CSX Initiating Coverage Report

INITIATING COVERAGE REPORT

William C. Dunkelberg Owl Fund
September, 10
th
2014

Jesse Barone: Lead Analyst
[email protected]
Ethan Friedland: Associate Analyst
[email protected]
Joseph Heidt: Associate Analyst
[email protected]

COMPANY OVERVIEW

CSX Corporation is a diversified freight transportation
company that provides rail-based transportation services
throughout the eastern United States. CSX transports
chemicals, automotive products, agriculture, forest products,
metals, phosphates, fertilizers, minerals, food and consumer
products, along with waste and equipment. In addition, the
company uses its network of 50 terminals and 21,000 miles of
rail to transport coal and provide intermodal transportation
services. The company’s four business segments, all based in
the United States, are Total
Merchandise (58.5% of FY
2013 revenue), Coal (24.1%),
Intermodal (14.1%), and other
services (3.3%).

INVESTMENT THESIS

CSX is currently trading at an
8.04% discount to its
competitors. Investors have been devaluing CSX because of
the decrease in demand for coal (Coal is 24% of revenue for
CSX), and the recent dip in the company’s performance metrics
due to congestion of railways from substantial volume growth.
CSX is seen to have two economic moats, which are barriers to
entry and an expansive network of railways and terminals that
cannot be replicated, giving it a competitive advantage over its
competitors. Through CSX’s strategic rail network, it is able to
provide service to 66% of the population in the United States,
and currently is in charge of 50% of rail volume on the east
coast. Looking forward, investors have not accounted for the
new capital expenditure projects that CSX have started in 2014,
and the recently completed projects in 2014 in order to keep up
with the increasing volume it is experiencing. These projects
will expand its performance metrics back to normal historical
levels. Investors also haven’t accounted for the new coal
demand to be capitalized on by CSX in the Illinois Coal Basin,
the United States energy boom, which has created new markets
for CSX such as crude oil, liquefied petroleum gases, and frac
sands, and increased regulation in the trucking industry
allowing CSX to claim market share away from trucking
companies. We believe the company will appreciate from its
current EV/EBITDA multiple of 8.77x, to the 5 year historical
spread average compared to peers of 9.69x, resulting in a price
target of $36.61, and a total return of 19.34% including a
dividend yield of 2.05%.








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CSX Corp.
Exchange: NYSE Ticker: CSX Target Price: $36.61

Sector Outperform
Recommendation: BUY

Key Statistics:
Price $31.49 52 Week Low $25.04
Return 19.34% 52 Week High $31.50
Shares O/S (mm) 999.6 Yield 2.05%
Market Cap (mm) $31,476 Enterprise Value $40,018

1 Year Price Graph



Earnings History:
Quarters EPS Δ Rev. YoY Δ Price
3Q13 $0.460 3.63% -0.80%
4Q13 $0.420 4.73% -6.81%
1Q14 $0.400 1.65% -1.77%
2Q14 $0.530 6.50% 0.13%

Earnings Projections:
Year Q1 Q2 Q3 Q4 Total
2012 $0.41 $0.48 $0.44 $0.39 $1.75
2013 $0.45 $0.52 $0.46 $0.42 $1.83
2014(Q3,4E) $0.40 $0.53 $0.46 $0.48 $1.86
2015e $0.45 $0.60 $0.53 $0.53 $2.11


All prices current at end of previous trading sessions from
date of report. Data is sourced from local exchanges via
CapIQ, Bloomberg and other vendors. The William C.
Dunkelberg Owl fund does and seeks to do business with
companies covered in its research reports.


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SEGMENT OVERVIEW

Total Merchandise:
The merchandise
business shipped nearly
2.8 million carloads and
generated approximately
59% of FY 2013
revenue. Along with
being CSX’s largest
segment (42% of FY
2013 volume), total
merchandise is the most
diverse segment consisting of nine sub-segments. The Merchandise
segment transports chemicals, automotives, agricultural products, forest
products, metals, phosphates and fertilizers, minerals, food and consumer
products, as well as waste and equipment.

Chemicals
The Chemicals segment made up 27% of Total Merchandise revenue and
15.8% of total revenue in FY 2013. In this segment, CSX transports
plastics, plastic feedstock, plastic intermediaries, crude oil, liquefied
petroleum gas (LPG), and frac sand.

Automotive
The Automotive unit made up 17.3% of the Total Merchandise business
and 10.1% of total revenue in FY 2013. The Automotive segment is an
essential part of North American vehicle distribution, as it ships almost
1/3 of all light vehicles produced. CSX handles nearly 4 million vehicles
annually through its network of 35 auto distribution centers and a fully
enclosed multilevel fleet. In addition to transporting finished vehicles,
CSX transports auto parts throughout the eastern United States.

Agricultural
The Agricultural segment made up 14.4% of the Total Merchandise
business and 8.4% of total revenue in FY 2013. The agricultural unit
transports products such as grain, flour, oils, sweeteners, and ethanol.
Through this business, CSX directly serves grain elevators, feed mills,
grain processing facilities, bakeries, ethanol plants, and soft drink
production facilities.

Coal:
The Coal business shipped nearly 1.2 million carloads and generated 24%
of revenue and 18% of volume in FY 2013. CSX transports domestic coal,
coke and iron ore to electricity-generating power plants, steel
manufacturers, and industrial plants. CSX also exports coal to deep-water
port facilities. CSX is the largest coal transporter east of the Mississippi
and serves more than 120 load-outs in 9 states.

Intermodal:
The Intermodal business contributed 14% of revenue and 40% of volume
in 2014. Intermodal transportation is using at least two modes of
transportation to move freight. CSX’s intermodal line of business
combines long distance rail transportation with short-haul trucking. The
intermodal business has 50 terminals east of the Mississippi River and uses
them to transport mainly manufactured consumer goods in containers.

RISKS
 New Legislation or Regulatory
Changes: Legislation passed by Congress
or new regulations issued by federal
agencies regarding pricing negotiation and
constraints, climate change, emissions,
capacity, and hazardous waste
transportation could have a negative effect
on top or bottom line growth.
 Declining Natural Gas Prices: As
natural gas prices decrease, coal-fired
power plants are being replaced by natural
gas-fired power generation facilities. If
natural gas prices remain low and continue
to decrease, more coal-fired plants could
be replaced, which would reduce CSX’s
domestic coal volumes and revenues.
 Demand Fluctuation: General domestic
and global economic conditions that
affect demand for the commodities and
products CSX transports could adversely
affect the top line.
 Severe Weather: Extreme weather
conditions can adversely affect the
company’s operations and incur additional
costs, negatively affecting top and bottom
line growth.
 U.S. Energy Markets: Over the past few
years, production of natural gas in the U.S.
has increased dramatically, resulting in
lower natural gas prices, causing a negative
impact on CSX. As a result of sustained
low natural gas prices, coal-fired power
plants have been displaced by natural gas-
fired power generation facilities.

ECONOMIC MOATS: Narrow and
Stable
 Rail Network: CSX spans the densely
populated eastern U.S., capturing about
half of the rail volume in the region. CSX
operates approximately 21,000 miles in rail
network, which serves various population
centers in 23 states east of the Mississippi
River, the District of Columbia, and the
Canadian provinces of Ontario and
Quebec, as well as operates approximately
4,000 locomotives.
 Barriers to Entry: The network of rails is
very unlikely to have any new main lines
built especially since most regions already
have two main competitors and replicating
the network in place is nearly impossible.


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CATALYSTS

New terminals/expansion of old terminals
CSX in recent months has experienced a significant increase in demand for its
service. With the substantial increase in demand, several performance metrics
have fallen in recent quarter such as dwell time, average velocity, EBITDA
margin, and profit margin. Stemming from this decline, CSX has committed to
improving these metrics by creating new terminals, expanding capacity of old
terminals, and improving infrastructure. During 2013 and 2014, the company has
expanded terminals in Columbus, Ohio, Louisville, Kentucky, Atlanta, Georgia,
and Worcester Massachusetts. An example of the benefits from this additional
capex is a 50% increase in capacity at the company’s terminal in Columbus, Ohio.
The company expects to open new terminals in Winter Haven, Florida and
Quebec, Canada during 2014. Investors and the company should start to see
benefits from the 2013 projects that the company has recently completed in the
second half of 2014, and should expect to see the rest of the terminals fully
operational by end of 2015. Some other notable investments that are occurring is
an upgrade in infrastructure in the Chicago area, specifically with the Elsdon sub-
division, which will provide this area with double track miles (having a track run
in each direction so trains going opposite directions aren’t on the same track), which will increase average train velocity
and flexibility in the area to be able to divert traffic away from the more congested routes. In the River Line area, which
is from New Jersey up to Boston, double track is being added to capitalize on those same benefits listed above. This
specific infrastructure project is crucial because it is going to address a growing need as demand increases in one of
CSX’s busiest regions.

Illinois Basin Coal Shift
Historically, the Appalachian region was a main supplier of coal and was a large part of CSX’s coal business. However,
with decreasing coal demand, the Appalachian region has not been growing in terms of coal output. The Illinois Basin
has become a large hotspot for coal production to make up for the significant decline seen in the Appalachian region.
Extracting coal from the Illinois Basin cost about $44 a ton, 22% cheaper than Central Appalachia and 30% cheaper
than Northern Appalachia. Powder River Basin has the cheapest extraction price tag of $11 per ton. CSX is positioned
to take advantage of this shift away from the Appalachian region to the new Illinois Basin region. CSX is investing in a
new coal unit train processing facility that will support this growth, while also adding increased employees and
infrastructure in the region. CSX is in a unique position as one of only two companies that can add the capex needed to
support the growth that is having in this region.

United States Energy Boom
The surge seen from the increased drilling for the extraction of oil and natural gas has created several new high growth
markets and products such as crude oil, liquefied petroleum gases, and frac sands that CSX is uniquely positioned to
capitalize on. Along with these markets, CSX is capable to capitalize on transporting the supplies needed for drilling for
natural gas and oil. CSX is able to transport the material from the gas processing plants to the market. With these
expanding markets, CSX has invested in new terminals, railcars, locomotives, and additional employees in order to meet
the demand stemming from these specific markets and products.

Public-Private Partnerships and Increased Regulation
CSX is joining with several government partners such as the Commonwealth of Massachusetts and the State of Florida,
to increase capacity, efficiency, and safety with railroads. The reason for this is these government organizations have
begun to recognize the benefits of using rail instead of trucking. Some of the benefits of using rails instead of trucks are
reduced traffic, reduced pollution (rails are four times more efficient than trucks), and increased activity at U.S. ports by
the use of intermodal transportation. One of the projects called National Gateway, which is a project totaling $850mm
in investment from CSX and government organizations throughout the east coast, is outfitting tracks and bridges to
allow double stacking of freight. This will increase the percentage of tracks outfitted for double stacking from 90% to
95%. There are several of these projects underway currently, such as creating a rail corridor parallel to interstate 70 and
76 between Washington, D.C. and northwest Ohio, replacing bridges in Maryland, and expanding the Virginia Avenue
Tunnel. Along with these partnerships, the Federal Government continues to put stricter regulations on the trucking
industry, which continues to increase costs for companies causing them to switch to another mode of transportation
such as rail, or the use of intermodal transportation by using rail for long distances and trucking for shorter distances.

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INDUSTRY OVERVIEW

The Rail Renaissance
In 1980 the Staggers Rail Act severely deregulated the railroad industry and allowed rail companies to set their own rates
as long as there was competition and create service contracts. This has led to significant consolidation in the railroad
industry in order to increase efficiency. The number of Class I rail companies has reduced from over 40 in 1980 to just 8
today, which CSX is one of them. Over the past five years the S&P 500 Rail Index has grown over 182%. During the
recession there were as little as 80 freight cars per train. However, once demand picked up Class I railroads were able to
expand their operating margins by 26.8% in 2010, just by adding more freight cars per train and having a minimal
increase in operating cost. Operating cost was able to stay low since the railroads didn’t need any additional engines or
crews to operate the longer trains. Even as demand rose and more operating cost were incurred, it was offset by more
fuel efficient locomotives, widening margins to 27.1% in 2012. The Association of American Railroads reported that fuel
efficiency rose from 235 ton-miles per gallon in 1980 to 476 ton-miles in 2012. Today we are seeing a lot of these same
things play out for Class I railroads. There is significant congestion and volume growth, making companies like CSX
increase their capex in order to keep up with the demand and keep performance metrics at high levels.

Future Demand for Coal
Future Domestic Coal Demand
The Mercury and Air Toxics Standards take effect
next year, and coal powered plants will need to equip
their facilities with scrubbers that remove sulfur
dioxide to comply with the new regulation. The
Obama administration is trying to reduce carbon
dioxide emissions, but still estimates the nation to
burn 616 million to 636 million tons of coal in 2020.
Coal current share of power generation is 41%, but is
expected to fall to 33% by 2020 and 30% by 2030
under the new regulation.

Future Foreign Coal Demand
Coal remains the 2nd largest energy source worldwide. Annual consumption of worldwide coal is expected to increase
1.3% per year until 2020. In the longer term, growth of coal consumption decelerates as policies and regulations
encourage the use of cleaner energy sources, natural gas becomes more economically competitive as a result of shale gas
development, and growth of industrial use of coal slows largely as a result of China's industrial activities. Globally,
generating electricity accounts for 60% of coal consumption, followed by industrial facilities at 36%. Most countries that
consume substantial amounts of coal have domestic coal resources. For that reason, the volume of world coal trade
tends to be small relative to worldwide coal consumption.
PEER GROUP IDENTIFICATION
 Union Pacific Corporation (NYSE: UNP)
o Provides rail and freight transportation services for various cargo.
It primarily operates on the Pacific and Gulf Coast.
 Canadian National Railway Company (CN: CNR)
o Operates a transcontinental railway throughout Canada and parts
of the United States. Also, offers logistics and supply chain
expertise services.
 Norfolk Southern Corporation (NYSE: NSC)
o Provides rail transportation in 22 states and Washington D.C. and
transports overseas freights through Atlantic and Gulf Coast ports.
It also operates a logistics services segment.
TARGET PRICE

CSX is currently trading at an 8.04% discount relative to its
competitors based on a 5 year EV/EBITDA multiple spread
average. Currently, competitors are trading at an 11.57x multiple,
and when multiplied by the mean factor of 0.845, gives us a target
multiple of 9.69x. Using consensus NTM EBITDA estimate of
$4,656.30B and a target multiple of 9.69x, we calculated an
enterprise value of $45,133.89. Adding back cash of $789.00mm,
subtracting debt and preferred of $9,331.00B, yielded an equity
value of $36,591.89B. Dividing by total number of shares
outstanding of 999.6mm, yielded a target price of $36.61, yielding
a total return of 19.34% including the dividend yield of 2.05%.

Historical Average Target Price= $36.61
Historical Average Multiple = 9.69x
Equity Value = $36,591.89B



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Rail and Intermodal Traffic
The Association of American Railroads
reported an increase in U.S. rail traffic in
August 2014, both carload and intermodal
volume increasing compared with August
2013. “The rail industry has played and is
continuing to play a critical role in the U.S.
economy’s resurgence. In fact, average
weekly U.S. rail volume, in terms of
carloads plus intermodal containers and
trailers, was higher in August 2014 than in
any month since October 2007,” said
AAR Senior Vice President John T. Gray.

Regulations Regarding the Safety and Efficiency of Railroads
The U.S. Department of Transportation released the details of its comprehensive rulemaking proposal on July 23
rd
2014.
The report emphasized on improving the safe transportation of large quantities of flammable materials by rail -
particularly crude oil and ethanol. Specifically, within two years, it proposes the phase out of the use of older DOT 111
tank cars for the shipment of packing group I flammable liquids, including most Bakken crude oil, unless the tank cars
are retrofitted to comply with new tank car design standards. The main problem with this proposal is that the
production capacity for new tank cars about 35,000 cars a year and industry analysts say the railcar industry could have
difficulty expanding production fast enough to accommodate the short time frames proposed by regulators for ushering
out older tank cars for transporting flammable liquids. At current production rates, cars ordered today couldn't be
delivered until 2016. Regulators have proposed a 2018 deadline for removing all the older, general-purpose tank cars.
Outlook for Chemicals such as Crude Oil and Frac Sands
The need for sand used in fracking has never been higher than it is today. Sand demand is forecasted to grow by 96%
from 2013 till 2016, while capacity is only growing 76% in that time period. What this means is that the growth is being
constrained by the lack of rail service available to transport the sand from areas like Pennsylvania, Minnesota, and
Wisconsin. Sand prices could increase as much as 50% due to this supply side shortage.






Chemicals Petrochemicals

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FINANCIALS

Revenue

In Q2 FY 2014, CSX reported sales of $3.244B, representing an
increase of 6.50% QoQ. Since 2010, sales have grown from $10.636B
to $12.026B, representing a CAGR of 4.18%. From 2013 to 2016, sales
are expected to grow from $12.026B to $13.749B, representing a
CAGR of 4.57%. Sales are being driven by increased volume, stemming
from strength in several end markets that CSX serves, such as
chemicals and automotives. Intermodal transportation is set to continue
to be a driver of revenue as stricter regulations come down on trucking,
making companies rely on rails for longer distance shipments. Through
CSX’s increased spending on infrastructure and terminals, the company
has been able to serve more customers through intermodal transportation, as well as steal market share away from
trucking. Revenue per unit has been consistently increasing since 2009, showing greater efficiency and better pricing. In
2009, revenue per unit was $1,561, growing to $1,839 in 2013, representing a CAGR of 4.18%.

Total Merchandise
Total Merchandise was 58.5% of revenue in 2013, up 4.6% from 2009. This is beneficial for CSX because total
merchandise is the company’s most diversified segment, consisting of nine sub-segments. By increasing total
merchandise’s percent of total revenue, CSX becomes less reliant on one product or market, such as coal. There are four
main sub-segments under total merchandise, which are chemicals (15.8% of revenue), automotive (10.1%), agricultural
products (8.4%) and forest products (6.4%). The other five sub-segments are each less than 5% of revenue and in total
account for 17.8% of revenue. Total merchandise’s revenue in 2009 was $4.875B, growing to $7.037B in 2013,
representing a CAGR of 9.61%. Total revenue per unit has also been increasing since 2009, growing from $2,085 to
$2,548 in 2013, representing a CAGR of 5.14%

Chemicals
Chemicals represented 15.8% of revenue in 2013. This segment has seen an
increase of 1.8% in terms of percent of total revenue since 2009. This is
mainly derived from the United States energy market boom providing an
increase in the shipping of crude oil, liquefied petroleum gas, frac sands, as
well as other materials needed for the drilling of oil and natural gas. The
chemicals segment has been, and is going to continue to be one of the fastest
growing segments for CSX since the growth in chemicals is stemming from a
decrease in coal usage and an increase in natural gas and crude oil usage. This
segment is vital in counteracting the decrease in coal volume and revenue,
but continuing to provide increased revenue and volume growth. We have
seen this trend occur as coal’s percent of total revenue has decreased from
30.7% in 2010, down to 24.1% in 2013. Chemical’s total revenue has grown
from $1.267B in 2009 to $1.896B in 2013, representing a CAGR of 10.60%,
outpacing overall revenue growth by 6.42%. Revenue per unit for this
segment is the highest out of all segments for CSX, mainly because the
materials for chemicals are far more dangerous than other products it
transports, meaning these products carry a pricing premium compared to
other less hazardous products. Revenue per unit in 2009 was $2,988 and has
grown to $3,564 in 2013, representing a CAGR of 4.51%.









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Automotive
Automotive represented 10.1% of revenue in 2013. This segment has seen an increase of 2.6% in terms of percent of
total revenue since 2009. This is mainly derived from the expansion of the domestic auto market as CSX ships nearly
one third of all light automobiles, totaling 4 million units. Automotive’s total revenue has grown from $511mm in 2009,
to $1.217B in 2013, representing a CAGR of 24.23%, outpacing general revenue growth by 20.05%. Automotive’s
revenue per unit in 2009 was $2,184, and has grown to 2,817 in 2013, representing a CAGR of 6.57%.

Agricultural Products
Agricultural Products represented 8.4% of revenue in 2013. This segment
has seen a decrease of 2.2% in terms of percent of total revenue since
2009. This is mainly due to volatility in the harvests on a per year basis.
Also, this segment is limited in its growth potential because there is only so
much food that needs to be produced to serve the domestic demand. This
segment’s revenue has grown from $960mm in 2009 to $1.013B in 2013,
representing a CAGR of 1.35%, under-pacing general revenue growth by
2.83%. We do believe in the future this segment does have some room for
growth as ethanol from corn becomes more widely used. Agricultural
Product’s revenue per unit has grown from $2,243 in 2009 to $2,597 in
2013, representing a CAGR of 3.73%. The company guided that this
segment in the short-term will grow as population grows, so 1-2% YoY
growth.

Forest Products
Forest Products represented 6.4% of revenue in 2013. This segment has
seen an increase of 0.3% in terms of percent of total revenue since 2009.
This segment’s revenue has grown from $547mm in 2009 to $775mm in
2013, representing a CAGR of 9.10%, outpacing general revenue by 4.92%.
Forest Product’s revenue per unit has grown from $2,120 in 2009 to $2,601
in 2013, representing a CAGR of 5.24%.

Coal
Coal represented 24.1% of revenue in 2013. This segment has seen a decrease of 6.1% in terms of percent of total
revenue since 2009. This is due to the recent discovery of large supplies of natural gas, causing the price for natural gas
to decrease dramatically. Also, coal is more of a pollutant when used compared to natural gas. The revenue in this
segment bottomed out at $2.727B in 2009, and has increased to $2.895B in 2013, representing a CAGR of 1.51%, under-
pacing general revenue growth by 2.67%. In that time period, coal’s revenue peaked in 2011 at $3.709B and proceeded
to fall to $3.190B in 2012, and $2.895B in 2013. Even though coal’s revenue is slightly decreasing, it is good that at the
same time coal’s percent of total revenue is also decreasing. This will enable CSX to be less reliant on coal, allowing it to
be a more diversified company and not as exposed to large changes in the macro environment regarding coal. Coal’s
revenue per unit has grown from $1,756 in 2009 to $2,423 in 2013, representing a CAGR of 8.38%.

Intermodal
Intermodal represented 14.1% of revenue in 2013. This segment has seen an increase of 1.00% in terms of percent of
total revenue since 2009. This is due to stricter regulations on the trucking industry making trucking companies unable
to meet the growing demand that has been seen in the recent year. The revenue in this segment was $1.184B in 2009,
and has increased to $1.697B in 2013, representing a CAGR of 9.47%, outpacing general revenue growth by 5.29%.
Even though intermodal is seen as the smallest of the three main segments for CSX, we see this segment as being one of
the biggest growth opportunities for CSX. As trucking regulations keep restricting driver availability and efficiency,
intermodal will become more and more prevalent, especially in longer distance shipments. Also, with CSX upgrading
and building new terminals, this will allow them to serve even more customers using intermodal transportation than ever
before. With the regulations on the trucking industry, customers are finding it cheaper and cheaper to transport goods
using rail, especially for longer distances. Forbes notes that transporting freight by truck is 10 times more expensive than
rail. Intermodal’s revenue per unit has increased from $623 in 2009 to $657 in 2013, representing a CAGR of 1.34%.




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Margins

CSX has seen significant margin expansion by growing operating margin to 28.88%
in 2013 from 25.11% in 2009, EBITDA margin to 39.87% from 35.1%, and profit
margin to 16.54% from 12.64%. As talked about before, CSX has faced significant
railway congestion due to increased volumes. This is causing compression of
margins in 2014 due to the company not being able to handle the additional volume
as efficiently. However, the company is expecting to see margins expand back to
2013 levels by 2015, and then above 2013 levels in 2016. In 2016, it is projected that
CSX will report operating, EBITDA, and profit margins of 30.67%, 39.87%, and
16.54% respectively. The biggest downside for this company is that its margins are lagging behind its competitors. The
reason for CSX’s lagging margins is because its other competitors have not been faced with the type of rail congestion
that CSX has. CSX operates in highly populated and highly dense areas, such as Chicago and New York causing the
company to be more prone to rail congestion than its competitors. That is why CSX is devoting itself to increasing its
capex to try and lessen the impact of rail congestion in the future, and to make its railways more efficient.

Railroad Performance Metrics

There are several metrics that railroad companies use in order to judge how efficient they are acting compared to their own history
and competitors. Below, are a list of metrics that CSX tracks in comparison to its competitors, and the QoQ growth or decline for Q2
FY 2014. Starting from the top, average dwell time, average velocity, on-time arrivals, and on-time originations all performed worse in
2014 compared to 2013. This stems directly from the substantial increase of 13.86% in cars online during the period. This wasn’t just
solely CSX, NSC and UNP also experienced the same results, but weren’t quite as severe as CSX because of the location of its
railways. However, as you can see, CSX also experienced the greatest increase in cars online outpacing NSC by 8.62%, and UNP by
18.07%. CSX did see improvements in the quarter in its injury and accident rate. Both of these are important because a lot of concern
surrounding the railroad industry is the risk of accidents and injuries associated with increasing the use of railroads compared to
trucks. To show improvement QoQ with both of these metrics, despite all the growth the company has experienced is a testament to
the company’s safety precautions and procedures.




Earnings

CSX has a strong track record for beating earnings estimates, beating
estimates 9 out of the last 10 quarters, with an average earnings surprise
of 6.12%. Since 2010, CSX has been able to grow earnings at a CAGR of
10.67%. From 2013 to 2016, CSX is expected to grow earnings at a
CAGR of 8.54%. The reason for this slight decline in EPS growth is due
to the extreme growth seen from CSX in 2011, increasing EPS by 23.4%
YoY. The slight decline in EPS growth is also due to the small YoY growth of 1.5% that is expected in 2014. After 2014,
the company has provided guidance that it expects EPS growth to be in the range of low to mid double digit YoY
growth. This is a testament to the company being able to capitalize on the additional capital it is setting aside for capex,
and the ability to capitalize on the energy market boom seen in the US to offset the decline in the coal market. Analysts
are concerned that with the declining coal industry, CSX will not be able to maintain the EPS guidance it has provided,
and will have to reduce guidance to the range of mid to high single digit YoY EPS growth. However, we feel that the
energy market opportunity, and the positive effects felt from the increased capex will enable CSX to meet the goal of
double digit EPS growth. In 2013, CSX reported EPS of $1.83, and are projected to earn $1.86 in 2014, representing
growth of 1.5% YoY. This low growth year is due mainly to the growth and congestion that the company and industry
has seen, which have increased costs at a pace $10mm per month, or $120mm annually. In 2015, EPS is projected to be
$2.12, representing YoY growth of 14.2%, returning EPS growth to levels that the company and analysts are more
comfortable with. The accelerated growth expected in 2015 is due to the lowering of costs after the capex projects CSX
is investing in now come online. In Q2 FY 2014, CSX reported EPS of $0.53, beating estimates of $0.52, representing
QoQ growth of 2%.

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Cash Flow

CSX reported CFFO of $3.3B and FCF of $954MM in 2013. In
FY 2014, CFFO and FCF are projected to be $3.1B and
$702.5MM respectively. The reason for the decrease in CFFO is
due to the slower than usual earnings growth that the company
has historically seen, and the higher costs associated with the
congestion of railways, compressing margins, and deteriorating
performance metrics. FCF is projected to decrease because of the
ramp up of capex that is projected for 2014 of $2.4B, which
represents an increase of $100MM YoY. CFFO and FCF have
grown at CAGR’s of 12.49% and 11.69% respectively since 2009.
From 2013 to 2016 CFFO and FCF are expected to grow at CAGR’s of 2.28% and 4.16% respectively. Although these
CAGR’s are lower than historic numbers, we think this isn’t a bad thing for CSX because they are making a commitment
to invest capital to increase capex to all-time high levels, which in turn should provide increased efficiency, improvement
of performance metrics, and expansion of margins. All of those results will then translate into higher EPS growth
moving forward, allowing the company to stay within its target of YoY double digit growth.

Capital Expenditures

In 2013, capex was $2.31B and has been increasing at a CAGR of 12.83% since 2009. In 2014, CAPEX is projected to
reach its highest level ever at $2.4B. CSX is growing capital expenditures to finance capacity-related projects such as its
new coal unit train processing facility in the Illinois Basin, expanding terminals in Ohio, Kentucky, Georgia, and
Massachusetts, along with opening new terminals in Winter Haven, Florida and Quebec, Canada. In addition, CSX has
increased capex to add double track miles in both the Chicago-based Elsdon sub-division, along with the River Line
area. capex is projected to remain relatively the same in 2015 at $2.38B, but it is expected to ramp up in 2016 to $2.42B.
In FY 2013, capex as a percentage of depreciation was 210%, showing that the company is not only replacing its aging
equipment, but that it is adding in new terminals, expanding its fleet
size, and making investments in rail expansion. For FY 2014,
CAPEX as a percentage of depreciation is projected to remain
above 200%, reflecting the company’s persistent efforts to grow its
rail and terminal network, improve quality of existing infrastructure,
and bring a younger fleet of trains. In terms of ROIC/WACC, CSX
has seen a steady increase from its 2010 value of 0.85 to its 2013
value of 1.18. CSX’s ROIC/WACC LTM as of the beginning of
September was 1.65, which is a record high and a significant
increase from CSX’s 2013 number of 1.18. CSX has guided that it
expects capex to remain between 17 and 19% of revenue.

Debt

CSX’s total debt is $9,309mm. The company has $3,156mm due in bond principle through 2020, with $627mm, $18mm
and $630mm due in 2015, 2016 and 2017, respectively. The net interest expense was down to $554mm in 2013 from
$561mm in 2012. Also, CSX’s interest coverage ratio is 6.27x showing the company’s ability to pay its interest payments.
CSX has decreased their debt/equity in 2013 to 91% from 107.6% in 2012 driven by a net reduction in total debt of
$277mm. CSX has a high credit rating with ratings of BBB+ at S&P.




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FLEET AGE/SIZE
CSX uses 3 main types of locomotives that make up its fleet of 4,259 locomotives: freight, switching, and auxiliary units. Freight
locomotives, which account for 87% of the fleet, are the power source used to pull trains. Switching locomotives are used to sort
railcars so the right railcar and train are properly connected and make up 8% of the fleet. Finally, auxiliary units make up 5% of the
fleet and provide extra traction for heavy trains in hilly areas. In terms of age, CSX’s fleet has remained relatively stable since 2009.
Average age for freight locomotives has remained steady at 20 since 2010. Auxiliary units have dropped in age to 21 in 2013 from
their all-time high of 50 in 2010. Switching locomotives have grown in average age by one year from 32 in 2010 to 33 in 2013.
Management has made a concentrated effort to use capital expenditures on growing fleet size and minimizing the fleet’s average age,
as seen by an 8% expansion in fleet size YoY since Q2 FY 2013, and 10% YoY growth since Q4 FY 2013.

SHAREHOLDER RETURNS

The company announced a $1B share repurchase program starting April 2013 spanning two years. CSX is funding the
repurchasing program through excess cash and free cash flow. Since 2005, CSX has increased its quarterly dividend 12
times from $0.017 in 2005, to its current quarterly dividend yield of $0.16. The LTM dividend payout ratio is 35.21%,
slightly higher than the company’s target dividend payout ratio range of 30-35%. The company believes this payout ratio
is justified due to strong EPS growth. CSX’s dividend payout ratio has grown every year over the past 4 years from
23.8% in 2010, to its current dividend payout ratio of 35.21%. Looking ahead, the company plans to keep increasing
quarterly dividend payouts due to its strong earnings growth. Dividends are projected to grow at a 10.65% CAGR over
the next 3 years, with the expected 2017 quarterly dividends to be $0.22 per share.









VALUATION
Undervaluation
CSX is currently trading at an 8.04% discount to its competitors on a 5 year EV/EBITDA basis. There are several
reasons why CSX has begun trading at a discount. The first of these reasons is due to the decrease in coal volume. Coal
volume has been continuously falling due to the energy boom in the U.S., causing natural gas prices to be significantly
cheaper than coal. Also, companies are now trying to be more environmentally friendly, and switching away from coal to
other forms of energy such as natural gas is a way cost effective way to do this. The second reason that CSX is trading at
a discount to its competitors is because of the company’s declining performance metrics, such as dwell time, average
train velocity, and on-time arrivals. These metrics have decreased more than peers due to CSX’s rail network position
and significant volume growth.

Peer Group Valuation
The companies used in my relative valuation are Union Pacific Corporation (UNP), Norfolk Southern Corporation
(NSC), and Canadian National Railway (CNR). All of these companies have been listed as direct competitors, transport
the same kind of goods, and have the same kind of business model that CSX has. As stated before the company is
trading at an 8.04% discount to its historical 5 year spread on an EV/EBITDA basis. The company is index is trading at
11.47x EV/EBITDA multiple and multiplying it by the mean factor gives us a target multiple of 9.69x. Using the 9.69x
multiple and consensus NTM EBITDA of $4,656.30, we calculated an enterprise value of $45,133.89. Adding back cash
of $789.00 and subtracting debt of $9,309.00 yield an equity value of $36,591.89. Dividing number of shares of 999.60,
yields a target price of $36.61, giving a total return of 19.34% with a 2.05% dividend included.

Target EV/EBITDA
•9.69x
NTM EBITDA
•$4,656.30
Target Price
•$36.61

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Discounted Cash Flow

Assumptions
The 7 year CAGR of for sales growth of 4.5% was found using a combination of Bloomberg estimates and company
guidance. The company has guided for the foreseeable future that it expects revenue to grow by mid-single digits. Sales
growth is being driven by a combination of strength seen in end markets, as well as continued growth of the company’s
intermodal segment as more truckers continue to use intermodal as a practical and cost efficient mode of transportation.
Margins are expected to slightly contract in 2014, due to the explosive increase in volume the company has experienced
recently, but are expected to return to 2013 level in 2015, and exceed those levels in 2016 and beyond. Capex has been
projected by the company to be between 17-18% of revenue after 2014. 2014 is slightly higher because of additional
capex the company felt was needed in order to handle the growth it has seen.

WACC
The WACC of 9.33% is calculated using the 5 year average weights of 71.65% for equity and 28.35% for debt. Cost of
equity of 10.919% is calculated using CAPM, with a risk free rate of 2.47%, a market risk premium of 9.57%, and using a
beta of 1.19. Cost of debt of .02% is calculated using the pre-tax weighted cost of ST debt total of 0.1%, ST debt rate of
0.53%, LT debt total of 0.90%, LT debt rate of 2.47%, and a tax rate of 36.35%.




WACC
•9.33%
EM Method
•EM: 7.64x
•$45.17
GP Method
•GP: 3.8%
•$36.45

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DISCLAIMER
This report is prepared strictly for educational purposes and should not be used as an actual investment guide.
The forward looking statements contained within are simply the author’s opinions. The writer does not own any
CSX Corp. stock.
TUIA STATEMENT
Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his
tireless dedication to educating students in “real-world” principles of economics and business, the William C.
Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,
practical learning experience. Managed by Fox School of Business graduate and undergraduate students with
oversight from its Board of Directors, the WCD Owl Fund’s goals are threefold:
 Provide students with hands-on investment management experience
 Enable students to work in a team-based setting in consultation with investment professionals.
 Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs
and partial scholarships for student participants.