Does KSU's Great Q1 Matter? Yes, Actually....

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Greetings;

Kansas City Southern (KSU, or sometimes by railroaders, KCS) led off the railroad group’s Q1/2020 earnings “period” with a bang, or an off-the-wall extra-base hit, as they had predicted in their useful later period webcast a few weeks ago (so much of this was in effect “pre-covered”).  How good?  EPS up 30% YOY, fully beating expectations by 10%, units up 4% and revenues 8&, OR down by 650bps to 59.7%, proudly and justifiably noted by CEO Pat Ottensmeyer as their first sub-60 and living proof that PSR, KCS-style, is working.  In fact, it’s hard to see a better quarter anywhere by a company not called “Netflix”, although Canadian Pacific, the other Class One rail with positive volumes in Q1 – making for an unusual railway one-two punch) will give it a try later today, FERDA.

 

So, does the great earnings performance matter? 

  • No – this argument would rely on the not bad argument that everything before the Coronavirus is “old news”.  After all, the C19 impact only began to show up mid-March (volumes down 2% that month; then off of a cliff (-21% April-to-date).  The company “withdrew previously provided….guidance (revenues, volume, OR & EPS)”.  And the shutdown of the auto industry has impacts across several commodities (notably auto parts in containers); coming will be the impact of lower oil prices (on CBR, sand, IM, etc) and of the demand destruction in general and specifically of the hottest commodity, refined products heading south into Mexico (units and revenues up 43% in Q1/20).  Cross-border business is now 53% of the total (including interlining) so I also worry about the Mexican government’s poor reaction to the C19 pandemic, and the impact on Mexican GDP, even if most of KCS’s related traffic is B2B.  The FX situation is also exacerbating the issues at Lazaro Cardenas.
  • Of course it does!  This is a clear demonstration of where KCS is heading absent the pandemic, and the direction they will resume when(ever) it is “over”.  Not just on the top line, as impressive as that was, but clearly on the expense side.  They are above FY goals on 3/5 KPIs (velocity – up 26% YOY, aided by teachers’ strike comparisons, as well as dwell and fuel efficiency) and close on the other two (train length and car miles/day).  There is room for more – they mentioned a focus on fuel efficiency (seemingly the hot topic in the PSR world in 2020), crew movements/planning, and reducing leased rolling stock and “limiting contractor spend”.

 

What can they do in the meantime?  A lot.  KSU management detailed their C19 safety initiatives. And, as they said in their earlier webcast, fully 60% of their expenses are variable/semi-variable; they have a terrific financial position and ample liquidity to weather this or (almost?) any storm.  Moreover, they have retained one level of crucial “guidance” – their ability to generate at least $500mm in free cash flow (FCF) through continuing PSR initiatives ( a hard yes on reaching $61mm in 2020 savings no matter the economy) and retooling 2020 Capex down to $450mm (with “optionality” on another ~$50mm).  They have modeled various scenarios including what I might call close to Doomsday, and are noticeably “rightsizing resources to volumes” (train starts/length//tonnage).  Perhaps best summed up by their {SR Czar Sameh Fahmy noting that the “economic downturn provides (a) breakthrough in (the) PSR ‘Journey’”.

 

Remember:

  • KSU is in great financial condition – ignore those “false prophets” who think that railroads face financial ruin – this along with their critical long-lasting assets is a source of strength, not fear! (see Tweet!)
  • The railway is in excellent (fluid) operating condition
  • They retain a great – maybe the freight industry’s best - growth opportunity which may even be enhanced by “nearshoring” Après la Guerre. 

 

Furthermore:

KSU answered questions on preparing for the eventual recovery (be still my heart!) and KCS’ ability to “flex up” by stating that their cost reductions were mostly coming from process not from “big reductions in force”, and close contacts with shippers (notably the auto industry).  This sudden burst of enlightenment form the Q part of the webcast Q&A was tempered by usual questions on share buybacks and another phrase so awful it requires instant exorcism (“detrimental margins”).

 

Now, ahora de kansas ciudad a Calgary/maintenant de Kansas City à Calgary!

Will CP’s earnings matter?  Yes, actually….Will the others’?

 

Anthony B. Hatch
abh consulting
www.abhatchconsulting.com
abh18@mindspring.com

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