Credit analyst suggests current spread climate signals time to exit CSX

By Ronda Fears

Nashville, Tenn., Sept. 11 - With the woes buffeting the transportation sector, Felice Shiroma, bond analyst at Gimme Credit, recommends using the current spread environment to sell CSX Corp. paper.

"All railroad stocks traded down last week, but CSX Corp. (Baa2/BBB) stock took the worst hit, as the company revised sharply downward its projected coal carloads and revenues for the third quarter," Shiroma said in a report Wednesday.

"We expect continued disappointing results from CSX and would use the current spread climate to take profits and exit its bonds."

CSX did not provide specific earnings guidance in its press release but Wall Street analysts immediately lowered their third quarter estimates by as much as 15 cents per share and the stock traded off 20%, Shiroma noted.

The market sell-off of CSX reflects uncertainty over whether the outlook has changed or the company was overly optimistic on the forecast, she added.

CSX affirmed projections for year-over-year gains in merchandise, auto and intermodal categories for third quarter, but said railroad expenses will rise from last year and that could be bad on the operating ratio front.

Although CSX is still the worst performing of the major carriers, Shiroma noted its second quarter operating ratio improved to 84%, even excluding the benefit of lower fuel prices.

The ratio has strengthened significantly from the weak levels associated with the difficult Conrail integration, she added, but management's stated goal for it to be under 80% by 2004 seems wishful.

Despite drastic cuts in capital expenditures and the dividend, CSX has posted negative free cash flow in recent years, Shiroma said. Management originally forecast free cash flow of $150-$200 million for 2002.

With the impact of the reduced coal revenue estimated at $70 million, and rising fuel prices, the free cash flow forecast looks dubious.

"This has limited the company's ability to pay down debt, which at June 30 was slightly above the 1997 peak levels," Shiroma said.

Debt protection measures remain weak, she added, with lease adjusted debt as a percent of capitalization in the high 50s and EBITDA/fixed charge coverage around 3x at June 30."

"Since all the cash uses have been cut to the bone, the company needs strong earnings growth to hit this goal," Shiroma said.

"If CSX is unable to fund internally even this reduced level of capital needs, it may have to borrow money to cover the dividend and any increased spending, further eroding its credit ratios."

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