In this article, let's take a look at Kansas City Southern (KSU, Financial), a $12.68 billion market cap company, which is a holding company with railroad investments serving the central and south central U.S., northeastern and central Mexico and Panama.
Mexico
The company is one of the smallest of the Class I railroads and operates a north-south route in the U.S. while half of its revenue came from Mexico. More precisely, the U.S. operations generated 54% of 2013 revenue and Mexico the remaining 46%. This is explained by the acquisition in 2005 of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V., which was Mexico's largest railroad. The deal created a kind of special link between the U.S., Canada and Mexico, which operates under a concession from the Mexican government up to 2047.
The company renamed the subsidiary Kansas City Southern de Mexico (KCSM) and in that year it also assumed control of the Texas-Mexican Railway (Tex-Mex).
This route is well placed to help NAFTA trade. The three railroads give shippers in the NAFTA trade corridor a transportation alternative with a cost-effective advantage when moving goods through the three countries.
On the other hand, operations in the U.S. are provided by its Kansas City Southern Railway subsidiary.
Margins
Further, in Mexico the company has higher rates but less for fuel so margins are boosting and are better than the ones obtained by U.S. operations. Also, they are similar to the large Class I railroads.
Good cash
Moreover, it has good cash that allowed the company to start a dividend on common shares in early 2012 of $1.12 per year. We think the company has a strong balance sheet and good cash that allows the company to hike its dividend payout in the future.
Revenues, margins and profitability
Looking at profitability, revenue growth by 12.15% led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($1.18 vs $0.14). The net income increased tremendously when compared to the same quarter one year prior, rising to $129.80 million from $15.40 million.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| KSU | Kansas City | 12.89 |
| ANP | Union Pacific Corp | 21.94 |
| ARCB | ArcBest Corp | 6.83 |
| CNI | Canadian National Railway Co. | 21.06 |
| CGI | Celadon Group Inc. | 11.85 |
| Â | Industry Median | 6.88 |
The company has a current ROE of 12.89% which is higher than the industry median and the ones exhibit by ArcBest Corp. (ARCB, Financial) and Celadon Group Inc. (CGI, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Union Pacific Corp (ANP, Financial) and Canadian National Railway Co. (CNI, Financial) could be good options. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 28.0x, trading at a premium compared to an average of 23.1x for the industry. To use another metric, its price-to-book ratio of 3.61x indicates a premium versus the industry average of 1.46x while the price-to-sales ratio of 5.11x is above the industry average of 1.11x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $49.431, which represents a 37.7% compound annual growth rate (CAGR).
Final comment
As outlined in the article, we think that the company will have an attractive growth potential for its exposure to Mexico. Also, apart from revenue expansion, margins are boosting and having good levels due to its cost advantages and efficient scale. Finally, the huge CAGR level makes me feel bullish on this stock.
Hedge fund gurus like Ray Dalio (Trades, Portfolio), Andreas Halvorsen (Trades, Portfolio) and Frank Sands (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014 as well as Manning & Napier Advisors, Inc.
Disclosure: Omar Venerio holds no position in any stocks mentioned
