Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

It appears recent service disruptions at railroad operator CSX Corp. weren't as "overplayed" as its new CEO Hunter Harrison made them out to be.

Harrison, a longtime railroad executive, was pushed into the top spot at CSX earlier this year by activist investor Mantle Ridge, who wanted him to work the same earnings magic he had used as head of Canadian Pacific Railway Ltd. and Canadian National Railway Co. But his push to make CSX more efficient by closing train-sorting yards has hit some snags, with customers complaining about delayed shipments and shoddy service. Harrison has apologized, but has also said complaints were "exaggerated" and disruption "overplayed." It now looks like they were at least meaningful enough to hurt CSX's bottom line.

High Hopes for Harrison
CSX has climbed about 38 percent since reports emerged of Harrison's interest in being CEO. But the stock has slipped of late amid reports of service disruptions.
Source: Bloomberg

CSX on Wednesday said it was lowering (oh sorry, "refining") its 2017 guidance in light of operating challenges this summer. It now expects earnings per share to increase between 20 percent and 25 percent, down from an earlier forecast for a gain of about 25 percent. It still expects to achieve an operating ratio in the mid-60s, but it will be toward the high end (a lower number is better in this measure of profitability). CSX's 2016 operating ratio was 69.4 percent.

Investors responded by sending shares of the company up by as much as 4.8 percent, which is a bit ironic seeing as how they clobbered the stock by more than that when CSX failed to raise its guidance as it reported second-quarter earnings in July. They seem to have been heartened by a statement from Harrison noting that "many of the challenges we and our customers have recently faced are behind us" and "the railroad is now returning to a normal operating rhythm."

Things do seem to be stabilizing. The amount of time trains spend lingering in terminals is coming down after an upward blip, CSX said in a presentation at a Cowen & Co. conference on Wednesday. Month-to-date, its dwell time is 11.2 hours, an improvement from the third quarter of last year. Train velocity, another measure of efficiency, is also improving. But on both metrics, 2017's performance on average has been worse than 2016, even per CSX's revised methodology. And it's hard to believe employee morale hasn't been battered by Harrison's blaming of some resistant-to-change workers for the service disruptions, not to mention the large number of layoffs.

CSX has characterized the challenges as mere speed bumps on the way toward ultimately making the railroad run more efficiently for customers. Bloomberg Intelligence analyst Lee Klaskow notes that things got worse at Canadian Pacific under Harrison's tenure before they got better.

Getting Down
CSX's operating ratio was the worst among the top North American railroads in 2016. It can obviously improve but how much is a matter of debate.
Source: Bloomberg
Note: A lower number is better

But while Canadian Pacific's network ran in almost a straight line, CSX's is more circuitous and cuts across more difficult terrain. Some analysts have wondered whether that distinction will ultimately limit Harrison's ability to get CSX's profitability in line with what he achieved at his previous post. And he has a limited time frame: the contract he signed with CSX lasts four years and, unfortunately, he has a medical condition that requires supplemental oxygen and limits his travel.  

Time will tell if these service disruptions were really just momentary or a longer-term challenge. But CSX's cut to an aggressive earnings outlook that was supposed to herald his potential impact on the company is just another reminder that this push for profit gains comes at a cost.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net