- Kansas City Southern experienced robust expansion in revenue and profitability.
- Long-term debt refinancing resulted in a 10% decline in interest expense.
- Kansas City Southern pays a small but sustainable dividend.
On Jan. 30, Midwestern and Mexican railroad company Kansas City Southern (NYSE: KSU) came out with its 2014 annual 10-K that follows up on its earnings statement released on Jan. 23. The company had a robust 2014. Let's take a look to see what's going on with this company.
Robust revenue and profitability growth
In 2014, Kansas City Southern saw its revenue increase 9%. An expanding U.S. Economy as well as record corn harvests due to recovery from droughts in the U.S. Midwest contributed to increases in the overall revenue. Only one segment, energy, saw revenue break even with last year due to prolonged weaknesses in the coal and oil market. Kansas City Southern like its western peer Union Pacific (NYSE: UNP) possesses a fairly even revenue stream without heavy reliance on any one segment. In other words, most of its freight doesn't come from one source such as coal or oil. Anticipated weaknesses in energy can be made up for with increased shipments of more consumer driven freight such as automotive.
Kansas City Southern's yearly net income increased 43% year-over-year due to leverage from the revenue increase. In other words, costs as a percentage of expenses decreased. Kansas City Southern saw its operating margin go from 31.2% in 2013 to 31.4% in 2014. Interestingly, increased equipment ownership lowered the company's equipment leasing costs contributing to lower expenses. Kansas City Southern also lowered it interest expense due to refinancing some of its debt. Long-term debt decreased 1% year over year. Kansas City Southern also saw its yearly free cash flow increase 17% in 2014. Increased net income filtered down to free cash flow.
Good balance sheet
Kansas City Southern has a good balance sheet. It ended 2014 with $348 million in cash, which equates to 9% of stockholders' equity. This is a little lower than the 12% at the end of 2013 and the opposite of what I want to see. I like to see companies with cash to stockholders' equity amounting to 20% or more to get them through difficult times.
Kansas City Southern lowered its long-term debt 1%, which is a good thing. Long-term debt creates interest cost, which chokes out profitability and cash flow. My personal preference is for a company to maintain a long-term debt level amounting to 50% or less of stockholders' equity. At the end of 2014, Kansas City Southern's long-term debt equated to 45% vs. 51% at the end of 2013. In 2014, Kansas City Southern's operating income improved and exceeded interest expense by 11 times vs. 9 times in 2013.
Kansas City Southern does pay a small but sustainable dividend. I always gauge dividend sustainability by comparing how much a business pays in dividends relative to its free cash flow. I like to see companies pay out 50% or less of their free cash flow in dividends so they can utilize the remainder for something else. Last year, Kansas City Southern paid out 47% of its free cash flow in dividends, which lies just below my threshold. Currently, the company pays its shareholders $1.12 per share per year and yields 1% annually.
Kansas City Southern's management believes the economy will remain robust in 2015. Over the long term, they are even bullish on the energy sector. This company provides a crucial service to society, the movement of goods and services, making me bullish on the company long-term.
Kansas City Southern currently trades at a P/E ratio of 26 vs. 19 for the S&P 500, according to Morningstar. This is below its five-year average P/E of 32 making it undervalued on this front. The company trades at a forward P/E ratio of 18 vs. 17 for the S&P 500. This company deserves a spot in your portfolio. Investors may want to buy more shares during market corrections.
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