Download - CSX Initiating Coverage Report

8/11/2019 CSX Initiating Coverage Report

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INITIATING COVERAGE REPORT William C. Dunkelberg Owl FundSeptember, 10th2014

Jesse Barone: Lead Analyst

[email protected]

Ethan Friedland: Associate Analy

[email protected]

Joseph Heidt: Associate [email protected]

COMPANY OVERVIEW

CSX Corporation is a diversified freight transportationcompany that provides rail-based transportation servicesthroughout the eastern United States. CSX transportschemicals, automotive products, agriculture, forest products,metals, phosphates, fertilizers, minerals, food and consumerproducts, along with waste and equipment. In addition, thecompany uses its network of 50 terminals and 21,000 miles ofrail to transport coal and provide intermodal transportation

services. The companys four business segments, all based inthe United States, are TotalMerchandise (58.5% of FY2013 revenue), Coal (24.1%),Intermodal (14.1%), and otherservices (3.3%).

INVESTMENT THESIS

CSX is currently trading at an8.04% discount to itscompetitors. Investors have been devaluing CSX because ofthe decrease in demand for coal (Coal is 24% of revenue forCSX), and the recent dip in the companys performance metrics

due to congestion of railways from substantial volume growth.CSX is seen to have two economic moats, which are barriers toentry and an expansive network of railways and terminals thatcannot be replicated, giving it a competitive advantage over itscompetitors. Through CSXs strategic rail network,it is able toprovide service to 66% of the population in the United States,and currently is in charge of 50% of rail volume on the eastcoast. Looking forward, investors have not accounted for thenew capital expenditure projects that CSX have started in 2014,and the recently completed projects in 2014 in order to keep upwith the increasing volume it is experiencing. These projectswill expand its performance metrics back to normal historicallevels. Investors also havent accounted for the new coaldemand to be capitalized on by CSX in the Illinois Coal Basin,the United States energy boom, which has created new marketsfor CSX such as crude oil, liquefied petroleum gases, and fracsands, and increased regulation in the trucking industryallowing CSX to claim market share away from truckingcompanies. We believe the company will appreciate from itscurrent EV/EBITDA multiple of 8.77x, to the 5 year historicalspread average compared to peers of 9.69x, resulting in a pricetarget of $36.61, and a total return of 19.34% including adividend yield of 2.05%.

Indust

rials:Railroad

CSX Corp.Exchange:NYSE Ticker:CSX Target Price:$36.61

Sector Outperform

Recommendation: BUY

Key Statistics:Price $31.49 52 Week Low $

Return 19.34% 52 Week High $

Shares O/S (mm) 999.6 Yield 2

Market Cap (mm) $31,476 Enterprise Value $

1 Year Price Graph

Earnings History:Quarters EPS Rev. YoY Pric

3Q13 $0.460 3.63% -0.804Q13 $0.420 4.73% -6.811Q14 $0.400 1.65% -1.772Q14 $0.530 6.50% 0.13%

Earnings Projections:Year Q1 Q2 Q3 Q4

2012 $0.41 $0.48 $0.44 $0.39

2013 $0.45 $0.52 $0.46 $0.42

2014(Q3,4E) $0.40 $0.53 $0.46 $0.48

2015e $0.45 $0.60 $0.53 $0.53

All prices current at end of previous trading sessions f

date of report. Data is sourced from local exchanges

CapIQ, Bloomberg and other vendors. The William C.

Dunkelberg Owl fund does and seeks to do business w

companies covered in its research reports.


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Fall 2014

T h e W i l l i a m C . D u n k e l b e r g O w l F u n d Page

SEGMENT OVERVIEW

Total Merchandise:The merchandisebusiness shipped nearly2.8 million carloads andgenerated approximately

59% of FY 2013revenue. Along withbeing CSXs largestsegment (42% of FY2013 volume), totalmerchandise is the mostdiverse segment consisting of nine sub-segments. The Merchandisesegment transports chemicals, automotives, agricultural products, forestproducts, metals, phosphates and fertilizers, minerals, food and consumerproducts, as well as waste and equipment.

Chemicals

The Chemicals segment made up 27% of Total Merchandise revenue and15.8% of total revenue in FY 2013. In this segment, CSX transports

plastics, plastic feedstock, plastic intermediaries, crude oil, liquefiedpetroleum gas (LPG), and frac sand.

Automotive

The Automotive unit made up 17.3% of the Total Merchandise businessand 10.1% of total revenue in FY 2013. The Automotive segment is anessential part of North American vehicle distribution, as it ships almost1/3 of all light vehicles produced. CSX handles nearly 4 million vehiclesannually through its network of 35 auto distribution centers and a fullyenclosed multilevel fleet. In addition to transporting finished vehicles,CSX transports auto parts throughout the eastern United States.

Agricultural

The Agricultural segment made up 14.4% of the Total Merchandisebusiness and 8.4% of total revenue in FY 2013. The agricultural unittransports products such as grain, flour, oils, sweeteners, and ethanol.Through this business, CSX directly serves grain elevators, feed mills,grain processing facilities, bakeries, ethanol plants, and soft drinkproduction facilities.

Coal:The Coal business shipped nearly 1.2 million carloads and generated 24%of revenue and 18% of volume in FY 2013. CSX transports domestic coal,coke and iron ore to electricity-generating power plants, steelmanufacturers, and industrial plants. CSX also exports coal to deep-waterport facilities. CSX is the largest coal transporter east of the Mississippiand serves more than 120 load-outs in 9 states.

Intermodal:The Intermodal business contributed 14% of revenue and 40% of volumein 2014. Intermodal transportation is using at least two modes oftransportation to move freight. CSXs intermodal line of businesscombines long distance rail transportation with short-haul trucking. Theintermodal business has 50 terminals east of the Mississippi River and usesthem to transport mainly manufactured consumer goods in containers.

RISKS

New Legislation or RegulatoryChanges: Legislation passed by Congressor new regulations issued by federalagencies regarding pricing negotiation and

constraints, climate change, emissions,capacity, and hazardous wastetransportation could have a negative effecon top or bottom line growth.

Declining Natural Gas Prices:Asnatural gas prices decrease, coal-firedpower plants are being replaced by naturagas-fired power generation facilities. Ifnatural gas prices remain low and continuto decrease, more coal-fired plants couldbe replaced, which would reduce CSXsdomestic coal volumes and revenues.

Demand Fluctuation: General domestic

and global economic conditions thataffect demand for the commodities andproducts CSX transports could adverselyaffect the top line.

Severe Weather: Extreme weatherconditions can adversely affect thecompanys operations and incur additionacosts, negatively affecting top and bottomline growth.

U.S. Energy Markets: Over the past fewyears, production of natural gas in the U.Shas increased dramatically, resulting inlower natural gas prices, causing a negativ

impact on CSX. As a result of sustainedlow natural gas prices, coal-fired powerplants have been displaced by natural gas-fired power generation facilities.

ECONOMIC MOATS: Narrow and

Stable Rail Network: CSX spans the densely

populated eastern U.S., capturing abouthalf of the rail volume in the region. CSXoperates approximately 21,000 miles in rainetwork, which serves various populationcenters in 23 states east of the Mississippi

River, the District of Columbia, and theCanadian provinces of Ontario andQuebec, as well as operates approximately4,000 locomotives.

Barriers to Entry:The network of rails ivery unlikely to have any new main linesbuilt especially since most regions alreadyhave two main competitors and replicatinthe network in place is nearly impossible.


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CATALYSTS

New terminals/expansion of old terminalsCSX in recent months has experienced a significant increase in demand for itsservice. With the substantial increase in demand, several performance metricshave fallen in recent quarter such as dwell time, average velocity, EBITDAmargin, and profit margin. Stemming from this decline, CSX has committed to

improving these metrics by creating new terminals, expanding capacity of oldterminals, and improving infrastructure. During 2013 and 2014, the company hasexpanded terminals in Columbus, Ohio, Louisville, Kentucky, Atlanta, Georgia,and Worcester Massachusetts. An example of the benefits from this additionalcapex is a 50% increase in capacity at the companys terminal in Columbus, Ohio.The company expects to open new terminals in Winter Haven, Florida andQuebec, Canada during 2014. Investors and the company should start to seebenefits from the 2013 projects that the company has recently completed in thesecond half of 2014, and should expect to see the rest of the terminals fullyoperational by end of 2015. Some other notable investments that are occurring isan upgrade in infrastructure in the Chicago area, specifically with the Elsdon sub-division, which will provide this area with double track miles (having a track runin each direction so trains going opposite directions arent on the same track), which will increase average train velocityand flexibility in the area to be able to divert traffic away from the more congested routes. In the River Line area, whichis from New Jersey up to Boston, double track is being added to capitalize on those same benefits listed above. Thisspecific infrastructure project is crucial because it is going to address a growing need as demand increases in one ofCSXs busiest regions.

Illinois Basin Coal Shift

Historically, the Appalachian region was a main supplier of coal and was a large part of CSXs coal business. However,with decreasing coal demand, the Appalachian region has not been growing in terms of coal output. The Illinois Basinhas become a large hotspot for coal production to make up for the significant decline seen in the Appalachian region.Extracting coal from the Illinois Basin cost about $44 a ton, 22% cheaper than Central Appalachia and 30% cheaperthan Northern Appalachia. Powder River Basin has the cheapest extraction price tag of $11 per ton. CSX is positionedto take advantage of this shift away from the Appalachian region to the new Illinois Basin region. CSX is investing in anew coal unit train processing facility that will support this growth, while also adding increased employees andinfrastructure in the region. CSX is in a unique position as one of only two companies that can add the capex needed to

support the growth that is having in this region.

United States Energy Boom

The surge seen from the increased drilling for the extraction of oil and natural gas has created several new high growthmarkets and products such as crude oil, liquefied petroleum gases, and frac sands that CSX is uniquely positioned tocapitalize on. Along with these markets, CSX is capable to capitalize on transporting the supplies needed for drilling fornatural gas and oil. CSX is able to transport the material from the gas processing plants to the market. With theseexpanding markets, CSX has invested in new terminals, railcars, locomotives, and additional employees in order to meetthe demand stemming from these specific markets and products.

Public-Private Partnerships and Increased RegulationCSX is joining with several government partners such as the Commonwealth of Massachusetts and the State of Florida,to increase capacity, efficiency, and safety with railroads. The reason for this is these government organizations havebegun to recognize the benefits of using rail instead of trucking. Some of the benefits of using rails instead of trucks are

reduced traffic, reduced pollution (rails are four times more efficient than trucks), and increased activity at U.S. ports bythe use of intermodal transportation. One of the projects called National Gateway, which is a project totaling $850mmin investment from CSX and government organizations throughout the east coast, is outfitting tracks and bridges toallow double stacking of freight. This will increase the percentage of tracks outfitted for double stacking from 90% to95%. There are several of these projects underway currently, such as creating a rail corridor parallel to interstate 70 and76 between Washington, D.C. and northwest Ohio, replacing bridges in Maryland, and expanding the Virginia AvenueTunnel. Along with these partnerships, the Federal Government continues to put stricter regulations on the truckingindustry, which continues to increase costs for companies causing them to switch to another mode of transportationsuch as rail, or the use of intermodal transportation by using rail for long distances and trucking for shorter distances.


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INDUSTRY OVERVIEW

The Rail Renaissance

In 1980 the Staggers Rail Act severely deregulated the railroad industry and allowed rail companies to set their own ratesas long as there was competition and create service contracts. This has led to significant consolidation in the railroadindustry in order to increase efficiency. The number of Class I rail companies has reduced from over 40 in 1980 to just 8today, which CSX is one of them. Over the past five years the S&P 500 Rail Index has grown over 182%. During therecession there were as little as 80 freight cars per train. However, once demand picked up Class I railroads were able toexpand their operating margins by 26.8% in 2010, just by adding more freight cars per train and having a minimalincrease in operating cost. Operating cost was able to stay low since the railroads didnt need any additional engines orcrews to operate the longer trains. Even as demand rose and more operating cost were incurred, it was offset by morefuel efficient locomotives, widening margins to 27.1% in 2012. The Association of American Railroads reported that fuelefficiency rose from 235 ton-miles per gallon in 1980 to 476 ton-miles in 2012. Today we are seeing a lot of these samethings play out for Class I railroads. There is significant congestion and volume growth, making companies like CSX

increase their capex in order to keep up with the demand and keep performance metrics at high levels.

Future Demand for CoalFuture Domestic Coal DemandThe Mercury and Air Toxics Standards take effectnext year, and coal powered plants will need to equiptheir facilities with scrubbers that remove sulfurdioxide to comply with the new regulation. TheObama administration is trying to reduce carbondioxide emissions, but still estimates the nation toburn 616 million to 636 million tons of coal in 2020.Coal current share of power generation is 41%, but isexpected to fall to 33% by 2020 and 30% by 2030under the new regulation.

Future Foreign Coal DemandCoal remains the 2nd largest energy source worldwide. Annual consumption of worldwide coal is expected to increase1.3% per year until 2020. In the longer term, growth of coal consumption decelerates as policies and regulationsencourage the use of cleaner energy sources, natural gas becomes more economically competitive as a result of shale gasdevelopment, and growth of industrial use of coal slows largely as a result of China's industrial activities. Globally,generating electricity accounts for 60% of coal consumption, followed by industrial facilities at 36%. Most countries thatconsume substantial amounts of coal have domestic coal resources. For that reason, the volume of world coal tradetends to be small relative to worldwide coal consumption.

PEER GROUP IDENTIFICATION

Union Pacific Corporation (NYSE: UNP)

o Provides rail and freight transportation services for various cargoIt primarily operates on the Pacific and Gulf Coast.

Canadian National Railway Company (CN: CNR)

o Operates a transcontinental railway throughout Canada and partsof the United States. Also, offers logistics and supply chainexpertise services.

Norfolk Southern Corporation (NYSE: NSC)

o Provides rail transportation in 22 states and Washington D.C. and

transports overseas freights through Atlantic and Gulf Coast por

It also operates a logistics services segment.

TARGET PRICE

CSX is currently trading at an 8.04% discount relative to its

competitors based on a 5 year EV/EBITDA multiple spread

average. Currently, competitors are trading at an 11.57x multiple,

and when multiplied by the mean factor of 0.845, gives us a target

multiple of 9.69x. Using consensus NTM EBITDA estimate of$4,656.30B and a target multiple of 9.69x, we calculated an

enterprise value of $45,133.89. Adding back cash of $789.00mm,

subtracting debt and preferred of $9,331.00B, yielded an equity

value of $36,591.89B. Dividing by total number of shares

outstanding of 999.6mm, yielded a target price of $36.61, yielding

a total return of 19.34% including the dividend yield of 2.05%.

Historical Average Target Price= $36.61

Historical Average Multiple =9.69xEquity Value = $36,591.89B


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Rail and Intermodal TrafficThe Association of American Railroadsreported an increase in U.S. rail traffic inAugust 2014, both carload and intermodalvolume increasing compared with August2013. The rail industry has played and iscontinuing to play a critical role in the U.S.

economys resurgence. In fact, averageweekly U.S. rail volume, in terms ofcarloads plus intermodal containers andtrailers, was higher in August 2014 than inany month since October 2007, saidAAR Senior Vice President John T. Gray.

Regulations Regarding the Safety and Efficiency of RailroadsThe U.S. Department of Transportation released the details of its comprehensive rulemaking proposal on July 23rd2014.

The report emphasized on improving the safe transportation of large quantities of flammable materials by rail -

particularly crude oil and ethanol. Specifically, within two years, it proposes the phase out of the use of older DOT 111

tank cars for the shipment of packing group I flammable liquids, including most Bakken crude oil, unless the tank cars

are retrofitted to comply with new tank car design standards. The main problem with this proposal is that the

production capacity for new tank cars about 35,000 cars a year and industry analysts say the railcar industry could have

difficulty expanding production fast enough to accommodate the short time frames proposed by regulators for ushering

out older tank cars for transporting flammable liquids. At current production rates, cars ordered today couldn't be

delivered until 2016. Regulators have proposed a 2018 deadline for removing all the older, general -purpose tank cars.

Outlook for Chemicals such as Crude Oil and Frac SandsThe need for sand used in fracking has never been higher than it is today. Sand demand is forecasted to grow by 96%from 2013 till 2016, while capacity is only growing 76% in that time period. What this means is that the growth is beingconstrained by the lack of rail service available to transport the sand from areas like Pennsylvania, Minnesota, andWisconsin. Sand prices could increase as much as 50% due to this supply side shortage.

ChemicalsPetrochemicals


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FINANCIALS

Revenue

In Q2 FY 2014, CSX reported sales of $3.244B, representing anincrease of 6.50% QoQ. Since 2010, sales have grown from $10.636B

to $12.026B, representing a CAGR of 4.18%. From 2013 to 2016, salesare expected to grow from $12.026B to $13.749B, representing aCAGR of 4.57%. Sales are being driven by increased volume, stemmingfrom strength in several end markets that CSX serves, such aschemicals and automotives. Intermodal transportation is set to continueto be a driver of revenue as stricter regulations come down on trucking,making companies rely on rails for longer distance shipments. ThroughCSXs increased spending on infrastructureand terminals, the companyhas been able to serve more customers through intermodal transportation, as well as steal market share away fromtrucking. Revenue per unit has been consistently increasing since 2009, showing greater efficiency and better pricing. In2009, revenue per unit was $1,561, growing to $1,839 in 2013, representing a CAGR of 4.18%.

Total Merchandise

Total Merchandise was 58.5% of revenue in 2013, up 4.6% from 2009. This is beneficial for CSX because total

merchandise is the companys most diversified segment, consisting of nine sub-segments. By increasing totalmerchandises percent of total revenue, CSX becomes less reliant on one product or market, such as coal. There are fourmain sub-segments under total merchandise, which are chemicals (15.8% of revenue), automotive (10.1%), agriculturalproducts (8.4%) and forest products (6.4%). The other five sub-segments are each less than 5% of revenue and in totalaccount for 17.8% of revenue. Total merchandises revenue in 2009 was $4.875B, growing to $7.037B in 2013,representing a CAGR of 9.61%. Total revenue per unit has also been increasing since 2009, growing from $2,085 to$2,548 in 2013, representing a CAGR of 5.14%

Chemicals

Chemicals represented 15.8% of revenue in 2013. This segment has seen anincrease of 1.8% in terms of percent of total revenue since 2009. This ismainly derived from the United States energy market boom providing anincrease in the shipping of crude oil, liquefied petroleum gas, frac sands, aswell as other materials needed for the drilling of oil and natural gas. Thechemicals segment has been, and is going to continue to be one of the fastestgrowing segments for CSX since the growth in chemicals is stemming from adecrease in coal usage and an increase in natural gas and crude oil usage. Thissegment is vital in counteracting the decrease in coal volume and revenue,but continuing to provide increased revenue and volume growth. We haveseen this trend occur as coals percent of total revenue has decreased from30.7% in 2010, down to 24.1% in 2013. Chemicals total revenue has grownfrom $1.267B in 2009 to $1.896B in 2013, representing a CAGR of 10.60%,outpacing overall revenue growth by 6.42%. Revenue per unit for thissegment is the highest out of all segments for CSX, mainly because thematerials for chemicals are far more dangerous than other products ittransports, meaning these products carry a pricing premium compared toother less hazardous products. Revenue per unit in 2009 was $2,988 and has

grown to $3,564 in 2013, representing a CAGR of 4.51%.


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Automotive

Automotive represented 10.1% of revenue in 2013. This segment has seen an increase of 2.6% in terms of percent oftotal revenue since 2009. This is mainly derived from the expansion of the domestic auto market as CSX ships nearlyone third of all light automobiles, totaling 4 million units. Automotives total revenue has grown from $511mm in 2009,to $1.217B in 2013, representing a CAGR of 24.23%, outpacing general revenue growth by 20.05%. Automotivesrevenue per unit in 2009 was $2,184, and has grown to 2,817 in 2013, representing a CAGR of 6.57%.

Agricultural Products

Agricultural Products represented 8.4% of revenue in 2013. This segmenthas seen a decrease of 2.2% in terms of percent of total revenue since2009. This is mainly due to volatility in the harvests on a per year basis.Also, this segment is limited in its growth potential because there is only somuch food that needs to be produced to serve the domestic demand. Thissegments revenue has grown from $960mm in 2009 to $1.013B in 2013,representing a CAGR of 1.35%, under-pacing general revenue growth by2.83%. We do believe in the future this segment does have some room forgrowth as ethanol from corn becomes more widely used. AgriculturalProducts revenue per unit has grown from $2,243 in 2009 to $2,597 in2013, representing a CAGR of 3.73%. The company guided that thissegment in the short-term will grow as population grows, so 1-2% YoY

growth.

Forest Products

Forest Products represented 6.4% of revenue in 2013. This segment hasseen an increase of 0.3% in terms of percent of total revenue since 2009.This segments revenue has grown from $547mm in 2009 to $775mm in2013, representing a CAGR of 9.10%, outpacing general revenue by 4.92%.Forest Products revenue per unit has grown from $2,120 in 2009 to $2,601in 2013, representing a CAGR of 5.24%.

Coal

Coal represented 24.1% of revenue in 2013. This segment has seen a decrease of 6.1% in terms of percent of totalrevenue since 2009. This is due to the recent discovery of large supplies of natural gas, causing the price for natural gas

to decrease dramatically. Also, coal is more of a pollutant when used compared to natural gas. The revenue in thissegment bottomed out at $2.727B in 2009, and has increased to $2.895B in 2013, representing a CAGR of 1.51%, under-pacing general revenue growth by 2.67%. In that time period, coals revenue peaked in 2011 at $3.709B and proceededto fall to $3.190B in 2012, and $2.895B in 2013. Even though coals revenue is slightly decreasing, it is good that at thesame time coalspercent of total revenue is also decreasing. This will enable CSX to be less reliant on coal, allowing it tobe a more diversified company and not as exposed to large changes in the macro environment regarding coal. Coalsrevenue per unit has grown from $1,756 in 2009 to $2,423 in 2013, representing a CAGR of 8.38%.

IntermodalIntermodal represented 14.1% of revenue in 2013. This segment has seen an increase of 1.00% in terms of percent oftotal revenue since 2009. This is due to stricter regulations on the trucking industry making trucking companies unableto meet the growing demand that has been seen in the recent year. The revenue in this segment was $1.184B in 2009,and has increased to $1.697B in 2013, representing a CAGR of 9.47%, outpacing general revenue growth by 5.29%.Even though intermodal is seen as the smallest of the three main segments for CSX, we see this segment as being one ofthe biggest growth opportunities for CSX. As trucking regulations keep restricting driver availability and efficiency,intermodal will become more and more prevalent, especially in longer distance shipments. Also, with CSX upgradingand building new terminals, this will allow them to serve even more customers using intermodal transportation than everbefore. With the regulations on the trucking industry, customers are finding it cheaper and cheaper to transport goodsusing rail, especially for longer distances. Forbes notes that transporting freight by truck is 10 times more expensive thanrail. Intermodals revenue per unit has increased from $623 in 2009 to $657 in 2013, representing a CAGR of 1.34%.


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Margins

CSX has seen significant margin expansion by growing operating margin to 28.88%in 2013 from 25.11% in 2009, EBITDA margin to 39.87% from 35.1%, and profitmargin to 16.54% from 12.64%. As talked about before, CSX has faced significantrailway congestion due to increased volumes. This is causing compression ofmargins in 2014 due to the company not being able to handle the additional volume

as efficiently. However, the company is expecting to see margins expand back to2013 levels by 2015, and then above 2013 levels in 2016. In 2016, it is projected thatCSX will report operating, EBITDA, and profit margins of 30.67%, 39.87%, and16.54% respectively. The biggest downside for this company is that its margins are lagging behind its competitors. Thereason for CSXs lagging margins is because its other competitors have not been faced with the type of rail congestionthat CSX has. CSX operates in highly populated and highly dense areas, such as Chicago and New York causing thecompany to be more prone to rail congestion than its competitors. That is why CSX is devoting itself to increasing itscapex to try and lessen the impact of rail congestion in the future, and to make its railways more efficient.

Railroad Performance Metrics

There are several metrics that railroad companies use in order to judge how efficient they are acting compared to their own historyand competitors. Below, are a list of metrics that CSX tracks in comparison to its competitors, and the QoQ growth or decline for Q2FY 2014. Starting from the top, average dwell time, average velocity, on-time arrivals, and on-time originations all performed worse in

2014 compared to 2013. This stems directly from the substantial increase of 13.86% in cars online during the period. This wasnt justsolely CSX, NSC and UNP also experienced the same results, but werent quite as severe as CSX because of the location of itsrailways. However, as you can see, CSX also experienced the greatest increase in cars online outpacing NSC by 8.62%, and UNP by18.07%. CSX did see improvements in the quarter in its injury and accident rate. Both of these are important because a lot of concernsurrounding the railroad industry is the risk of accidents and injuries associated with increasing the use of railroads compared totrucks. To show improvement QoQ with both of these metrics, despite all the growth the company has experienced is a testament tothe companys safety precautions and procedures.

Earnings

CSX has a strong track record for beating earnings estimates, beatingestimates 9 out of the last 10 quarters, with an average earnings surpriseof 6.12%. Since 2010, CSX has been able to grow earnings at a CAGR of10.67%. From 2013 to 2016, CSX is expected to grow earnings at aCAGR of 8.54%. The reason for this slight decline in EPS growth is dueto the extreme growth seen from CSX in 2011, increasing EPS by 23.4%YoY. The slight decline in EPS growth is also due to the small YoY growth of 1.5% that is expected in 2014. After 2014,the company has provided guidance that it expects EPS growth to be in the range of low to mid double digit YoYgrowth. This is a testament to the company being able to capitalize on the additional capital it is setting aside for capex,and the ability to capitalize on the energy market boom seen in the US to offset the decline in the coal market. Analystsare concerned that with the declining coal industry, CSX will not be able to maintain the EPS guidance it has provided,and will have to reduce guidance to the range of mid to high single digit YoY EPS growth. However, we feel that the

energy market opportunity, and the positive effects felt from the increased capex will enable CSX to meet the goal ofdouble digit EPS growth. In 2013, CSX reported EPS of $1.83, and are projected to earn $1.86 in 2014, representinggrowth of 1.5% YoY. This low growth year is due mainly to the growth and congestion that the company and industryhas seen, which have increased costs at a pace $10mm per month, or $120mm annually. In 2015, EPS is projected to be$2.12, representing YoY growth of 14.2%, returning EPS growth to levels that the company and analysts are morecomfortable with. The accelerated growth expected in 2015 is due to the lowering of costs after the capex projects CSXis investing in now come online. In Q2 FY 2014, CSX reported EPS of $0.53, beating estimates of $0.52, representingQoQ growth of 2%.


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FLEET AGE/SIZECSX uses 3 main types of locomotives that make up its fleet of 4,259 locomotives: freight, switching, and auxiliary units. Freightlocomotives, which account for 87% of the fleet, are the power source used to pull trains. Switching locomotives are used to sortrailcars so the right railcar and train are properly connected and make up 8% of the fleet. Finally, auxiliary units make up 5% of thefleet and provide extra traction for heavy trains in hilly areas. In terms of age, CSXs fleet has remainedrelatively stable since 2009.

Average age for freight locomotives has remained steady at 20 since 2010. Auxiliary units have dropped in age to 21 in 2013 fromtheir all-time high of 50 in 2010. Switching locomotives have grown in average age by one year from 32 in 2010 to 33 in 2013.Management has made a concentrated effort to use capital expenditures on growing fleet size and minimizing the fleets average age,as seen by an 8% expansion in fleet size YoY since Q2 FY 2013, and 10% YoY growth since Q4 FY 2013.

SHAREHOLDER RETURNS

The company announced a $1B share repurchase program starting April 2013 spanning two years. CSX is funding therepurchasing program through excess cash and free cash flow. Since 2005, CSX has increased its quarterly dividend 12times from $0.017 in 2005, to its current quarterly dividend yield of $0.16. The LTM dividend payout ratio is 35.21%,slightly higher than the companys target dividend payout ratio range of 30-35%. The company believes this payout ratiois justified due to strong EPS growth. CSXs dividend payout ratio has grown every year over the past 4 years from23.8% in 2010, to its current dividend payout ratio of 35.21%. Looking ahead, the company plans to keep increasingquarterly dividend payouts due to its strong earnings growth. Dividends are projected to grow at a 10.65% CAGR overthe next 3 years, with the expected 2017 quarterly dividends to be $0.22 per share.

VALUATIONUndervaluationCSX is currently trading at an 8.04% discount to its competitors on a 5 year EV/EBITDA basis. There are severalreasons why CSX has begun trading at a discount. The first of these reasons is due to the decrease in coal volume. Coalvolume has been continuously falling due to the energy boom in the U.S., causing natural gas prices to be significantlycheaper than coal. Also, companies are now trying to be more environmentally friendly, and switching away from coal to

other forms of energy such as natural gas is a way cost effective way to do this. The second reason that CSX is trading ata discount to its competitors is because of the companysdeclining performance metrics, such as dwell time, averagetrain velocity, and on-time arrivals. These metrics have decreased more than peers due to CSXs rail network positionand significant volume growth.

Peer Group Valuation

The companies used in my relative valuation are Union Pacific Corporation (UNP), Norfolk Southern Corporation(NSC), and Canadian National Railway (CNR). All of these companies have been listed as direct competitors, transportthe same kind of goods, and have the same kind of business model that CSX has. As stated before the company istrading at an 8.04% discount to its historical 5 year spread on an EV/EBITDA basis. The company is index is trading at11.47x EV/EBITDA multiple and multiplying it by the mean factor gives us a target multiple of 9.69x. Using the 9.69xmultiple and consensus NTM EBITDA of $4,656.30, we calculated an enterprise value of $45,133.89. Adding back cashof $789.00 and subtracting debt of $9,309.00 yield an equity value of $36,591.89. Dividing number of shares of 999.60,yields a target price of $36.61, giving a total return of 19.34% with a 2.05% dividend included.

Target EV/EBITDA

9.69x

NTM EBITDA

$4,656.30

Target Price

$36.61


11/12


12/12

Fall 2014


DISCLAIMER

This report is prepared strictly for educational purposes and should not be used as an actual investment guide.

The forward looking statements contained within are simply the authors opinions. The writer does not own any

CSX Corp. stock.

TUIA STATEMENT

Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his

tireless dedication to educating students in real-world principles of economics and business, the William C.

Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,

practical learning experience. Managed by Fox School of Business graduate and undergraduate students with

oversight from its Board of Directors, the WCD Owl Funds goals are threefold:

Provide students with hands-on investment management experience

Enable students to work in a team-based setting in consultation with investment professionals.

Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs

and partial scholarships for student participants.

Download - CSX Initiating Coverage Report

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