CSX, the heir to the once might New York Central and Pennsylvania networks, released their quarterly results a few days ago. Gudovac believes that CSX is simply one of the better run Enterprises on Earth from a pure operating perspective.
CSX Management simply lives and breaths productivity improvements. Management also pro-actively addressing changing conditions to serve Owners' interests. CSX, despite plummeting revenues, still managed to earn a decent profit.
CSX is a prime example of a enterprise in which managers proactively change their business in the face of changing business conditions. Seems obvious, but most successful Managers refuse to change soon enough - Think General Motors whose managers refused to move past the 1950's. Owners of pro-active Enterprises can pay higher prices because proactive managers reduce risk to Owners.
CSX financial highlights are shown on the left. CSX has a top line run rate of slightly more than $9 Billion in annual revenues. The railroad generates a whopping $3.3 Billion of EBITDA on these revenues which translates into a 35.8% EBITDA Margin. Using most recent quarter EBITDA as a proxy for long term operating income and adjusting for long term non working capital changes (such as CAPEX, Pension top-off, and Cash Taxes), CSX generates annual Free Cash Flow of about $3.4 Billion.
Free Cash Flow of $3 Billion on $9 Billion of revenues should give comfort to any Owner. That is a heck of a lot of cash generation for a decidedly mature business.
The Enterprise ratio versus book and versus revenue appear to in the high range. However, Owners should note that a high margin enterprise will have high multiples of book and revenues. CSX is certainly a high margin enterprise.
The dividend payout ratio is a prudent 29%.
Interest Coverage remains above 3x, after a 20% drop in revenues !
CSX appears to be a enterprise that can withstand dramatic negative swings in the external environment and still adjust to generate profits. Owners need to ask themselves what would be a good price to pay for such an Enterprise ?
What is a Good Price for CSX ?
CSX is the very model of a mature industry.
One can try and spin many strategic scenarios in which Rail steals Market share from Long Haul Trucking and turns into a double digit growth industry, but Gudovac dislikes betting that a 175 year old industry will suddenly be transformed into the next dotcom story.
Therefore, let us consider CSX from the prosaic standpoint of only a dividend payout. We often forget, but dividends - or the promise thereof - are what provide returns to Owners. CSX, is nearly a pure dividend play.
The current dividend is 88 cents. At $44 dollars per common, this is a meager 2% yield. 2% is minuscule and would not warrant purchase. However, CSX has been good about increasing dividends. Dividends (adjusted for stock splits) have grown at a compounded annual rate of 5% since 1981 and nearly 6% since 1990.
We can not predict when dividends will be increased at CSX. We only know there is a reasonable expectation that dividends will be increased in the future.
We can calculate what Mr. Market believes the eventual return will be once increased dividends are taken into account.
Gudovac has calculated that Mr. Market believes the equity discount rate for CSX is 8.37%.
This 8.37% CAGR for CSX is in line with its dividend growth performance over the last 28 and 19 years respectively. Mr. Market may be on to something.
Gudovac's calculation assumes on a perpetual Free Cash Flow growth rate of 2.125%. This long term rate is just slightly higher than the expected long term growth rate of US GDP. The After Tax cost of Debt ( and implied cost of other long term liabilities ) is 3.66%. Note, this is a implied long term cost of debt, not the actual cost of CSX debt today.
Gudovac believes that CSX could very well generate a 8.37% return for Owners. Mr. Market appears to be sensible about the price for CSX.
Owners need to ask themselves is a 8.37% long term return adequate for the risk presented by CSX ?
Gudovac likes CSX at a 8.37% return and would allocate an appropriate amount of cash-on-hand to the purchase of CSX at prices at or below $44.
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Don't Get Massacred !
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