CSX Corporation (NASDAQ:CSX) posted a disappointing fourth quarter a few months ago, but has since largely recovered from the resulting sell-off. The decline in earnings per share, compared to last year's fourth quarter, was partially blamed on the decline in CSX's coal business. Investors should be prepared to hear another target for blame if first-quarter results disappoint: harsh winter weather. The harsh weather during the first quarter has some analysts reducing earnings expectations for CSX. According to Thomson Reuters, analysts had initially expected earnings of $0.43 per share in the first quarter, but some have reduced their expectations to around $0.38 per share. Here are two things to look for when CSX releases its first-quarter results after the market closes today.
Perhaps the most important metric for CSX is its operating ratio (operating expenses divided by revenue). Management's goal is to sustain an operating ratio in the high 60s by 2015, but the harsh winter weather could present a big speed bump.
Labor and fringe costs accounted for 36% of CSX's overall expenses in the fourth quarter, which will move higher because CSX was forced to increase crew numbers and locomotives employed to keep business flowing smoothly through adverse weather. With the increase in crew numbers also came a 50% increase in overtime pay, according to Forbes, which will certainly balloon labor costs in the first quarter. Furthermore, additional locomotives bring additional fuel and equipment costs. CSX announced that first-quarter earnings could be negatively affected by as much as $0.10 per share, largely due to the harsh winter.
Putting costs aside for a moment, another factor just as important to first-quarter results will be CSX's coal shipments.
Will coal turnaround?
With a shift in energy demand from coal toward cheaper natural gas taking place, in combination with excess global coal inventories, CSX's coal revenue has declined over the last two years. But 2014 might bring some relief to the headwinds the company has been facing in the coal market.
Of the two parts of CSX's coal business, domestic and exports, the former could show a turnaround in this report. That's good news because domestic coal accounts for 69% of coal volume, compared to the 31% that composes exports. First-quarter shipments of domestic coal are expected to have risen, although it might not be enough to offset the decline in exports: Through the first nine weeks of the first quarter, coal exports declined 16%, according to Forbes. Investors looking for a silver lining should keep in mind that CSX's coal segment faces a much easier comparison to its own performance during last year's first quarter. In addition to rising domestic coal shipments and easier comparisons, if CSX was able to maintain stronger pricing with domestic coal, then it will help offset the further decline in revenue expected from its export coal business.
With that said, what might be more important to CSX's first-quarter earnings will be its merchandise business -- its largest revenue contributor.
While coal revenue declined 9% last quarter to $679 million, merchandise revenue jumped 10% to $1.8 billion. Merchandise volume was driven 7% higher by a strong harvest, continued growth in housing, and booming energy-related industries. If the strong volume from the fall season partially carried into the first quarter, it could set merchandise up for another significant revenue increase. That's especially true as other merchandise contributors, construction, and energy-related industries have remained active this year. Furthermore, the automotive industry has kept vehicle production high in preparation for its strongest-selling season, spring.
CSX has stated that when coal headwinds subside, earnings per share could increase by a significant amount. I don't believe we'll see that in 2014, and while headwinds for domestic coal seem to be lightening up and merchandise could drive revenues higher, investors would be wise to temper expectations for CSX's first-quarter earnings. Harsh winter weather will have increased costs and negatively affected shipments -- a tough combination to overcome in the first quarter. For CSX to beat earnings projections, it will need a combination of lowered analyst expectations, successful damage control on rising costs, and a strong performance from its merchandise segment to offset coal's revenue decline.