Kansas City Southern Kept Neutral - Analyst Blog

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Despite volatility in demand stemming from the ongoing economic upheaval, Kansas City Southern ( KSU ) continues to post strong year-over-year growth backed by a favorable pricing environment. We remain encouraged by the company's segment performance and look forward to accelerated growth, particularly in Intermodal, export coal and automotive shipments. We believe CSX will deliver volume growth above GDP levels, in parallel with pricing above inflation.

Kansas has taken pricing actions that have led to average pricing gains of nearly 4-5% per annum, enabling it to maintain a double-digit profit margin. Apart from strong pricing fundamentals, we believe that an improvement in business volumes and effective cost-control measures also remain catalysts for the company's growth.

Additionally, improving cross-border traffic between the U.S. and Mexico and emerging business opportunities in the Mexican market supported by its cheap labor cost will boost the company's bottom line.


Over the last few quarters, Kansas has significantly benefited from positive rail industry fundamentals supported by truckload conversion to rail. Additionally, several cost control initiatives have led to operating ratio improvement. As a result, management expects to post consistent operating ratio improvement, taking its U.S. operating ratio down to approximately 78.0% over the next 3-5 years.

In Mexico, the company targets a sustainable operating ratio in the high 60% range, primarily driven by the significant cost differential among employees. Despite the ongoing economic uncertainty, management remains committed to achieving an operating ratio in the low 70s over the long term. 

Going forward, the company has also taken significant steps to improve its balance sheet position by decreasing leverage and extending debt maturities. In 2011, the company completed debt refinancing of $200.0 million, which extended debt maturities and reduced future interest expense.

Further, it redeemed the remaining $123.5 million principal amount of the 13.0% Senior Notes that translated into reduced debt carry over. In February, Kansas was granted a term loan for $275 million, maturing January 15, 2017. The company expects this loan (carrying 1.25% interest rate) to reduce the interest rate burden significantly, since it will be used for redeeming debt worth $275 million, carrying an 8% interest rate.

However, the company faces significant competition from various transportation providers including railroad companies like Canadian National Railway Company ( CNI ) along with motor carriers that operate similar routes across its service area and, to a less significant extent, barges, ships and pipelines. Further, increased railroad regulation, highly unionized labor and softness in construction-related markets affecting the merchandise business may impede growth in the future.

The present volatilities in the fuel market are also expected to create a cost headwind of approximately $15 million to $20 million in the current year. Additionally, we believe that the weakness in construction-related markets will continue to persist through this year and hinder sales of forest products.

Consequently, we maintain our long-term Neutral rating on Kansas City Southern, supported by a Zacks # 3 Rank (Hold).


 
CDN NATL RY CO ( CNI ): Free Stock Analysis Report
 
KANSAS CITY SOU ( KSU ): Free Stock Analysis Report
 
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Stocks

Referenced Stocks: CNI , KSU

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