Excluding a $0.02 tax benefit, CSX reported 4Q EPS of $0.99, in line with Cons. and $0.01 better than our model. Yields and other revenue were both better than we expected, but CSX’s OR of 60.3% was 30bp worse than our model due to ~$10M of net one-time headwinds in MS&O and labor costs that cost $0.01 in the quarter.
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Nice rally to start the year! Our WR Transport index bounced 5.7% last week and outperformed the 2.5% rise in the S&P 500. Just a couple of weeks into the year and our Transport index is already up 7% YTD and outperforming the 4% rise in the S&P. Overall, the TLs (+10%) and Rails (+8%) have performed best to start the year while the non-asset Forwarders (+1%) have relatively lagged.
We spoke with a large chemicals shipper about current TL pricing and capacity trends. The shipper has seen the TL market loosen meaningfully as his tender acceptance rates improved 14 percentage points sequentially last quarter to their highest level since 2H:17. This shipper also noted that spot rates have fallen below contractual rates but he's hardly using the spot market right now since tender acceptance levels are so high. From a pricing standpoint, this shipper's TL rates increased 6% last year and he's currently forecasting a range of flat to +5% for rates this year. Unless the economy re-accelerates, our contact expects rates will be closer to flattish or up slightly. Meanwhile, our contact expects around 2% LTL rate increases this year, down slightly from 2.5%-3% increases last year.
After the close (01/09/19, UNP filed an 8-K and noted that C18 margins finished better than expected, driven by stronger than expected volumes in December, lower fuel prices, and better underlying cost performance. Based on our model, UNP’s update implies a 61.7% OR in 4Q:18E, 90bp improved y/y and 100bp better than our prior expectation. Based on unchanged revenue expectations, we’ve raised our 4Q EPS estimate from $2.03 to $2.09 vs. prior Cons. of $2.03.
After the market (1/7/2019), UNP named Jim Vena as its new Chief Operating Officer, effective Jan. 14. Jim previously spent 40 years at CNI, most recently as COO before retiring in June 2016. Jim will lead the implementation of precision railroading (PSR) at UNP. The stock has traded up around 6% after-hours, and we’d be buyers, even after this strength, as we believe this move significantly increases the probability of PSR success and a mid-50s OR at UNP.
Volatility has continued to start the year, but thanks to a strong rally on Friday, our WR Transport index is up 0.9% the first few trading days of the year, basically in line with the 1% increase in the S&P 500. We’re definitely seeing a little mean reversion as the 4 worst performing stocks last year – YRCW, USX, R and KNX – are the top 4 performing stocks just a few days into the year. Overall, the TLs (+3%) have performed best to start the year while the non-asset Forwarders (-2%) have performed worst.
We spoke with a chemicals shipper about recent trends in demand, rail pricing, and service with the Class I rails. Business overall is steady and rail volumes increased slightly last year. Looking to 2019, our contact rail volume growth to accelerate to 4%-5% based on further development of the petrochemical and plastics industries around the Gulf. From a rail service standpoint, our contact is seeing improved line-haul service on UNP and NSC as they implement precision railroading, but local first- and last-mile service is worsening. UNP and NSC have also become more restrictive on the number of cars that they are willing to accept in their yards. Looking ahead, our contact expects both UNP and NSC to reduce crews, park equipment, and consolidate yards. But the changes made by UNP and NSC so far have been more gradual and less painful than the PSR roll-out at CSX in 2017. In terms of rail pricing, our contact is seeing 4%-6% rate increases on average from most of the rails, with the exception of BNSF which has more aggressively been chasing freight with competitive rates. However, almost 70% of the traffic for this shipper is captive, so there are only limited opportunities to shift freight from UNP to BNSF.
CSX has materially outperformed the past 2 years (+73% vs. the other rails +27% on avg. and the S&P 500 +12%) as it generated by far the best EPS and free cash flow growth, and its margins improved from worst among the rails to first. We still expect good margin improvement and EPS growth to continue this year, but we see less potential EPS upside after 2018 benefited from a perfect storm of precision railroading, accessorial charges, real estate gains, export coal strength, and TL capacity tightness. So while we still see good absolute upside for the stock from here, we’re lowering our rating to Peer Perform relative to some of the other rails where we see more potential EPS upside.
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