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Morningstar | A Two-fer! CSX Posts Second Excellent Mid-58% Operating Ratio, Likely Matching the Canadian Rails. See Updated Analyst Note from 17 Oct 2018

CSX doubled third-quarter EPS to $1.05, beating consensus estimates by 11%, as it grew revenue 14% and increased EBIT 49% year over year. This marks two consecutive quarters of CSX generating operating ratios we expect to be near the head of the pack among Class 1 railroads, given this third-quarter record 58.7% OR (nearly 10 percentage points improved from the prior-year period). Management increased revenue guidance to 6%-8% improvement year over year, versus prior guidance of midsingle digits, and we model the midpoint of this range, with just a quarter remaining in the calendar year. We increased our fair value estimate, owing to this top-line growth and to our expectation, based on solid results, that the firm will pull margin improvement forward about three years from what we previously projected.

While the rails do not disclose margin by commodity, we believe export coal is among the most profitable products. Export coal increased 22% in the period and 27% year to date; we think this really elevates profitability. It's hard to predict when demand will reverse for export coal, but we model this starting next year. Management expects export coal to remain strong in 2018 and points out that price benchmarks are still strong. Management believes export in 2019 looks strong as well, but we've seen this change rapidly in previous years.

We believe intermodal is the sole significant source of secular volume growth, and think CSX will refine its franchise in 2019. CEO Jim Foote believes CSX can improve intermodal margins to match the overall portfolio, but we expect this effort, like route rationalization, to take place after peak season, giving shippers some respite from extreme change. Foote plans to unwind the hub-and-spoke system in northwest Ohio because it has excessive short-hauls and multiple handlings of the same box. We expect a typical intermodal yard will replace the Ohio hub, and anticipate rationalization of unattractive intermodal businesses.

We like that Foote acknowledged about 25% improvement year over year in car velocity and terminal dwell, but he emphasized that CSX is nowhere near the best in class. He seems genuinely dissatisfied with current levels, despite having been in the lead role for less than a year.