US railroad CSX (NASDAQ:CSX) probably isn’t the first name UK investors think of when it comes to passive income. There are a few reasons for this.
The stock doesn’t jump out with a dividend yield of 1.43%. But I think there’s a lot more than meets the eye with this one.
Dividends vs passive income
Let’s start with the elephant in the room — that dividend yield isn’t going to grab the attention of income investors. But there’s more to passive income than dividends and CSX’s track record over the last decade’s a great illustration of this point.
The company’s been reducing its outstanding share count by around 4% a year through share buybacks. This has provided shareholders with an important income opportunity.
By selling 4% of their shares each year, investors have been able to generate cash. And the declining share count means their stake in the overall business has remained the same.
From an income perspective, that means there’s more to CSX than just a 1.43% dividend yield. The actual return available’s been closer to 5% on average, which is much more attractive.
Reliable cash flows
Beyond the yield, there’s a lot to like about CSX from an investment perspective. It’s a freight railroad that makes money hauling commodities and finished products around the Eastern United States.
The first thing to like is the lack of competition – only Norfolk Southern does the same thing. And the prohibitive cost and logistical difficulty of setting up another railroad means this isn’t likely to change.
Another’s the offering to customers. Moving goods by this method’s a lot less carbon-intensive and a lot cheaper than trucking, making rails the only viable choice for a lot of bulk commodities.
As a result, CSX maintains operating margins of around 38% – higher than the likes of Alphabet and Apple. That shows the power of a dominant position in an important industry.
Volumes
The biggest risk with CSX is its exposure to coal, which makes up around 15% of revenues. And there’s no way around the issue that demand for this is set to fall as the US transitions to renewable energy.
It’s worth noting that a shift to cleaner energy sources might not be as bad as it sounds. For one thing, a lot of the coal CSX transports is exported to other countries where demand might be more robust.
Furthermore, not all coal is used in power generation. Some is used in steelmaking and this is also likely to be relatively stable in terms of demand.
Most importantly though, building renewable energy infrastructure’s going to need huge amounts of raw materials. And that’s going to have to be moved around – plausibly via rails and CSX’s network.
A long-term investment
I see CSX as a terrific long-term investment. Despite the company’s huge margins, the stock trades at a price-to-earnings (P/E) ratio of around 15.
For a business with a durable competitive advantage in an industry where demand looks strong, this is a powerful combination. That’s why I’ve been buying it for my Stocks and Shares ISA.
