revenue||$3.13 billion||$2.74 billion||14.2%|
|Net income||$894 million||$459 million||94.8%|
What happened with CSX this quarter?
Despite a top-line increase of 14%, operating expenses decreased by 2% to $1.83 billion. This created tremendous operating leverage that enabled the leap in both net income and diluted earnings per share.
As I've discussed previously, the expense control is a result of CSX's continued implementation of a scheduled railroad business model. In the third quarter, the company's operating ratio (total expenses divided by total revenue) dived against the comparable prior-year quarter, as has been the case in each quarter so far in 2018. The last three months' operating ratio of 58.7% -- a third-quarter record for CSX -- represented a 9.7 percentage point drop against the 68.4% benchmark set in the third quarter of 2017. This significant improvement (a lower reading is better), following those of the first and second quarters, provides evidence that CSX's efficiency gains aren't a temporary phenomenon.
Operational discipline manifested across CSX's biggest expense categories. Labor and fringe expense declined 4% to $695 million. Materials and supplies dropped 9% to $474 million. Equipment and other rents dipped by 18% to $89 million. These reductions offset fuel costs, which spiked 31% against the prior-year quarter to $268 million.
Of course, the operating ratio also benefits when shipments rise, leading to higher revenue. Volumes in chemicals, coal, and intermodal, the company's three biggest revenue categories, increased by 5%, 7%, and 3%, respectively, over the last three months. Total volume across all categories stepped up by 4% during the period. Revenue per unit climbed 9% due primarily to favorable mix and pricing gains.
CSX's operating statistics shed light on some of the diminished overhead during the last three months. Two metrics stand out: Average train velocity increased 28% against the comparable quarter to 17.9 miles per hour, and average train dwell time decreased by 26% to 9.0 hours. We'll visit the implications of these statistics below.
The company continued its swift and massive share buyback plan, which management launched in the first quarter of 2018 with the goal of completing a $5 billion repurchase authorization by the first quarter of 2019. CSX bought roughly $1.2 billion of its own stock during the quarter, bringing its year-to-date repurchase total to $2.92 billion.
What management had to say
The implementation of scheduled railroad principles encompasses a range of tactics aimed at winnowing expense. These include a stricter approach to scheduling, favoring direct routes where possible, and reducing or eliminating hump yards (where train cars can be switched between routes).
The spartan model also relies heavily on increasing throughput, or the rate at which trains take on loads, transit to their destinations, and unload. During CSX's post-earnings conference call, CEO James Foote discussed the importance of throughput to the organization's operational goals. Foote's comments illuminate for investors in simple terms the profit-and-loss effects of pushing a railroad to run faster:
As we improve velocity, as we improve throughput, as we improve all aspects of the railroad, what does it do? It creates capacity, i.e. takes out locomotives. So, we'll continue to take out locomotives. We'll continue to take out railcars. We'll continue to free up capacity across the railroad and in the terminals because we will drive more and more efficiency and fluidity in the network.
So, therefore, again, that's why the employee count goes down. Employee count goes down because we need fewer -- for example, 30 fewer locomotives for every mile an hour we can improve on velocity. So, having 30 fewer locomotives means you need fewer people to maintain the locomotives, which means you need fewer facilities to maintain the locomotives, and on and on and on and on and on and on. Fewer cars online, get them offline, get them moving, fewer people to maintain the cars, fewer inventories. So, that's the nature of the game here is continuing to drive throughput. And as I said, in terms of dwell, we're not the leader in dwell. We're not the leader in terms of velocity. But we will be. And as we do that, we'll free up and shift more and more assets.
CSX's management typically provides very general forward-looking guidance, and limits this to a revenue projection. This quarter, executives have quantified a previous "mid-single digit" revenue growth expectation for the full year, to a new 6%-8% range. Nine months into 2018, revenue has already advanced 7% to $9.1 billion, so unless volume or pricing diverge from recent trends, the rail giant's full-year target should be realized easily enough.