The purpose of a stock buyback plan should be to utilize excess cash to buy a significantly undervalued asset. In this case, the undervalued asset is the stock of the company involved. In order to even announce a buyback, the stock should be significantly cheap on a historical basis and future earnings expectations. For the stock to be significantly cheap, the company should be in a position that existing cash on the balance sheet and cash flows are enough to reduce the share count by a material amount over the next couple of years.
In the case of CSX Corporation (NYSE:CSX), the company announced plans for a buyback that doesn’t provide enough incentives to suggest the scale and scope that would move the needle. Considering the railroad operator has been a significant buyer of stock in the past, the new plan suggests caution at the operator or a general lack of free cash flow compared to the current market value.
The disappointing plan
CSX Corporation (NYSE:CSX) announced a plan to repurchase $1 billion worth of stock over the next two years. While a solid buyback program, the amount doesn’t move the needle much for a stock with a $24 billion market cap now. If the company splits the plan evenly over the next two years, it will only amount to roughly 2% of the outstanding shares each year.
With cash being a very precious commodity, the preference would be for the company to only utilize the buyback on stock swoons or if the prospects improve dramatically while the stock flat lines. Otherwise, it should only be used for extreme low valuations and not as a standard monthly program.
The current trailing PE (see chart below) is in the normal range over the last five years. If anything, the fourth quarter provided the opportune time to utilize a buyback yet CSX Corporation (NYSE:CSX) only bought $230 million of stock during that period. In addition, the company didn’t provide any indication that it would only initiate the buyback on weakness.
While not buying any stock during Q113, CSX Corporation (NYSE:CSX) bought $734 million in 2012 and $1.56 billion in 2012. The current plan calls for only $500 million on a annual basis suggesting the board of directors continues to be less enthralled with the prospects of the industry.
Solid dividend plan
CSX does offer a solid 2.3% dividend. The company raised the quarterly dividend to $0.15 and claims a record of increasing the dividend 11 times since 2005 with a compounded annual growth rate of 29%. Clearly the stock isn’t a horrible investment at these levels with a solid dividend and a decent buyback. The issue is that the railroad stocks might be played out based on the signals from management.
What’s up with the competition?
With several strong companies in the sector, it is always worthwhile to review the competition even if it competes mostly for investment dollars and not work.
Union Pacific Corporation (NYSE:UNP) is the largest railroad operator with a market cap of $67 billion. Though larger than CSX, Union Pacific Corporation (NYSE:UNP) trades at a trailing PE of over 17 and a forward PE of 13.3. The company has consistently bought around $300 million-400 million of shares on a quarterly basis. That pace only amounts to roughly 2% per year. Union Pacific Corporation (NYSE:UNP) has a smaller dividend at 2%.
Norfolk Southern Corp. (NYSE:NSC) is comparable in size to CSX Corporation (NYSE:CSX) at a market cap of just under $24 billion. The company has a trailing PE of 13.8 and a forward PE of 11.7. Both PEs are comparable to CSX. Norfolk Southern Corp. (NYSE:NSC) only repurchased $138 million of stock in the Q412 quarter. That number was down from the $440 million in the last quarter of 2011 and the lowest quarterly amount of 2012. The company has a slightly higher dividend at 2.6%.
While the announcement of a $1 billion stock buyback plan sounded impressive, the details suggest a different story. With corporate authorizations at record levels, the railroad sector appears to be cutting back on buyback plans. Is this signaling a potential top in the sector?
CSX Corporation (NYSE:CSX) trades within the valuation range of the sector and below that of industry leader Union Pacific. While not expensive, the stock isn’t overly attractive and investors should probably follow the company and buy less stock.
The article Not Impressed With the CSX Buyback Plan originally appeared on Fool.com and is written by Mark Holder.
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