Kansas City Southern Is Worth How Much?

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An amazing thing in the market are stocks such as Kansas City Southern (NYSE: KSU) that are suddenly worth an amazing value such as $10 billion. How many social media stocks or recent IPOs does the market obsess about with market caps hardly above the $1 billion level? Railroads have been hot for years and Warren Buffett has already collected Burlington Northern for his Berkshire portfolio, yet how many people knew that Kansas City Southern was now officially a large cap?

The operator of railroad networks between Kansas City and the Gulf of Mexico ports between Alabama and Texas announced Q4 earnings that provided a strong 15% gain in operating income even with the large decline in coal revenue. The company also provides the unique opportunity to benefit from growth in Mexico with direct rail connections to Mexico City.

The company remains largely overshadowed by peers such as CSX (NYSE: CSX) and Norfolk Southern (NYSE: NSC) that have market caps more than double that of Kansas City Southern.

Q4 2012 earnings results

The company provided the following highlights for Q4:

  • Revenue of $568 million, an increase of 7% over fourth quarter 2011.
  • Operating income of $174 million, 15% higher than a year ago.
  • Operating ratio of 69.5%, compared with 71.6% in fourth quarter 2011.
  • Diluted earnings per share for fourth quarter 2012 was $0.83. Adjusted diluted earnings per share was $0.92 for fourth quarter 2012.

The company reported adjusted earnings of $0.92 versus the analyst consensus of $0.82. The number easily surpassed the estimates after several quarters of lackluster earnings including a couple of quarters of missing estimates.

With the stock hitting all-time highs, the news further highlights how the ultimate trend of growing earnings boost stock prices more than whether the company beats analyst estimates.

Coal vs. oil

The stock continues to surge, as the railroad has been able to replace the revenue lost from the decline in utility coal ships. In the sector, Kansas City Southern benefits from a lower coal shipment customer base. Utility coal revenue is now less than 10% of total revenue. Conversely oil revenue was up $6.5 million to $7.3 million in Q4. Combined with increased revenue for frac sand, the company was able to replace most of the decline in coal revenue with oil and sand related to drilling for oil.

Both CSX and Norfolk Southern were more impacted with revenues declining from last year due to lower coal revenues. In Q4 2011, CSX and Norfolk Southern obtained 23% and 24% of revenues from coal, respectively. Both companies averaged around 20% revenue declines in Q4 2012. Consequently, neither stock is surging to all time highs similar to Kansas City Southern.

Between the drops in coal shipments, other categories now account for more revenue at Kansas City Southern. Intermodal, forest products, and metals all topped coal revenue in Q4. Other categories including chemicals, grains, an automotives account for similar revenue totals.

Stock valuation

With the stock hitting all-time highs, clearly the investment world is aware of the stock. It might be a surprise that Kansas City Southern is now worth over $10 billion, but investors are comfortable in paying 22.5x forward earnings. Clearly a few investment funds have found the stock already.

Conclusion

The recovery in automotives and forestry products (housing) combined with the move towards shipping oil and railroads has helped the industry overcome the slack demand in one of the past top revenue categories of utility coal.

While the railroads have a competitive advantage over other shipping methods such as trucking and even pipelines these days, it might surprise most in the investment community that Kansas City Southern now tops $10 billion and trades at a very rich multiple. Investors might want to step back and realize it no longer provides the value that it did a few years back.

If coal demand rebounds, the other stocks might provide the better investment options and value.


Mark Holder and Stone Fox Capital Advisors, LLC own positions in CSX Corporation. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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