Kansas City Southern Dividend Stock Analysis

Kansas City Southern (KSU) is the smallest of the North American Class 1 railroad companies. The company commands 6,500 miles of rail network serving southern US with seamless cross-border service to Mexico. The company serves 12 Gulf ports and 1 Pacific Ocean port. The following system map image demonstrates the scale and reach of Kansas City Southern.

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(Image Source: Kansas City Southern IR)
Kansas City Southern own 100% of subsidiary Kansas City Southern de México, S.A. de C.V. (“KCSM”), which has a 50-year concession from the Mexican government and could expire in 2047 unless extended – to operate the KCSM arm. The company directly competes with Ferrocarril Mexicano, aka FerroMex (which is partly owned by Union Pacific) inside Mexico.

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Sector Challenges – Railroads

Over the course of past few months, I have been featuring the Sector Overview series, where I take a sector (or an industry) and provide some basic/background information about the sector. In addition, I present the major companies in the field and profile at a high level comparing the peers. These articles are supposed to be what the title claims – an overview. It is up to each investor to compare and contrast individual companies and decide which one to pick if needed. These articles have garnered a lot of attention from readers (Thank you once again 🙂 ) and the feedback really helps me in making this a better blog for more quality articles. Lately, I have been thinking on the other side of these investment opportunities and decided to highlight the sectors to present the threats and challenges in current environment. I begin this series with a Sector Overview Challenges – Railroads.

The article Sector Overview – Railroads is available here. In that article, I explored the idea of investing in the railroad sector and presented the major railroad operators in N.America – which includes Union Pacific Corp (UNP), Canadian National Railway Co (CNI/CNR.TO), CSX Corp (CSX), Canadian Pacific Railway Ltd (CP), Norfolk Southern Corp (NSC), and Kansas City Southern Inc (KSU). In addition, there is Burlington Santa Fe (BNSF), but the company was bought by Warren Buffet’s Berkshire Hathaway and taken private.

Caveat: Before I get into the details of the challenges faced by the sector, I would like to highlight that this is by no means a recommendation to short the stocks. Remember each investment carries risk, and all I am trying to do with this article is to try and highlight the existing risks in current market conditions and during this part of the economic cycle. These conditions may disappear in due time as the economy goes through its ups and downs.

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Kansas City Southern – A Prime Target for Takeover

Kansas City Southern Inc (KSU) is the smallest of the North American railroad companies operating approximately 6,500 miles of rail network, serving business centers in south central US and Mexico.

The railroad industry is facing pressure to collapse in traffic in coal and petroleum products. This has caused companies to entertain the thought of M&A. KSU remains uniquely positioned with a great rail network and seamless access to the Mexican market – a region seeing higher industrial/manufacturing activity over the years in North America. A smaller company with a market cap of under $10B, makes KSU a great takeover target from any of the larger railroad operators. With a low starting yield of 1.5% and low payout ratio of 27%, there is plenty of room for those dividends to grow. Is this company a buy now?

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Sector Overview – Railroads

Fewer investments garner as much as attention to the pulse of the economy as the railroad sector. The railroads are considered a leading indicator for the overall health of the economy as transportation of goods is critical and gives investors a sense of how companies and consumers are spending their money. If we observe legendary investors such as Warren Buffett and Bill Gates – it is clear that they are fans of the railroad companies and believe in the long term prospects with Buffett’s Berkshire Hathaway buying out Burlington Santa Fe (BNSF), taking it private and Gates’ Cascade Investments holding a sizeable position in Canadian National Railway. Railroads are what we call a wide-moat industry sector – where it is extremely hard for new entrants to get established and challenge the incumbents. This makes the railroads very attractive for long term investors.

Whether transporting crude, lumber, merchandise, agricultural or industrial products, railroads are what keeps the economy moving. While the transportation for entities such as coal (which used to be the largest users of railroad services a few years ago) has fallen due to the fall in crude prices and rise of green energy alternatives, the transportation need for crude saw significant rise in the recent past. However, the recent turn of events with falling energy prices, has put a damper on crude transportation via railroads. The following chart from Association of American Railroads shows the trend in traffic for various payloads.

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