CSX Announces Record 58.6% OR, Says turnaround Not Finished Yet

• CSX: Customer relationships have improved
• Intermodal, already profitable, will be last segment to implement PSR
• Foote gives aggressive guidance on pricing CSX's ‘superior product'

CSX Corporation's CSX turnaround, which began in March 2017 with the appointment of the late Hunter Harrison as CEO, still has room for further improvements, CSX executives told investors during their second quarter earnings call on Tuesday afternoon. After taking the helm, Harrison quickly implemented his signature precision-scheduled railroading, which essentially converted CSX's network from a hub-and-spoke model to a leaner point-to-point system by closing many of the railroad's hump yards. When Harrison died a day after taking medical leave on December 16, Jim Foote was made acting chief executive officer and is the president and CEO today.

Foote and CSX EVP and CFO Frank Lonegro led the earnings call. The most impressive financial metric cited by Foote was CSX's operating ratio of 58.6 percent for the second quarter of 2018, which improved 490 basis points from the previous quarter and 880 basis points from the second quarter of 2017. Foote said that he believed that OR number was a record for any Class 1 railroad. The improved operating efficiency yielded a 58 percent growth in earnings per share year-over-year, from $0.64 in the second quarter of 2017 to $1.01 for the current quarter, easily beating the Street's expected $0.87 per share. CSX brought in $877M in net earnings for the quarter, a 71.9 percent improvement over the $510M net earnings for Q2 2017.

"These [record financial results] are due to the hard work of all CSX employees, who are really excited about what has been accomplished," said Foote.

Just as importantly, CSX managed to improve its financial efficiency at the same time it improved its service metrics. Simply put, the railroad is moving longer trains faster with shorter dwell times and covering more car miles per day. Average train velocity in Q2 was 17.4 mph, up 7.4 percent year-over-year; average train length was 7,241 feet, up 12.6 percent year-over-year; dwell times have contracted to an average of 9.7 hours, which represents an 11 percent improvement year-over-year; and car miles per day increased to 123.8 miles, 12 percent further than CSX's cars in the second quarter of 2017.

"Clearly, to be the best, we have more room to improve… [in] train speed specifically, we remain below the industry leaders. Our dwell is better than the industry average, but again, there is significant opportunity for improvement before we can call ourselves the best," said Foote in his closing remarks, before the Q&A period began.

"In closing, we have shown a relentless focus on executing our business model, but let me assure you: we have an eye on the horizon to develop long term sustainable growth," concluded Foote.

The majority of the call was devoted to answering investors' questions, and analysts wanted to know what further improvements CSX had planned for its operations.

Amit Mehrotra from Deutsche Bank asked, "Would it be fair to characterize the 2020 target [60 percent OR] as conservative based on what the team's accomplished so far, and if so, what do you feel is the structural limit of where you and the team could take that OR?" Foote responded that when the 2020 target was announced three months ago, everyone thought it was crazy, but that even though this quarter's OR was boosted by strong coal revenues and plenty of work was left to be done improving CSX's operations, his guidance for 2020 remained unchanged.

Then Mehrohtra followed up by specifically asking which business segments had not yet implemented precision-scheduled railroading. "One answer: intermodal," said Foote. "Our intermodal network needs a ton of work in order to become an efficient part of our system, and we're just really beginning to get in there and start to figure out how to rationalize that big part of our business so we can become much more efficient and have a much better product for our customers," Foote continued. "We have a network franchise here that to a large degree is dysfunctional, and it is the product of for many many many years CSX having a stand alone intermodal entity. So we need to kinda go forward and reconfigure the franchise and make sure it is properly and appropriately integrated into the rail company so that we can achieve the benefits of operating more effectively and efficiently," said Foote.

"We're going to take it very methodically," continued Foote. "We're going to have very good and open communications with our customers about what it is we're trying to accomplish. It involves train design changes, it involves potential terminal consolidations, and we'll do this very methodically and logically and appropriately and being fully aware of the fact that we're looking at a peak season this year which everybody is indicating that is gonna be very strong. We're not gonna do anything that's gonna screw up the railroads, and if it a takes a little longer—a quarter or two—then I'm fine with that."

When asked whether the faster-than-expected OR improvements would change CSX's philosophy on the revenue outlook and the dynamic between price and volume, Foote demurred, saying that his goal has always been to improve top line revenue (i.e., sales and discretionary contract renewals) and implement operational changes at the same time. "[Our customers] went from, when I showed up here, to hating me, to now on occasion even buying me a drink, so we've made great improvements to our customer relationships," Foote joked. 

Answering a different analyst's question, Foote said that he didn't see a reason why a very low operating ratio would cause CSX to lower price and chase volume. "I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind means that we continually improve the product that we offer to our customers," said Foote. "We are not working diligently to drive down the operating ratio so that we can be price leader in the marketplace. We don't get stickers and bonus points for volume, and therefore to the extent that we can sell our product as the superior product in the marketplace, we fully intend to do that."

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