Is Kansas City Southern too expensive?

KSU - Kansas City Southern

Kansas City Southern is a leading transportation company with railroad investments primarily in the U.S. and Mexico. The company operates through two primary subsidiaries – Kansas City Southern Railway Company (KCSR) in the U.S. and Kansas City Southern de Mexico, S.A. de C.V. (KCSM) in Mexico. KCSR serves a ten-state region in the midwest and southeast regions of the U.S. and has the shortest north/south rail route between Kansas City, Missouri and several key ports. KCSM operates the most strategic portion of the shortest, direct rail passageway in Mexico. Kansas City Southern also owns 50% of the Panama Canal Railway Company in Panama. The company operates an extensive rail network of 6,700 route miles linking commercial and industrial markets in the U.S. and Mexico. It serves a wide range of industries like chemical & petroleum (23% of revenue mix), industrial & consumer products (22%), agriculture & minerals (18%), intermodal (14%), energy & automotive (9% each) and other (5%).

Investment Data

Revenue Growth & Market Exposure

Kansas City is a key rail player connecting major commercial and industrial markets in the central U.S. with major industrial cities in Mexico. Railroads is a highly capital intensive business. Kansas City deployed approximately 40-50% of available cash towards capital projects and strategic investments in 2019. It is making significant capital expenditure on investment in growth including network resilience, capacity and overhauls, IT, and PTC. PTC interoperability with partner rails is expected to be completed by 2020. The company is now operating with ~16% fewer locomotives and 12% fewer cars. As a result, locomotive failures reduced by about 54% and fuel efficiency improved by 5% because of the longer, heavier trains and the tonnage on them.

The company is making good progress on its PSR initiatives which has boosted both its operational and financial performance in 2019. Significant gains in all key metrics were achieved in 2019, particularly, a 22% improvement in velocity and a 16% improvement in dwell. It is focusing on reduction initiatives to bring higher productivity out of fewer resources. Kansas is also looking at improving network flexibility by modifying the way its routes are serviced. In short, the company is focusing on enhancing its efficiency and improving its asset utilization.

The company has operated over 3,000 trains with International Crews to date, and is looking forward to expanding its International Crew base in 2020 which should allow the majority of KCS trains to operate with International Crews over the Laredo gateway. The company is also making good progress on cross-border growth opportunities.

The company is expecting low-single-digit volume growth and mid-single-digit revenue growth in 2020.

Dividends

Kansas City is a Dividend Starter and has a solid history of dividend payments with a dividend growth rate of 10% CAGR over the last five years. It sports a dividend yield of 1.1% and a very low payout ratio of 29%. Its last annual dividend hike was more than 11%. Kansas’ EPS has also grown at a rate of 6%+ CAGR in the last decade. It recently announced a $2 billion share repurchase program over the next three years.

Kansas City Southern is expecting to return 50% to 60% of its available cash to shareholders, primarily in the form of share repurchases and a modest dividend. The company has a sound track record of strong financial and operating performance, which should continue driven by precision scheduled railroading. It is targeting total annualized OpEx savings of $125 million from the PSR program.

Kansas City has a solid balance sheet with improving cash flow and return profile. Approximately 50-60% of available cash is generally deployed to share repurchases and dividends. Its CapEx as a percent of revenue will decrease from 20% in 2019 to ~17% in 2020, as there are no locomotive or equipment purchases planned for 2020. The company’s internally generated cash flows are expected to fund its cash capital expenditures.

Kansas City is expected to gain from its unique U.S.-Mexico cross-border network, profitable rail franchise in Mexico and a well-diversified customer base and commodity mix. The company is expecting mid-teens EPS CAGR growth in 2019 – 2021.

Competition

The railroad industry in North America is dominated by a few very large carriers. Kansas City competes with other railroad companies like BNSF Railway Company and Union Pacific Railroad Company. It is also subject to competition from motor carriers, barge lines and other maritime shipping that operate in the company’s routes. In Mexico, Kansas City faces intense competition from y Ferrocarril Mexicano, S.A. de C.V. and Ferrosur, S.A. de C.V. However, KCS’ significant investments and strategic alliances grant it an edge over the peers.

TickerKeyTickerCompanySectorIndustryScoreQuoteMarket CapP/EFPEEPSYield RawYieldPayoutRatioPaymentsDividendChowderGrowthRatingIncomeRatingTollboothAmbassadorAchieverAristocratKingCountryGraph
NYSE:UNPUNPUnion Pacific Corp.IndustrialsRailroads0.65169.86115.2619.7520.668.600.02282.280.451243.880.164286Tollbooth - UnregulatedYESYESNONOUSA1
NASDAQ:CSXCSXCSXIndustrialsRailroads0.6371.5854.7917.2620.664.150.01451.450.250641.040.102486Tollbooth - UnregulatedYESYESNONOUSA1
NYSE:NSCNSCNorfolk SouthernIndustrialsRailroads0.57178.2945.6719.3920.669.200.02112.110.408743.760.122664Tollbooth - UnregulatedNONONONOUSA1
NYSE:LUVLUVSouthwest Airlines CompanyIndustrialsAirlines0.7432.1018.929.4620.663.390.02242.240.212440.720.253785Consumable - DiscretionaryNONONONOUSA1
NYSE:KSUKSUKansas City SouthernIndustrialsRailroads0.38150.5214.3025.2420.665.960.01061.060.268541.600.049533Tollbooth - UnregulatedNONONONOUSA1
NASDAQ:AALAALAmerican Airlines Group Inc.IndustrialsAirlines0.3210.504.440.0020.66-1.870.03813.811.000040.400.038122Consumable - DiscretionaryNONONONOUSA1

Bottom Line

KCS is well-positioned to drive further improvements in 2020 based on the successful implementation of PSR initiatives. The company is expecting positive market trends in Chemical & Petroleum, Agriculture & Minerals and Industrial & Consumer markets in 2020. The company’s aggressive investments towards enhancing its network capacity, track infrastructure, modernizing and driving supply chain efficiency should support future growth. Kansas City Southern has enough room to grow its dividend given a low payout ratio and dividend payment streak.

What’s in store can always change these days and I find it expensive compared to its peers.

KSU vs Indexes

DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.

DISCLAIMER: Please note that this blog post represents my opinion and not an advice/recommendation. I am not a financial adviser, I am not qualified to give financial advice. Before you buy any stocks/funds consult with a qualified financial planner. Make your investment decisions at your own risk – see my full disclaimer for more details.
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