Kansas City Southern: No Reason To Buy

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About: Kansas City Southern (KSU)
by: Patrick Doyle
Summary

Although sales in the first half of 2019 are up, net income is down, even when we add back the impairment charge.

I think investors would be wise to follow the likes of Joel Greenblatt and Ken Fisher and avoid this name in favor of other public Class 1 rails.

Investing is relativistic, and this company is the least attractive of the Class 1 rails, prompting the question: why would you buy this?

Since I published my penultimate article on Kansas City Southern Railroad (NYSE:KSU) just under a year ago, shares have risen about 1.75% versus a 1% decline in the S&P 500 since then. The company has since reported earnings, so I thought I'd check in to see if there's anything to get excited about. There isn't. I'll go through my reasons for continuing to avoid the name, but I think they can be summed up onomatopoetically as "meh."

Financial Snapshot

There are some interesting bright spots in the financial history here. Over the past five years, revenue has grown at a CAGR of about 1.2%, while net income has increased at a rate of about 4.5%, suggesting that the company has grown more efficient over time. In addition, earnings per share have grown at an even faster pace, up at a CAGR of 6% on the back of a $1.7 billion share buyback program over the past 5 ½ years. Additionally, the company has returned just over $830 million to owners in the form of dividends over that time.

Looking at the first six months of 2019 relative to the same period a year ago, things look less good in my view. Although revenue was up ~5%, net income declined fully 21%. Much of this decline was caused by the $51 million impairment charge the company took as a result of writing off some redundant locomotives and rolling stock. Adding back this impairment charge (because, in the magical world of modern stock analysis, asset write-downs don't matter), net income still declined by ~3.5%. In addition, unlike CSX (NASDAQ:CSX), it's not like 2018 was a record year for the company in terms of net income, so beating the 2018 hurdle shouldn't be too difficult. The company hasn't so far managed it, though.

Source: Company filings

The Stock

Even a relatively mediocre business such as this can be a great business if the price is right, though. For that reason, I must spend some time looking at the stock itself. While it's been more expensive in the past, it has certainly been cheaper also. Again, "meh."

Source: GuruFocus

The history of Kansas City Southern stock is interesting in that it doesn't maintain a consistent dividend yield over time. The shares have basically not reacted to the fact that the dividend has grown at a CAGR of about 5.2% over the past five years, given that they have only "appreciated" at a .7% CAGR over the same time. This suggests that, in this case at least, concerns about the company outweigh any positives from dividend increases. This lack of stock appreciation may be the result of the fact that Kansas City Southern may be an also-ran among Class 1 railroads (see below).

Everything's Relative

Investing is an inherently relativistic process. Whenever we buy "X" we are, by definition, eschewing a host of "Ys." I would suggest that it's best to buy the best option available to us. Given that we have limited capital, and may want to own a railroad, we may as well seek the best option available to us. With all that in mind, I present for your enjoyment and edification the following chart that tracks significant statistics for the publicly traded Class 1 railroads. Incidentally, this table may indicate one of the reasons why CSX is currently my favorite Class 1.

Source: Author compilation

While inexpensive, Kansas City Southern is hardly the cheapest of the railroads. Also, the yield is below the average yield of 1.61%. Additionally, even after accounting for the recent $51 million impairment charge (caused by write-off of locomotives and rolling stock no longer needed in the business), the operating ratio remains the highest of the group. Thus, for investors who want exposure to a single Class 1, why would they choose the one with the lowest dividend yield and the worst operating ratio when they can just as easily buy the others?

Appeal To Authority

It must be said that some investors are better at this activity than others. Some people, as a result of temperament and training, produce better results than the rest of us. Some do relatively well because they are institutional investors, armed with a legion of analysts. Fortunately for the rest of us, we have access to institutional investors' trades and can ride their coattails to some degree. With that as background, I'd point out that both Joel Greenblatt and Ken Fisher have been generally reducing their stakes in Kansas City Southern over the past year, the former having sold out completely at the end of 2018. I think when investors of this caliber make moves, we should at least be aware of it.

Keeping on the relativistic theme, it should be pointed out that Greenblatt, Fisher, and Mario Gabelli have been adding to their positions in Union Pacific (NYSE:UNP) in 2019 for example.

Conclusion

I'm generally bullish on rails for a host of reasons. That said, not all rails are created equal, and I think Kansas City Southern is the least attractive of these from an investor's point of view. The company so far hasn't been able to match the mediocre income of 2018. The shares are not inexpensive. Institutional investors are selling this rail while buying others. That relative performance may be the most troubling thing in my view. If you can buy any railroad, why would you buy this one? There are many better choices among the traded Class 1 rails, and I would recommend one of them long before suggesting investors put capital to work with Kansas City Southern.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.