KCS 4Q20: ‘Strong Quarter, Despite Challenges,’ Improved Outlook (Updated, Cowen)

Written by Marybeth Luczak, Executive Editor
“Despite several significant challenges in the fourth quarter, including continued impacts from the pandemic, weather events and an extended outage from illegal protests on segments of our network in Mexico, KCS delivered strong fourth quarter results,” KCS President and CEO Patrick J. Ottensmeyer said.

“Despite several significant challenges in the fourth quarter, including continued impacts from the pandemic, weather events and an extended outage from illegal protests on segments of our network in Mexico, KCS delivered strong fourth quarter results,” KCS President and CEO Patrick J. Ottensmeyer said.

Kansas City Southern reported Jan. 22 that fourth-quarter 2020 revenue fell 5% to $693.4 million vs. $729.5 million in the comparable 2019 quarter. This was based on lower volumes (3% decline) related to a 59-day service disruption at Lazaro Cardenas due to teachers’ protests; lower fuel surcharge; and fluctuations in foreign currency.

Fourth-quarter net income, however, was $166.3 million, or $1.80 per diluted share, a 30% rise from the 2019 quarter’s $127.9 million, or $1.30 per diluted share. Operating income was $262.3 million, an 11.1% increase vs. $236 million in 2019.

“Despite several significant challenges in the fourth quarter, including continued impacts from the pandemic, weather events and an extended outage from illegal protests on segments of our network in Mexico, KCS delivered strong fourth quarter results,” President and CEO Patrick J. Ottensmeyer said. “Thanks to the hard work and dedication of our employees, we are overcoming the adversity that we faced in the fourth quarter and throughout 2020, and we heighten our focus on Precision Scheduled Railroading (PSR)-driven service improvements to realize the significant growth opportunities that we see going forward.”

Other fourth-quarter 2020 highlights:

• Operating expenses were $431.1 million, a 12.6% decrease vs. fourth-quarter 2019’s $493.5 million.

• The operating ratio was 62.2% for the fourth quarter vs. 67.6% in the comparable 2019 quarter.

Full-Year 2020 Results

Revenues for the year came in at $2.63 billion—a decrease of 8% from $2.87 billion in 2019—on a 6% decline in carloads. Operating income was $1.0 billion, a 12.8% increase vs. $886.3 million in 2019. The operating ratio was 61.9%. Net income was $619.1 million, or $6.54 per diluted share, a 14.5% increase vs. $540.8 million, or $5.40 per diluted share in 2019.

“During 2020, the KCS network experienced a rapid decline in volumes followed by an unprecedented volume rebound, forcing the company to quickly adjust its service model to match customer demand while optimizing its cost structure,” KCS reported. “These actions resulted in significant improvements to train length and fuel efficiency, improving 12% and 5%, respectively. PSR initiatives also contributed directly to operating expense savings of $96 million in 2020, and are projected to deliver incremental savings of $50 million in 2021.”

Future Outlook

Railroad officials offered an improved multi-year outlook with double-digit revenue growth in 2021; an operating ratio of approximately 57.5% in 2021 and between 55% and 56% in 2022; earnings per share of $9.00 or better in 2021 and between $10.50 and $11.00 in 2022; and capex of around 15% of revenue in 2021 and 2022.

KCS President and CEO Patrick J. Ottensmeyer

“As we turn our focus to 2021, our primary objective will be the implementation of PSR Phase 3, which combines improved operational performance with an intense focus on customer service and revenue growth,” Ottensmeyer said. “Phase 3 of PSR will help us capitalize on the unique growth opportunities available across our franchise. These growth opportunities, combined with an intense focus on excellent execution, give us confidence to reinstate a multi-year outlook, which has improved from the guidance provided a year ago. We look forward to delivering another year of strong returns to shareholders.”

Cowen Insight: ‘Full Speed Ahead’

Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl

“After enduring third-party service disruptions and a severe derailment in 4Q, KSU [Kansas City Southern] came out swinging in the new year with strong guidance,” reported Cowen and Company analysts Jason H. Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Elliot Alper. “The company’s 2021 outlook calls for double-digit top line gains and EPS growth of at least 29%. This fell well ahead of our prior estimate and Street expectations. We increase our EPS forecasts and PT, reiterate Outperform and top rail pick status.”

Cowen’s Key Takeaways:

• “KSU reported 4Q adjusted EPS of $1.89 vs. the consensus forecast of $1.92. This excluded $.09 ($14MM) of adjustments due to a write-off of software development costs. The railroad also had a severe derailment in the quarter, which led to its highest quarterly casualty costs in over a decade. Revenues declined 5% in the quarter, slightly below the consensus figure, with intermodal and energy as the largest decliners. A service interruption at Lazaro Cardenas due to teacher protests (unrelated to the railroad itself), as well as fuel surcharge and FX headwinds contributed to the revenue shortfall.

• “Intermodal carloads and revenue were down 7% and 20% respectively, due to the Lazaro business. Excluding Lazaro, intermodal volumes were up 11%, driven by inventory replenishment, e-commerce demand and tight truck capacity (which was in-line with other railroad commentary).

• “KSU continues to benefit from PSR implementations that accounted for savings of $96MM in 2020, with $50MM expected in 2021 (likely back-end loaded). The company continues to optimize its networks and grow train lengths by approximately 5%.

• “Mexico continues to be a key partner for KSU. In the north zone of Mexico, KSU has seen robust growth in cross-border volumes, led by refined product. Relationships with the Mexico labor union remain important to the company to reach agreements on efficient operations. Approximately 15% of KSU’s Mexico T&E workforce is on COVID-related leave, primarily from a mandatory stay at home order. KSU has been working with the labor union to minimize impacts to operations. Additionally, the Biden Administration has taken immediate actions via executive orders that will likely bolster relationships between the countries. In terms of mix, the company assumes slightly higher revenue growth in Mexico than the U.S. for 2021.

• “Management provided a 2021 outlook that was well-above consensus expectations and our forecasts; with double-digit revenue growth, an OR of approximately 57.5% and EPS growth of at least 29%. While easy [year-over-year] comparisons will exist for 2Q, we believe the bulk of the aforementioned PSR savings are going to be back-end loaded. KSU also reinstated long-term forecasting by providing a strong 2022 outlook that called for an OR of 55-56% and EPS of $10.50-$11.00 (well ahead of our forecasts of 57.3% and $9.65).

• “We adjust our 2021 and 2022 EPS estimate to $9.15 and $10.70, from $8.50 and $9.65, respectively. Our price target rises to $246 from $203 as we increase our 2022 EPS estimate while raising our multiple back to 23x from 21x. We believe this is justified due to KSU’s robust outlook, continued PSR savings, and anticipated improved relations between the US and Mexico. Indeed, KSU stock traded at these levels before the last Administration in the U.S. took office. We continue to rate the stock an Outperform and keep it as our top pick in the railroad space.”

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