New CEO Hunger Harrison is the low-risk, high-potential leader for this wide-moat railroad in need of margin improvement.
today named Hunter Harrison as CEO of the railroad, charging him with his fourth railroad chief executive role and the opportunity to turn around one more rail. Our fair value estimate already incorporates our expectation of this leadership change, and we maintain our wide economic moat rating. While we don't criticize CSX leadership too strongly for mostly preserving flattish margins while its profitable coal franchise was eviscerated during the past decade, we think Harrison is the low-risk, high-potential leader for a railroad in need of margin improvement. He's proven this thrice over.
Keith Schoonmaker, CFA, is director of industrials equity research for Morningstar.
Back on Feb. 21, CSX announced that its then CEO and President would both retire from the firm at the end of May, and that current Chief Sales and Marketing Officer Fredrik Eliasson has been appointed president. At that time we opined that these moves smoothed the path for bringing Harrison on board, and construed this as support for our expectation that Harrison would become CEO of the firm this year.
CSX, in agreement with activist investor Mantle Ridge, appointed five new directors including Harrison and Mantle Ridge founder Paul Hilal. The board seeks shareholder input on repayment of $84 million of benefits Harrison forfeited by leaving his previous gig as CEO of Canadian Pacific in order to approach CSX. Should CSX fail to approve this repayment, Harrison indicates he will resign as CEO and return to Mantle Ridge.
We assume Harrison can drive CSX to a 60% operating ratio by 2021, chiefly by reducing labor, materials, and equipment expenses. We also assume that greater profit margin produced with fewer assets will strengthen returns on capital, and recently increased our assumptions for midterm returns on new invested capital from 15% to 18%. For additional elaboration, please see our Feb. 19 note titled "Raising CSX Fair Value to $48 as We Believe Hunter Harrison Will Become CEO, Drive Margin Expansion."
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