2022 has meant a lot of uncertainty in the marketplace. Inflation, rising interest rates and war are just the biggest headlines that have kept the markets on edge, pushing the market into a confirmed bear market by June that pushed to new lows earlier this month.
One of the big questions that just about everybody seems to have been asking, especially for the last few months is “how long is this bear market going to last,” with “are we looking at the next, extended recession next year” as an almost immediate follow up. These are today’s version of the proverbial million-dollar question, that of course nobody can definitively predict (although lots of people are willing to try). Over the last couple of weeks, though, the market has shown some since of stabilization, with the last three days’ worth of bullish momentum leading some “experts” on market media channels to point out that October could mark the first positive month for the stock market since July. Will it last? Well, that’s the next million-dollar question.
The market’s move into positive territory over the past month, off of a yearly low brings the concept of cyclicality back into focus. While everybody wants to keep the good times rolling and see long-term market rallies extend into infinity, the reality is that economies ebb and flow through cycles of prosperity to scarcity and back again. Cyclicality can also be seen in the stock market, as stock prices follow their own ebb and flow. Industries whose peaks and valleys tend to coincide with broad economic conditions are known as cyclical stocks.
Cyclical stocks are those that are expected to do well when economic conditions are generally healthy, and that will naturally struggle when the economy struggles. One of the core sectors of the economy that fits this very generalized description is the Transportation sector, which takes in a broad set of industries, including airlines, railroads, trucking and freight, overseas shipping, and so on. One of the major contributors to rising costs throughout the economy have been constraints on the supply chain, along with rising fuel prices. These are dynamics that generally work against stocks in the Transportation industry.
Uncertainty and volatility amid signs that the economy is struggling mean that you can often find stocks in these industries trading at pretty significant discounts to their not-so-distant highs. That makes them tempting fodder for a contrarian, value-oriented investor. I like to pay attention to these stocks, because their fundamentals can give me some useful clues about their ability to weather an economic downturn. These are also stocks that, like any other, can see big swings from high to low based on nothing more than the market’s expectation for what the economy might do in the near future.
CSX Corporation (CSX) is a good example of the kind of stock I’m referring to. As one of the four largest transportation companies in the oligopoly that is the U.S. Road & Rail industry, this is a stock that is very sensitive to a variety of economic dynamics, from commodity and fuel prices to interest rate fluctuations. The collapse of oil prices during the pandemic might have been taken as a good thing for this sector, since fuel costs should generally be lower; but as economy activity ground to a halt during the second quarter of 2020, so did the demand for transportation services. This year, rising interest rates and supply challenges have led to rising cost for practically every sector of the economy; but an interesting tailwind for Road and Rail stocks comes in the tragedy that is Russia’s war with Ukraine. That conflict has disrupted the supply of energy commodities from that region, which is crucial for all of Europe, and that has kept prices for crude as well as natural gas products elevated throughout the year. That disruption means that international demand for energy products from North America should remain high, I believe well into next year. That should provide a healthy boost for the Road & Rail industry that I think CSX stands to benefit from.
The sensitivity of stocks like CSX to the kind of pressures and dynamics I’ve just outlined is why it is important to take a critical look at the company’s balance sheet and overall fundamental strength. This is a company with a strong fundamental profile, and a balance sheet that has weathered the economic storms of the past three years remarkably well and still appears well positioned now. That is a positive sign that bodes well for the company in the long-term; for bargain hunters, the stock’s current trading price prompts the question of whether CSX represents a compelling enough value under current market conditions to justify taking its long-term opportunity seriously. Let’s dive in.
Fundamental and Value Profile
CSX Corporation is a transportation company. The Company provides rail-based freight transportation services, including traditional rail service and transport of intermodal containers and trailers, as well as other transportation services, such as rail-to-truck transfers and bulk commodity operations. The Company categorizes its products into three primary lines of business: merchandise, intermodal and coal. The Company’s intermodal business links customers to railroads through trucks and terminals. The Company’s merchandise business consists of shipments in markets, such as agricultural and food products, fertilizers, chemicals, automotive, metals and equipment, minerals and forest products. The Company’s coal business transports domestic coal, coke and iron ore to electricity-generating power plants, steel manufacturers and industrial plants, as well as export coal to deep-water port facilities. CSX has a current market cap of $60.2 billion.
Earnings and Sales Growth: Over the last twelve months, earnings were 21% higher, while sales increased more than 18%. In the last quarter, earnings grew 4% while sales were about\ 2.1% higher. CSX operates with a healthy, robust margin profile that has been remarkably resilient, and has even strengthened; in the last twelve months, Net Income was a little over 28% of Revenues, and strengthened to 28.52% in the last quarter.
Free Cash Flow: CSX’ Free Cash Flow is healthy, at a little over $3.8 billion. That is roughly even over the last year, but increased from $.37 billion in the last quarter. Their current Free Cash Flow number translates to a Free Cash Flow Yield of 6.32%.
Debt to Equity: CSX has a debt/equity ratio of 1.39. This indicates the company is highly leveraged; but this is also very typical of stocks in the Transportation industry. Their balance sheet shows $2.4 million in cash and liquid assets against about $17.9 billion in long-term debt as of the most recent quarter. The company’s operating profile suggests there should be no problem servicing the debt they carry.
Dividend: CSX pays an annual dividend of $.40 per share, which at its current price translates to a dividend yield of about 1.42%. Their dividend payout ratio is also conservative, at less than 25% of their earnings over the last year.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $34 per share. That means the stock is undervalued at its current price, with 20% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the past year of price activity for CSX. The red diagonal line traces the stock’s downward trend from its March high at around $39 to its low at around $26. It also provides the baseline for the Fibonacci retracement levels outlined on the right side of the chart. From its low, which was reached a couple of weeks ago, the stock has rallied to its current price a little above $28 per share. Immediate resistance is around $29, based on pivot activity in June and earlier this month, with current support back at $26. A push above $29 should have upside to about $31, where the stock used that level for previous support in September as well as in May. Using the current distance between support and resistance as a reference means that a drop below $26 could see short-term downside to about $23.
Near-term Keys: CSX is a stock with healthy fundamentals and a value proposition that is attractive. I also think that this is a company that is nicely positioned to weather economic uncertainty and take advantage of its dominant position in its industry; however keep in mind that taking a value-based position in this stock means that you are tacitly accepting the likelihood of continued price volatility for as long as current market conditions last. If you prefer to work with short-term, momentum-oriented trades – and you are willing to be very aggressive – you could use a push above $29 as a signal to consider buying the stock or working with call options, with a practical target price at around $31. A drop below $26 could be a signal to consider shorting the stock or buying put options, with a practical exit target at around $23 on a bearish trade.