How many times have we seen the same movie? The good or bad guy, chased by the law, going south. And when saying south, we mean Mexico. It seems to be the paradise for all U.S. citizens looking for some tranquility. What has never been seen though, is the escapee travelling on the Kansas City Southern (KSU). The train operator is commonly known as the NAFTA Railway, since it offers services across North America through a key partnership with Canadian National Railway (CN). In addition, the company owns former Grupo Transportación Ferroviaria Mexicana, today Kansas City Southern of Mexico. Hence, services today connect Canada and Mexico through the Midwest and Mississippi River basin, making the firm a true regional railroad operator. Most important, overall performance continues to catch the market’s attention, and there are clear evidences of gurus making long-term investments.
Freighting Profits Along
Throughout April, five financial institutions have emitted a report on Kansas City Southern. One initiated coverage, two reiterated the previous rating, one downgraded the stock, and the last boosted target price. As expected, opinion on the stock is not uniform. The firm received an “Underperform” rating from Macquarie, while FBR Capital Markets and Zacks issued a “Hold” rating, and Morgan Stanley considered the stock “Overweight.” BMO Capital Markets only boosted the target price, the only indicator on which all financial institutions coincide, as the value remains above the $100 mark.
For the first quarter of 2014, Kansas City Southern reported record revenue, thanks to a 4 percent increase in rail car shipments. However, profit slid 9.7% as the regional railroad operator recorded higher expenses and debt-retirement costs. Most responsible for the increase in revenues is related to the agriculture and minerals segment, representing a total raise of 40% in grain volume. The phenomenon has been associated with the ability by the company to differentiate with the competition by providing a north-to-south transnational service, in opposition to an east-to-west service.
Bad news for Kansas City Southern has arrived in the form of a legal lawsuit. The firm and four of its top executives are accused of participating in a scheme to mislead investors about the financial health of the company, with the final intention of inflating stock value. Hence, some explanation for the mixed reviews may be found here, in the incomplete information held by analysts and impossibility to fully assess the business. Some evidence pointed to by claimants is: declining coal volumes and crude oil shipments; delays in the construction of a new terminal in Port Arthur, Texas; and Mexican officials working to end the agreement with Kansas City Southern.
All Along the Southbound Odyssey
Those who question Kansas City Southern’s performance, or downplay higher revenues, have misunderstood the business. The company has reported increasing revenues five years in a row, while net income only saw a small setback on 2013. Also, cash volume greatly surpassed previous recorded levels, a growth greater than that experienced by debt. Most important, since 2009 the business model has been widening operating margins, reaching and sustaining above the 30% mark for two years now. Those results are not the consequence of misleading information; they are the material evidence of a favorable market environment.
There are several upsides to investing on Kansas City Southern: first, sustained double-digit profit margin, with service networks across both sides of the U.S. and Mexico border, and a strong improvement in operating ratio that was 68.1% in fourth quarter 2013; second, market synergies at the merchandise business and automobile industry, compounded by higher export volumes at the Port of Lázaro Cárdenas and demand increases for intermodal cross-boundary; third, a capital-intensive operating environment, evidenced by a number of growth projects in the pipeline.
Trading at 33 times its trailing earnings, Kansas City Southern carries a 68% premium to the industry average. Annual yield amounts to 0.91%, thanks to a quarterly dividend payment of $0.28. Hence, even with great evidence of long-term investments by Pioneer Investments (Trades, Portfolio) and John Keeley (Trades, Portfolio), the stock is comparatively expensive while rumors of a stagnant performance become louder. It is recommended to wait for a solution of the lawsuit, as the impact on profitability can be important, and benefits from record grain harvest in Canada will dwindle during 2014.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.