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Railroad company CSX (CSX) was rolling higher heading into its 2Q23 earnings report, but that momentum has been derailed by a top line miss and the end of a winning streak against EPS estimates that spans over five years. Amid a challenging macro environment, the company executed well during the quarter, as reflected by its operating ratio improving to 59.9% from 60.5% in Q1. However, CSX faced an uphill climb in Q2 as a host of headwinds put the brakes on its growth.

• The intermodal business in particular continues to stand out as an area of weakness. Discouragingly, intermodal is going in reverse with revenue declining by 18% yr/yr following a drop of 5% in the prior quarter.
  • Similar to Q1, high retail inventory levels and an associated decline in imports negatively impacted international shipments. While domestic shipments also decreased due to a softening trucking market, CSX is at least seeing signs of improvement there.
  • Unfortunately, the same can't be said for international as CSX acknowledged that it's seeing no signs of a near-term recovery.
• Lower diesel prices also pressured CSX's revenue. CSX and other railroad operators charge a fuel surcharge to recover the cost of fuel when they transport goods. When diesel prices are higher, the margin between the fuel surcharge and cost of fuel typically expands, creating an additional source of revenue for railroad companies.
  • In the year-earlier period, a higher fuel surcharge helped drive a 10% increase in merchandise revenue.
• Compounding the problem, coal experienced a significant downturn from last quarter as lower export benchmarks led to a 2% decrease in revenue, despite a 4% volume gain. In Q1, coal was a source of strength with revenue jumping by 19%, fueled by healthy export volumes on strong utility restocking demand and higher commodity prices. Coal prices are impacted by natural gas prices, which have plummeted over the past year.

It's not all bad news for CSX.

• Automotive remained a bright spot with revenue increasing by 21%, bolstered by more consistent production from manufacturers amid an improving supply chain situation. Additionally, the metals (+11%) and minerals (+12%) markets benefitted from strong construction demand.
• Overall, total merchandise revenue was up by 5% yr/yr, which CSX was satisfied with given the difficult climate. From a broader perspective, CSX and peers such as Union Pacific (UNP) and Norfolk Southern (NSC) -- which are slated to report earnings on July 26 and July 27, respectively -- are benefitting from a shift from trucking to rail.
  • In the wake of the pandemic, manufacturers are looking to make their supply chains more cost effective and efficient, making rail a more attractive option.

The main takeaway is that CSX is performing well in terms of factors that are under its control, but business conditions remain mixed with weakness in intermodal continuing to weigh on its results.