CSX: Wide Moat, Solid Earnings, But Wait for a Pullback

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On Tuesday afternoon, CSX (NYSE:CSX) reported its second-quarter earnings results. The company was pleased to report that its quarterly revenues rose 7 percent to $3.2 billion and that its earnings grew slightly, to $529 million. Earnings per share grew 2 cents from 51 cents per share to 53 cents per share. The stock was largely flat after hours, although we should keep in mind that it hit an all-time high during the early part of Tuesday’s trading session.

CSX has been a solid performer year to date with a gain of 8 percent, which is slightly better than the 7 percent gain we have seen in the S&P 500. The company also hiked its quarterly dividend earlier in the year from 15 cents per share to 16 cents per share, giving it a 2 percent yield versus the S&P 500, which yields about 1.8 percent. These aren’t phenomenal numbers, but CSX is delivering what investors expect from railroads: strong, consistent cash flow.

But should you buy the stock now?

While I am a shareholder, I don’t think the current price is a good entry point. This is a stock that investors should buy on weakness, and investors were given that opportunity earlier in the year, when the company reported weak fourth-quarter numbers due to low coal shipments. While investors were panic selling the stock down to $26 per share, wise investors who saw the company’s solid future potential were picking up shares.

Now the stock trades 20 percent higher at well over 17 times earnings, and while this is below the S&P 500’s 22.6 earnings multiple, it seems that investors have become optimistic again, and while I agree with this optimism, it doesn’t make for a good buying opportunity.

This optimism extends to the larger rail transport sector, which has generally been outperforming for the year, as it has for the past decade and longer. There are a couple of reasons for this. The first is that the rail-transport sector is a de facto oligopoly. There are only a handful of players in the space, and they know better than to start a price war, as that hurts everybody in the sector. This means that there is effectively no competition in the space. Furthermore, these companies have a wide economic moat in that it is virtually impossible for a new player to enter the space. It would take years and billions of dollars in order to replicate the 20,000 miles of track that CSX has.

The second reason is that the rail transport space is far more efficient than other forms of freight transportation, especially trucking. A train is like hundreds of trucks tied together with one driver, and so rail transport companies have minimal labor costs relative to trucking companies. Trains also use far less fuel, and while we have seen a pullback in oil over the past couple of weeks, the price is still several times higher than it was just 10 to 15 years ago. This has put a lot of pressure on the trucking industry, but rail transport companies have benefitted tremendously.

We see this in CSX’s strong sales figures, which were up 7 percent on an 8 percent increase in revenue. Considering that economic data have been largely mixed, it is evident that CSX is benefitting from the aforementioned tailwinds, and I suspect that it will continue to do so.

But with that being said, the rail transport stocks are stocks you want to buy on weakness, and we simply aren’t seeing that weakness in this market environment. Investors who want to take a position — and I think this is a wise decision – should consider taking it around $28 to $29 per share, where there is relatively strong technical support.

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