EUR 850.00 For Business Accounts Only

Morningstar | Kansas City Southern Produced Record Revenue and EPS Even Amid Expected Sharp Coal Diminution

Kansas City Southern increased second-quarter revenue 4% on modest 1% volume growth and greater fuel surcharges, while EBIT improved just 3% as the operating ratio fell 50 basis points to 64.0%. While management decreased its full 2018 volume expectation to up 3%-4% (previously mid-single-digit growth) on weak year-to-date realized carloads, particularly in energy, among reported segments only energy remains unfavorable in the company’s annual outlook; all others look positive. We retain our wide moat rating, and we expect that any increase to our fair value estimate as we update our model would be upward and minor.

Overall, we are bullish on volume growth despite a couple pockets of weakness. Carloads declined 30% in steam coal, owing to the announced Texas coal plant closure in January, but improved in most other reported segments, including large 17% and 15% respective increases in autos and chemicals/petroleum. The rail improved cross-border revenue 19% year on year and reached a new peak of about 32% of total firm revenue; cross-border volume improved 13% and constituted about 26% of total carloads, a new high in absolute carloads and in proportion to the railroad’s total volume. This healthy growth surprised us, as cross-border intermodal volume improved just 5% year over year. Currency hampered Mexico intermodal growth because the rail prices this in U.S. dollars whereas domestic truckers price in pesos, but intermodal units still grew 3.3%, helped by the robust U.S. trucking market that enjoys high demand and strong prices, in part due to a driver shortage.

The rail indicates it has not seen any negative impact from tariffs even into the third quarter. Management says there is a lot of strength across the board, excluding coal and the Lazaro Cardenas port intermodal business, which suffers from a currency-pricing headwind. Management is considering increasing Lazaro train length even at rates constrained by the persistently low peso-based truck rates.

At this point, we are not overly alarmed by political risks to Kansas City Southern. Management indicates the election of President Obrador appears to pose a low level of threat to the status quo of railroad concession operations, based on communication with his staff and cabinet, and also based on his party not controlling a sufficient majority to pass a constitutional amendment. As legislation from recent years is implemented, energy liberalization is generating rapidly growing related volume. Nafta renegotiation, furthermore, is still on the table.