THE HEDGEYE EDGE
Since the Trump administration took over, Kansas City Southern (KSU) shares have failed to rally along with the rest of the rails, in part due to policy and trade concerns surrounding the company’s business in Mexico. We think the trade risk with Mexico and border adjustment tax will prove less likely than feared. Prior to the election, 2017 and 2018 looked favorable for KSU with its own growth and profit improvement opportunities – KSU still does post-election.
KSU has pretty much always traded at a higher multiple (historically at 22-25 P/E) compared to the other rails because of better growth prospects and exemption from some rail merger tests, which could make the company a consolidation target. Now KSU trades at ~19.6 times earnings vs. CSX ~26.2 and NSC ~20.7.
We expect clarity on policy and revenue growth to support shares of KSU, paying investors for the significant volatility amid Trump administration uncertainty in the months ahead.
INTERMEDIATE TERM (TREND)
The new management team has set beatable expectations while growth opportunities add flexibility. In addition, KSU faces easy comps along with customer plant openings in 2017. Rails are reporting a better start to pricing for 2017 compared to 2016.
On the macro side, as the U.S. data continues to improve (Industrial Production, ISM New Orders, etc.), rail traffic should benefit aiding revenue growth.
LONG TERM (TAIL)
KSU is in a position to benefit from top-line growth, cost management, and lower capital expenditures. Some areas of potential revenue growth include Mexico opening up its energy industry to privatization, new auto and chemical plants and port openings along key KSU routes.
Furthermore, we think KSU retains a significant market penetration opportunity, particularly versus trucking. KSU, along with the industry, continues to drive the operating ratios down in part due to lower labor costs. This will likely continue to be a source for higher margins as productivity and technology improvements (PTC, one-man crews, potentially autonomous trains, etc) drive efficiencies.
After a wave of capex investment in the last 12 years, railroads will be able to deploy more cash to shareholders and/or focus on productivity improvements versus rail equipment spending.
ONE-YEAR TRAILING CHART
