Chugging Along

Features - Transportation

Despite some softening in the fourth quarter, CSX predicts good things to come for the rail industry.

December 7, 2012
Fredrick Eliasson

Editors’ Note: The following text is an edited transcript of a presentation delivered by Fredrick Eliasson, chief financial officer and executive vice president of Jacksonville, Fla.-based CSX Corp., during Baird’s 2012 Industrial Conference Nov. 7, 2012.

Since 2003, which is essentially when the current management team came together, we transformed CSX from a transportation conglomerate to a pure-play railroad company. During this period, we were able to grow our operating income significantly from $861 million to $3.42 billion, which is almost 300 percent, or 19 percent CAGR (compound annual growth rate). Margin expansion nearly tripled from 11 percent to 29 percent. Also, earnings per share grew 26 percent CAGR, almost 500 percent in total, from 26 cents to $1.67.

Any time you celebrate your own success, it is also important that you calibrate [your company’s performance against competitors and other sectors]. If we look at our performance versus our peers in the broader market, we stack up very well there as well. Our operating income more than doubled versus the broader market and our peers. Our market expansion also is significantly above what the broader market and our peers did during time, as was earnings per share growth (26 percent for CSX compared with 14 percent for industry peers and 3 percent for Standard & Poor’s 500 companies).

A very focused management team and a very focused organization led to strong financial performance and, as a result, significant value creation as well. Our stock price during this period went up more than 300 percent.

The other driver of our performance throughout this period has been our balanced approach toward our cash deployment. During 1996 to 2005, our core earnings power was not where it needed to be to reinvest at the level we needed to or to provide a direct financial distribution to our shareholders. But, since 2006 and through 2011, we reinvested in our business and provided dividends and buybacks to our shareholders, at a tune of almost $20 billion, which was split about 45 percent to our shareholders and 55 percent to reinvesting in the business.

This [cash deployment strategy] continues into 2012. We are investing about $2.25 billion back into our organization, and our dividends increased 17 percent earlier this spring. We are on track to complete a $2 billion share buyback program by the end of this year.

Cash Deployment

As we look at our guidance period, which is through 2015, we have a transparent framework for how we are deploying our cash. The first priority is to make sure we reinvest in our business. We target about 16 to 17 percent of revenue going back into the business, with an overlay for the positive train control project of $1.7 billion that should run until 2017 or 2018, until we complete that project. [The positive train control program] is a mandatory, regulated project that we are forced to put in to our network. But, overall, 16 to 17 percent is what we are targeting on the revenue side.

On the dividends, as I said earlier, we are targeting about 30 to 35 percent of trailing 12-month earnings. We increased our dividend 17 percent earlier this year. Each May is the time we announce what the dividend will be for the following year.

On the buyback side, which is the third priority, since 2005 we have bought back $7.75 billion, or about one-third, of outstanding shares. As I said earlier, we are on target to complete our $2 billion reinvestment program. (We expect to announce a second program as we complete this $2 billion program by the end of this year.)

The buyback program is primarily funded through free cash flow, but if there is opportunity to use some of the balance sheet capacity that is out there, we do that; but, it is also in the context of an improving credit profile.

The financial performance we’ve had over this time starts with our competitive advantage, which is our network. We have about 21,000 miles operating essentially in every state east of the Mississippi River—23 states in total. We serve about two-thirds of the U.S. population and, actually, an even greater percentage of overall consumption. We connect all mega-regions of the eastern U.S., and we also have a network that is positioned for growth. We do have superior market reach into the Northeast and Florida compared to our competitors. This sort of network access is what really what allows us to have the diverse portfolio of business that we have.

Markets Served

Our volume [as of Oct. 26, 2012] is about 5.4 million units, of which intermodal is the biggest market that we serve at 38 percent. The container unit makes up about one-third of the intermodal market on a revenue basis. Intermodal has a tremendous amount of growth opportunity.

Automotive [is] 7 percent of our overall volume. Clearly, the biggest driver there is finished vehicles. The [rail] industry touches about 70 to 80 percent of all of the vehicles produced in North America, and CSX touches about 30 percent of that.

The metals side (4 percent), historically, has been driven by the automotive industry and construction, but more and more is being driven by what we are seeing on the energy side.

Our chemical business is about 7 percent of our volume. We have seen a resurgence in the U.S. chemical industry’s competitiveness. We also have great expectations going forward for the opportunity to do crude by rail on the East Coast, which the western railroads have been enjoying for a period of time.

The phosphate (5 percent) and agricultural (6 percent) markets this year are tough markets because of the drought; but, long-term we think they have a tremendous amount of opportunity as well. Food and consumers is a small market (2 percent), but we are targeting getting some of that market share back with perishable goods.

Emerging markets (6 percent) are a lot of different markets that we have, such as waste out of the Northeast, minerals and also some machinery and military equipment.

The last two markets are our coal markets: domestic coal (14 percent) and export coal (7 percent). The domestic coal market declined significantly this year. The export coal business is one of the businesses we feel very comfortable with long term and we think will have great growth opportunity.

We have a very diversified portfolio of business, which allows us to absorb market softness in any given market at any time and still produce earnings growth. This diverse portfolio essentially touches all facets of the U.S. industrial economy.

In addition to connecting different population centers, what the network also does is connect our manufacturing base and our natural resources with the global market through our port system. Overall, CSX serves more than 70 ports. We also have the ability to connect imports through the East Coast ports to the population centers in the middle part of our country. Overall, we have a very broad market reach connecting all the major population centers, a very diverse portfolio of business and an ability to connect natural resources to the global market and also are able to participate in import flows on the East Coast and also from the West Coast through our western carriers.

Economic Effects
We’ve seen a little bit of a slowdown [in the U.S. economy] over the last couple of months. GDP (gross domestic product) in the fourth quarter is expected to moderate a little bit from the third quarter (2 percent to 1.6 percent).

Perhaps more telling in terms of a better barometer for our business is the industrial production index (IDP) growth. In the first half [of the year], we averaged about 4.5 percent in IPI growth, and in the second half we are going to be somewhere around 3 percent.

The ISM Manufacturing Purchasing Managers Index shows no impetus for either contraction or growth as we look at the market right now, and we’re predicting steady state slow growth as we get into 2013.

Volume growth has been moderating across all market sectors since the start of the year. Our export coal market was up significantly for the first three quarters of the year, but in the fourth quarter, we are seeing a softer environment. Our intermodal sector is also a little softer, predominantly because of what we are seeing on the domestic trucking side. International business continues to be pretty strong, but we are seeing a softer market on the domestic side in the fourth quarter. I’ll remind you that this is through the first four weeks of the fourth quarter.

Our industrial sector is up only 1 percent [in the fourth quarter] compared with an average for the first three quarters of about 7 or 8 percent. That is partly because … automotive was ramping up in the fourth quarter last year and also [because] of the fact that our metals business is down a lot more now in the fourth quarter. For those of you that follow that [steel] industry, you know that the [capacity] utilization rate is down in the 60s, and so it got a lot softer from what we saw in the second quarter, which was around 80 percent.

The construction and agricultural sectors are rebounding a little bit. And, on the domestic coal side, slowly but surely we are starting to work off some of the excess stockpiles that are out there, even though it is going to be well into 2013 until we think we are going to get back to a more normalized level. But, the combination of what we’re seeing on the domestic coal side and the decline of export coal in the fourth quarter is why we think the fourth quarter will probably be the most difficult quarter for us in terms of year over year for coal overall this year.

It is a difficult top-line environment, but what we at CSX are trying to focus on is the things that we control most, which is to have the safest, most productive and service-oriented railroad that we can have. Our year-over-year improvements on both on-time originations and arrivals continue to be significant for our scheduled network, which is about 75 percent of our overall business.

Emphasizing Service
A strong service product is critical in reaching our inflation-plus pricing. And, as we’ve seen this year, it is critical for us to drive our productivity efforts to higher levels. Normally we target about $130 million in productivity [savings]; this year, we are looking at more than $180 million. The key driver for that incremental gain is the fact that our asset utilization has improved as much as it has.

In addition to productivity, we are working to make sure that we right-size our resources—that is a must in this sort of environment. We are monitoring our volumes essentially on a weekly basis to see if there are more things we have to do to reduce our locomotive count, adjust our crew resources and other support functions to make sure that we match the demand levels that are out there with our resources to produce the sort of service that we have. But we are doing this in the context of making sure that our service product still remains strong. The reason why that is so critical is that we do see a lot of opportunities longer term for us to grow our volume.

Track to Opportunity

We see a highway system that is significantly congested already. And we see freight demand increasing up to 60 percent, according to some estimates, through 2040. We also know that fixing our highway system to where it needs to be is a $5 trillion effort, and that is just maintaining the existing network. We at CSX have a privately funded network that connects all of these same regions and it doesn’t have the same sort of challenges.

In addition to infrastructure issues … our truckload partners are looking for intermodal and rail to solve some of their challenges. Between regulations like CSA (Compliance, Safety, Accountability) 2010, driver retention, congestion, high fuel prices and environmental regulations, we are seeing a bigger partnership opportunity with our trucking partners.

In our territory, for hauls of more than 550 miles between population centers, we think that there are about 9.3 million units that are not being served by intermodal already. We think that over time we can convert these units. As you’ve seen this year, our domestic business is up 6 or 7 percent in an environment where overall output is up 2 to 3 percent. That is good testament to the strength that we see in this market long term.

In terms of international markets, we expect … a growth rate of 4 to 5 percent both on imports and exports. We also see opportunities in a lot of our merchandise markets in regard to intermodal conversion because of some of macrotrends.

Globally, more people are consuming more things at a higher quality of life in a world that continues to be more interconnected and where global trade continues, which means that supply chains are increasing. Being a railroad in the eastern U.S. where we serve two-thirds of the population and a greater percentage of overall consumption is a really good place to be and sets us up well long term.

CSX remains on track for earnings growth in 2012, despite some of the challenges that we face this year with utility coal, a slower economic environment in the U.S. and based on what we are seeing so far from Hurricane Sandy.

We’ve seen the economic environment moderate, but all we can do is focus on the things we control, which is to continue to drive productivity and put a service product out there that makes sense.

We think we have long-term growth opportunities that are very significant, and we are still on target to produce a 65 percent operating ratio by 2015, though the path is more challenging.


Fredrick Eliasson is chief financial officer and executive vice president of Jacksonville, Fla.-based CSX Corp.