We are downgrading our recommendation on CSX Corp. (CSX), one of the leading U.S. transportation suppliers, to Neutral from Outperform. We downgraded the stock on concerns that new pricing may reduce profitability of the company. Currently, the stock has a Zacks #3 Rank (Hold).
 
The U.S. regulator is seeking new pricing rules to give more leverage to shippers in price disputes with freight railroad companies. The new pricing is expected to weigh on the overall freight railroad industry.
 
We anticipate that CSX Corp. will benefit from improved railroad fundamentals, increased coal demand, better pricing environment, cost-control measures and growth in productivity. In addition, the company’s strong and cash-rich balance sheet along with shareholder returns makes it attractive for long-term investment.
 
CSX Corp. has a history of increasing its dividend. The company recently increased its quarterly cash dividend by 8% to 26 cents per share, payable in December. This marks the company’s eighth dividend hike during the last five years. The company previously increased its dividend in the beginning of 2010 by 9% to 24 cents per share. The new quarterly dividend equates to $1.04 per share on an annual basis, representing a dividend yield of 1.88%.
 
This dividend yield is lower relative to its peer Norfolk Southern Railway (NSC), which has a current yield of 2.44% on average. However, it is higher than Union Pacific Corporation (UNP), which is currently yielding 1.63%.
 
Notably, the company’s second-quarter results surpassed the Zacks Consensus Estimate and the year-ago numbers on a strong rebound in demand for cars and metals. Revenues increased 22% year over year with volume gains across all major markets. Results were driven by increased revenues from volume improvement in chemicals, metals, automotives, coal and intermodal in the wake of an economic resurgence.
 
Furthermore, operating leverage remains a significant driver in producing strong bottom-line results. The company expects to deliver high double-digit earnings per share growth on strong volumes, revenue growth as well as operating ratio improvement. Intermodal is expected to be the company’s fastest growing segment with its new service offerings. In addition, CSX Corp. continues expand its network and terminal capacity for the long term.
 
However, we remain cautious on the stock based on increased competition, unionized workforce, capital intensive nature as well as increased railroad regulation. The company’s primary rail competitor is Norfolk Southern which operates throughout much of the company’s territory.
 
Moreover, CSX Corp. is subject to jurisdictions of various regulatory agencies, including the Surface Transportation Board, the Federal Railroad Administration and other state and federal regulatory agencies. New rules or regulations by these agencies could increase the company’s operating costs or reduce operating efficiencies.
 
The company accesses the credit markets for additional liquidity from time to time. Adverse conditions in the credit markets could increase the company’s costs associated with issuing debt, limit its ability to sell debt securities on acceptable terms and impede revisions in its current debt arrangements. Moreover, the economic downturn has adversely affected demand for rail and intermodal services. Further, a decline in general domestic and global economic condition may hurt revenues.
 
 
 
CSX CORP (CSX): Free Stock Analysis Report
 
NORFOLK SOUTHRN (NSC): Free Stock Analysis Report
 
UNION PAC CORP (UNP): Free Stock Analysis Report
 
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