Why CSX Earnings Should Make Shareholders Spurn a Canadian Pacific Merger

Source: CSX.

Earlier this week, CSX (NYSE: CSX  ) saw its stock soar by 10% as news emerged that North American peer Canadian Pacific (NYSE: CP  ) had reportedly approached CSX with a possible merger deal. Yet even as investors speculated about the possible implications of a merger on the short-term value of their holdings, CSX's earnings the following afternoon gave the railroad's shareholders plenty of reasons not to want to give Canadian Pacific the chance to buy them out at what could prove to have been a bargain price.

Merger bids often result in huge short-term profits for those who've just bought shares of a stock. Yet if you're a long-term investor rather than a short-term trader, you'll often find yourself opposed to merger bids, especially if they come at an inopportune time for the company. As CSX's earnings show, the railroad is firing on all cylinders right now, and that should make investors want to turn down the chance at a quick gain in favor of the longer-term growth prospects that CSX has in a healthy and growing market.

Another set of records from CSX 

Just as CSX did last quarter, the railroad kept up its string of record results during the third quarter. Revenue jumped 8% to $3.2 billion, and operating income rose by an even more impressive 16% as CSX managed to improve its operating ratio by more than two full percentage points, sending it below the key 70% level. That pushed net earnings up 12% to $509 million, or $0.51 per share.

Looking more deeply at the company's numbers, CSX saw promising signs from most of its key segments. Industrial chemicals and agricultural products saw the largest volume gains, while strong pricing in the housing and construction segments helped boost overall revenue there as well. The key coal business saw further deterioration in revenue per unit, but volume gains of 7% helped keep overall segment revenue stable. CSX's intermodal business also kept chugging along, with sales gains of 6% for the quarter.

Higher volumes did contribute to greater expenses for labor, materials, and supplies. But even with the rise in traffic, CSX managed to cut its fuel costs, taking advantage of lower prices and improved fuel efficiency with its equipment.

Source: CSX.

CSX did face some challenges during the quarter, though. On-time originations plunged to 54% from 90% a year ago, and on-time arrivals fell even further to 43%. Average train speeds fell more than 3 miles per hour to 20.2, and figures for cars-on-line and terminal dwell time rose alarmingly.

Why shareholders should stick with CSX

Still, the future looks bright for CSX. Although the railroad said that it expected only modest earnings growth for the full 2014 year, it expects accelerating growth in EPS next year, as margins expand even further. CEO Michael Ward said that CSX remains focused on "enhancing our ability to grow faster than the economy, price above inflation, make strategic investments and produce ever more efficient operations to continue delivering superior shareholder value."

CSX's optimism about its own prospects is likely a big part of why the company downplayed the prospects for a Canadian Pacific merger. With so many positives happening at CSX, rocking the boat by taking on a major consolidation simply seems unnecessary in many investors' minds.

Source: Canadian Pacific.

Proponents of the merger point to the possible positive impact on traffic congestion, especially at key chokepoints in the North American rail system. The rise in demand for rail transport of oil and gas has created delays of coal shipments to power plants, raising concerns among struggling coal companies that their major customers could give up on coal if transportation becomes unreliable. Many believe that a merger could improve traffic efficiency. Moreover, by creating a geographically diverse system, a Canadian Pacific merger could help remove transfers for some deliveries.

Yet while CSX hasn't directly addressed Canadian Pacific's overtures, Ward did comment generally that consolidation in the industry could actually make service worse. He cited past mergers and the service disruptions that resulted from them, arguing instead that CSX's current course of investing in more track and better terminal facilities is the right way to alleviate temporary problems.

As most investors focus all their attention on the likelihood of a Canadian Pacific merger, CSX is doing all the right things with its own internal operations. As long as its success continues, CSX shareholders should look forward to the long-term growth opportunities the railroad has.

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