Record revenues for Kansas City Southern

Written by Railway Age Staff
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Despite some network issues, Kansas City Southern saw record revenues in the third quarter that, at $699 million, were 6% higher from a year ago.

Revenues for the quarter ending Sept. 30 increased in three commodity groups, led by a 17% increase to $179 million in Chemicals and Petroleum due to refined product shipments to Mexico. Automotive and Intermodal each grew by 8% to $193.3 million and $284.6 million, respectively. Industrial and Consumer Products and Agriculture and Minerals were each flat compared to prior year, and Energy declined by 2%.

Overall, carload volumes increased 4% compared to prior year.

Excluding a gain on insurance recoveries related to damage and service interruptions from Hurricane Harvey in 2017, adjusted operating expenses in 3Q18 were $443 million, 5% higher than 2017. Adjusted operating income was $256 million, up 9%.

Fuel expense rose to $90.2 million from $80.1 million in the year-ago quarter.

The Kansas City-based company said the adjusted third quarter operating ratio was 63.4%, a 1.0 point improvement over third-quarter 2017.

Net income in the third quarter was $174 million, or $1.70 per diluted share, compared with $129 million, or $1.23 per diluted share in the third quarter of 2017. Adjusted diluted earnings per share were $1.57, 16% higher than a year ago, excluding the impacts of foreign exchange, adjustments to 2017 provisional income tax benefit for the Tax Cuts and Jobs Act and a gain on insurance recoveries related to hurricane damage.

“Kansas City Southern faced a challenging third quarter, as network congestion in northern Mexico led to a difficult operating environment,” said Kansas City Southern President and CEO Patrick J. Ottensmeyer. “However, we have taken steps that we are confident will restore our service levels and allow us to continue delivering strong and diversified franchise cross-border volume and revenue growth, led by increased refined product shipments to Mexico and strength in our Intermodal and Automotive commodity groups.

The company operates a Mexican subsidiary, Kansas City Southern de México.

“As we look to 2019, our cross-border network offers unique opportunities for volume growth from our robust Chemicals & Petroleum, Intermodal, Automotive and Export Grain franchises,” said Ottensmeyer. “Moreover, the capital investments that we have made throughout our network position us to deliver superior long-term growth and strong financial results to our stockholders.”

“KCS reported 3Q18 results that saw a top line miss and a bottom line that was in line with the consensus estimate,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “The 3Q18 results were the first quarterly results and opportunity to hear from management since the new U.S.-Mexico trade deal was agreed upon. The stock traded up on the print, and though we continue to recommend the stock as one of our top rail picks, we adjusted our estimates slightly downward.”

KCS’s reported EPS of $1.57 was below Cowen’s $1.64 forecast but in line with consensus. Excluding FX (Forward Transactions) adjustments, EPS was $1.70. Record revenue of $699 million was below Cowen’s $718 million estimate as well as the consensus $708 million. Adjusted operating income of $256 million was below Cowen’s $264 million estimate and in line with the consensus $255 million. The adjusted OR was 63.4%, slightly higher than Cowen’s estimate but better than the consensus 160bps. Non-adjusted OR was 62%.

On the conference call, management lowered full-year volume guidance to low-single digit YoY growth from a 3%-4% range on their 2Q18 call. “Though 3Q18 was marred by ongoing service issues in Mexico, we continue to believe that Mexico remains a good growth opportunity for KCS,” Seidl noted. “In fact, management seemed to say on the conference call that the service issues were at least in part a result of strong business growth in Mexico and at the terminals in the surrounding area. As KCS adjusts to this increased business, it will be able to sort out these service issues—it is leasing 30 locomotives and has temporarily relocated crews into Northern Mexico—while continuing to add incremental business.

“KCS derives nearly 50% of its business from Mexico, so the tariff and trade agreements are front and center when it comes to business. This was a component of our thesis for upgrading the stock when the preliminary version of the trade deal was announced, and why we were encouraged by management’s commentary that the new deal, when fully approved and ratified, will be good for KCS.

Looking at 4Q18 in particular, management “gave positive guidance on chemicals and petroleum, intermodal, automotive, and agriculture and minerals markets, along with negative guidance for industrial and consumer and energy markets.” Seidl said. “Interestingly, KCS listed industrial and consumer as a positive market looking out to 3Q18 in their 2Q18 call, but have since shifted that to a negative market now looking out to 4Q18.”

Addressing current business trends, in particular a tariff pull-forward, peak season, and KCS’s competition in the trucking market, management “said it’s pleased with the way that the peak season came in during 3Q18 and thus far in 4Q18,” noted Seidl. “Second, management definitely noticed some sort of pull-forward in July and August, specifically in intermodal and steel. Last, the company said it is still seeing a very tight trucking market, which, along with additional trucking regulations being implemented in Mexico, should only add to a shift from highway to rail. We maintain our price target of $138, and continue to rate shares of KCS as Outperform.”

 

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