CSX Corporation — Q3 2018 Form 10-Q
Business context and period. CSX provides rail freight, intermodal and related transportation services across an approximately 21,000-mile network. This unaudited filing covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $3.129 billion | $2.743 billion | $9.107 billion | $8.545 billion |
| Operating income | $1.293 billion | $868 million | $3.620 billion | $2.594 billion |
| Operating ratio | 58.7% | 68.4% | 60.3% | 69.6% |
| Net earnings | $894 million | $459 million | $2.466 billion | $1.331 billion |
| Diluted EPS | $1.05 | $0.51 | $2.83 | $1.45 |
| Operating cash flow | Not separately provided | Not separately provided | $3.406 billion | $2.861 billion |
- Q3 revenue rose 14%, while operating expenses declined 2% to $1.836 billion. Operating income increased 49% and diluted EPS increased 106% year over year.
- Nine-month revenue increased 7%; operating expenses fell 8% to $5.487 billion. Management cited operating efficiencies, lower workforce and crew-start costs, real estate and line-sale gains, and the absence of 2017 restructuring charges.
- Nine-month adjusted free cash flow before dividends, a non-GAAP measure, was $2.426 billion, versus $1.566 billion in 2017. Capital additions were $1.240 billion, compared with $1.462 billion.
- At September 30, cash and cash equivalents were $663 million and short-term investments were $615 million. Working capital was a surplus of $840 million, up from $21 million at year-end 2017.
- Long-term debt, including current maturities, was $13.772 billion, up from $11.809 billion at December 31, 2017. CSX issued $2 billion of long-term notes during the nine months. It had no borrowings under its $1 billion revolving facility, commercial paper program or receivables securitization facility.
- Cash dividends paid were $570 million for the first nine months. Share repurchases were $2.816 billion during that period, with a further $100 million pending final settlement at quarter-end.
Changes and operating drivers
- Q3 volume increased 4%; revenue per unit increased 9%. Growth across most merchandise categories, coal and intermodal, as well as higher fuel recovery, pricing and favorable mix, contributed to revenue growth. Domestic coal volume was pressured by competition from natural gas; fertilizer volume declined following a customer facility closure.
- Expenses benefited from lower headcount and crew starts and gains from line and real estate sales. These benefits were partly offset by higher fuel prices: Q3 fuel expense rose $63 million, including $57 million attributed to a 27% price increase.
- Interest expense increased $30 million in Q3, primarily because of higher average debt balances. The Q3 effective tax rate declined to 22.3% from 38.8%; the nine-month rate declined to 23.1% from 38.4%, mainly reflecting the lower federal corporate tax rate.
- The prior-year nine-month comparison included a $296 million restructuring charge, of which $226 million was operating and $70 million non-operating. Payments related to that charge were substantially complete by March 31, 2018.
- Management reported record train velocity and car dwell for a third consecutive quarter despite Hurricane Florence’s network impacts. Q3 train velocity was 17.9 mph versus 14.0 mph, and dwell was 9.0 hours versus 12.1 hours. The filing notes its velocity and dwell calculation method differs from the STB method.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said it remains focused on further service gains, improved transit times, asset utilization and cost control.
- The approved 2018 capital plan was $1.7 billion, including approximately $200 million for Positive Train Control (PTC). Estimated total multi-year PTC implementation cost was approximately $2.4 billion; $2.2 billion had been spent through September 2018.
- Of the $5 billion authorized share-repurchase program, approximately $1.9 billion remained after quarter-end settlements, and management expected the program to be completed by the end of Q1 2019. Future repurchases may be funded with cash, operating cash flow and debt issuance.
- Key risks include fuel-price changes, demand and competition from trucking and natural gas, severe weather and operational disruption, safety and hazardous-material incidents, labor and benefit costs, PTC compliance costs, access to capital markets, and litigation and environmental liabilities.
- Management estimated reasonably possible aggregate legal losses in excess of established reserves at $2 million to $118 million; actual outcomes could differ materially. CSX identified itself as a potentially responsible party at approximately 216 environmentally impaired sites. It stated that some additional environmental exposure cannot yet be reasonably estimated.
- A long-running fuel-surcharge antitrust case remained pending; an appeals court was reviewing denial of class certification. CSX said an unexpected adverse outcome could materially affect a particular period. Separately, the company agreed to pay penalties of $1.2 million to federal authorities and $1.0 million to West Virginia related to a 2015 derailment.
- CSX planned to adopt the new lease accounting standard in Q1 2019 and did not anticipate material effects on operating results or liquidity, although additional right-of-use assets and lease liabilities were expected on the balance sheet.
Important facts for investors to verify
- Whether improved operating performance and the lower operating ratio are sustainable, particularly as fuel costs, volumes and service demands change.
- The composition and recurrence of gains from real estate and line sales, and their contribution to expense reductions and cash flow.
- Debt levels, interest costs and funding sources as CSX continues capital spending and the authorized buyback program.
- Actual PTC spending and implementation costs compared with the approximately $2.4 billion estimate.
- Developments in the fuel-surcharge litigation and environmental matters, including whether reserves remain adequate as cases and site assessments progress.
- The effects of tax reform and the transition to lease accounting on future reported results and balance-sheet measures.