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Is CSX Corp A Good Stock to Buy?

Railroads sound old-fashioned but the rails are still a popular way to move freight throughout the U.S. cheaply, quickly, and without having to depend on highways or waterways. Railroads, as with other transportation companies, are also a good barometer of general economic activity and investors should watch for good or challenging times in the business whether or not they own stock in the industry. Investors should also note that Burlington Northern Santa Fe, the largest railroad in the U.S., was purchased by Berkshire Hathaway in 2010, meaning that the industry carries the Warren Buffett seal of approval.

Warren Buffett

Railroad transportation company CSX Corp (NYSE:CSX) announced its second quarter earnings earlier in July, missing revenue targets but beating expected earnings due to high margins. As might be expected, the continued decline in coal demand- coal is commonly freighted by rail- impacted the company’s business but other sources of cargo made up for the decrease (read the details about CSX’s Q2 earnings). Digging into the numbers, the first half of 2012 has seen little change in revenue compared to the first half of 2011, based on flat prices and flat volumes, though margins have increased and allowed the company to deliver more earnings.

CSX is priced for value. Its trailing P/E is 12, and analyst estimates- which have been within a nickel each of the last four quarters- imply a forward P/E of about 10.5. CSX Corp also pays a 2.5% dividend yield to shareholders, providing some solid cash alongside a strong estimated earnings yield. Given the existing market capitalization of $22.5 billion, the company has an enterprise value of seven times trailing EBITDA. These are reasonable valuations for a low-to-no growth company paying a moderate dividend in the current market environment.

Any major railroad can be considered a peer for CSX. Norfolk Southern (NYSE:NSC), Union Pacific (NYSE:UNP), Kansas City Southern (NYSE:KSU) are three publicly traded American railroads that make for good comparisons- they range from about a third CSX’s market cap in the case of KSU to about two and a half times the market cap in the case of UNP. So far this year, CSX and these peers are generally flat; the only exception, Union Pacific, is up roughly 10%. CSX’s trailing P/E matches Norfolk Southern’s, and Union Pacific’s multiple is slightly higher. Kansas City Southern trades at twenty times its trailing earnings. A similar story plays out on the divided front, with NSC and UNP paying similar dividend yields but KSU only paying 1.1%. In summary, CSX’s valuation is in line with most of its peers.

A number of funds join Buffett in investing in the railroad industry, and CSX is no exception. Renaissance Technologies, owned by billionaire Jim Simons, added to its CSX position in the first three months of the year and owned 2.2 million shares at the end of March (see more stock picks from Renaissance Technologies). Billionaire Jeffrey Vinik’s Vinik Asset Management also added to its holdings and finished the quarter with 2 million shares of the railroad (find other favorite stocks at Vinik Asset Management). This stock is in a cyclical industry and its stock price may decline significantly if the economy goes into a recession. However, CSX is trading at a 30% discount to several utility stocks that yield between 4 to 5%. Duke Energy Corp (NYSE:DUK) and First Energy (NYSE:FE) are examples of this. Both stocks yield between 4 and 5% and have trailing PE ratios of 20 and 18 respectively. Duke Energy’s 2013 forward PE ratio is also 15, same as First Energy’s forward earnings multiple. We think CSX Corp is a much better long-term investment than utilities at this moment.

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