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By Erik Kobayashi-Solomon | 07-20-2010 02:56 PM

CSX Is Back on Track

Morningstar's Keith Schoonmaker believes that CSX has solved its operational problems.

Securities mentioned in this video

Eric Kobayashi-Solomon: Hi. I'm Eric Kobayashi-Solomon, Co-Editor of Morningstar's OptionInvestor. Today it's my great pleasure to welcome Keith Schoonmaker, who's Senior Equity Analyst in-charge of transportation stocks.

Keith, thanks for coming.

Keith Schoonmaker: Thanks for having me, Eric.

Kobayashi-Solomon: Just recently I did an option strategy on one of the stocks that you cover, CSX, a rail company. And one of the first things that really appealed to me about this is the nature of rails themselves. Can you talk a little bit about the competitive advantage of a rail?

Schoonmaker: Sure, I'd be glad to. Well, as we think about railroads in North America, there are only seven railroads now. Following the passage of 1980 Staggers Act, we went from about 40 railroads through mergers and acquisitions consolidated down to about seven now.

There are only two basically in each geographic region. CSX competes with Norfolk Southern.

Kobayashi-Solomon: And that's along the east, east coast side.

Schoonmaker: In the Eastern region, correct.

Kobayashi-Solomon: Florida to Canada.

Schoonmaker: Right. And we would say, there's these competitive advantages of just a colossal barriers to entry. It's going to be very, very difficult to build any new railroads.

Kobayashi-Solomon: Basically if a competitor wanted to go he'd have to buy real estate all the way up and down the East Coast, right?

Schoonmaker: It would be virtually impossible to erect a new network, very high expensive erecting yourselves, do a network like this.

Kobayashi-Solomon: Sure. Now let's turn a little bit to CSX. The thing that really interested me in CSX is that it seems like a turnaround story. From what you're saying before CSX wasn't a great operator. It seems to be operating better now. Can you tell me a little bit about that?

Schoonmaker: Sure. Since what we call the railroad renaissance began in about 2004, all of the rails improved their performance tremendously. However, CSX was a bit of a laggard compared to Norfolk Southern and some others. It had a lot of turnover in the Chief Operating Officer role and until Tony Ingram came in about 2004 and had a vision for what the railroad could be five years from now. Without so much turnover in their Chief Operating Officer role, CSX has made tremendous progress in their operations.

In fact, last year, Eric, when volume slumped about 15%, CSX still produced its own record operating ratio. This is basically a measure of profitability, costs over revenue.

Kobayashi-Solomon: Operating ratio, basically we want it to be as small as possible.

Schoonmaker: Correct, it's operating expenses over revenue, so smaller is better. One minus operating ratio is margin. So smaller is going to be more profitable railroad.

Kobayashi-Solomon: And even with the volumes really declining with the economic environment not being so great in 2009, even in the face of that they were more profitable.

Schoonmaker: Yeah, it was shocking to see it, Eric. You think of this industry as being an old, stodgy industry, fully unionized, highly asset intensive, perhaps the most asset intensive of any industry we can think of.

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