KCS: Challenging 1Q21, Improving Outlook (Updated, Cowen)

Written by Marybeth Luczak, Executive Editor
“Although our first-quarter performance was impacted by several unique and challenging events, including the Polar Vortex, and lingering network congestion, our operating team is focused on improving operating metrics and customer service through PSR phase III,” President and CEO Patrick J. Ottensmeyer said.

“Although our first-quarter performance was impacted by several unique and challenging events, including the Polar Vortex, and lingering network congestion, our operating team is focused on improving operating metrics and customer service through PSR phase III,” President and CEO Patrick J. Ottensmeyer said.

Kansas City Southern’s first-quarter financials were slightly off from the prior-year period due to several factors, but the merger-bound Class I says it anticipates improved operating and service metrics and revenue growth this year.

KCS reported April 16 that first-quarter 2021 revenue fell 4% to $706.0 million vs. $731.7 in the comparable 2020 quarter. This was based on lower volumes (1% decline), lower fuel surcharge, and fluctuations in foreign currency.

Other KCS first-quarter 2021 highlights:

• Net income was $153.4 million, or $1.68 per diluted share, a 0.72% increase vs. the January-March 2020 period’s $152.3 million, or $1.58 per diluted share.
• Operating income was $253.0 million, a 12.4% decrease vs. $288.8 million in 2020.
• Operating expenses came in at $453.0 million, rising 2.28% from $442.9 million last year.
• The operating ratio was 64.2% vs. 60.5% in first-quarter 2020.

“Although our first-quarter performance was impacted by several unique and challenging events, including the Polar Vortex, and lingering network congestion, our operating team is focused on improving operating metrics and customer service through PSR Phase III,” President and CEO Patrick J. Ottensmeyer said.

KCS President and CEO Patrick J. Ottensmeyer

“During the first quarter, we also announced an exciting and historic combination with Canadian Pacific [CP], creating the first rail network connecting the U.S., Mexico, and Canada. This combination is expected to provide an enhanced competitive alternative to existing rail service providers, resulting in improved service to customers of all sizes.”

The railroad reported that it expects to file a proxy statement in late April or early May. And by mid-2021, it anticipates that “[f]ollowing approval by CP and KCS shareholders and satisfaction or waiver of other customary closing conditions, and, if necessary, prior approval by the STB [Surface Transportation Board] for the use of a voting trust, CP will acquire KCS shares and place into voting trust; KCS shareholders receive consideration.” By mid-2022, KCS said it expects to “obtain common control approval from STB and other applicable regulatory authorities.” 

Future Outlook

KCS reported that it would see “double-digit” revenue growth in 2021; an operating ratio of approximately 57.5% in 2021, and between 55% and 56% in 2022; and capital expenditures of about 17% of revenue in 2021 and 2022.

“Based on an outlook for improvement in volume growth and operational trends, we can confidently confirm our 2021 guidance,” Ottensmeyer noted.

The KCS Investor Relations site provides more details.

KCS has also bolstered its executive leadership team with two strategic appointments: Jeffrey M. Songer in the new role of Executive Vice President-Strategic Merger Planning, and John F. Orr as Executive Vice President-Operations.

Cowen Insight:Tough Q1 as Expected; Full Year Intact

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

“KSU [Kansas City Southern] kicked off first-quarter railroad earnings, setting the tone of a challenging first quarter due to severe weather, as expected,” reported Cowen and Company analysts Jason H. Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Elliot Alper. “Management reiterated the 2021 outlook despite a soft start to the year, which also included hits from fuel surcharge recovery and FX. We remain encouraged on the CP/KSU deal; next catalyst is Surface Transportation Board [STB] commentary on the exemption, which should come soon. We reiterate Outperform.”

Cowen’s Key Takeaways:

• “KSU reported 1Q21 adjusted EPS of $1.91—below our estimate of $1.95, which was a penny above the consensus forecast. Adjusted OR was 61.4%, slightly worse than our 59.5% forecast. Severe weather and power outages in February challenged the company, given that 60% of its business navigates through the state of Texas. A 29% increase in fuel prices (recall
railroads have a lag in their fuel surcharge recovery) coupled with FX headwinds also worked against KSU in the first quarter. Transaction-related expenses were approximately $19M in the quarter.
• “We are encouraged that KSU reiterated their full-year outlook, which calls for double-digit top-line growth and EPS of $9.00 or better. Management noted that both January and March were in-line with financial expectations and excluding weather impacts in the first quarter, business trends were favorable. KSU expects headcount growth to be muted for the rest of 2021 with robust volume growth, which should create operating leverage; we are
currently modeling 57.5% OR for 2021—in-line with management’s guidance.
• “In terms of business unit performance in the first quarter and expectations for the rest of the year, energy and chemical & petroleum were the best performances at 6.9% and 11.8%, respectively. Mexico energy volumes beat expectations in the first quarter and are expected to persist
through the rest of the year. Utility coal was the best performer at +29.8%. Microchip shortages in the first quarter caused automotive to decline 18%, but it is expected to rebound in second-half 2021 as the chip shortage abates. Slower Lazaro recovery caused intermodal to lag in the quarter. Business trends appear to be sequentially improving and volumes are rebounding in intermodal. Adjusting for the Lazaro impact and auto parts in the quarter, volumes would have been +10%. On a full-year basis, we expect intermodal to rebound driven by bullish economic consensus, e-commerce/consumer demand growth, and tight truck capacity.
• “Regarding the CP/KSU merger, management refrained from any speculation and pointed investors to a proxy statement that will be available in 2-3 weeks, which will answer questions about the process. The next step is up to the STB, which will decide on whether KSU’s exemption to the new merger rules still applies. Although no formal timetable exists for this opinion, we believe it will be in the coming weeks. As we have stated previously, we expect the STB is likely to take the cautious approach to the merger and will not allow for the rule exemption, thus using new rules. This will allow for a more formal review process and public comment. That said, we still believe this deal ultimately gets STB approval.
• “We adjust our 2021 estimate to $9.05 from $9.15 while maintaining our 2022 EPS estimate of $10.50; our $300 price target remains intact. Our KSU price target is based off terms of potential merger of .489 share conversion tied to our 12 month CP price target of $431, as well as $90 cash, per terms of the deal.”

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