Rail Reflections Part 2 - KSU PLUS a slight rant walk-back

1200Px Kansas City South Lines Logo.Svg

Greetings;


Rant mea sorta culpa: I did blast the statement that rail reg/re-reg was partisans (ie; Dems bad – for
rails) and I stand by it. In analyst/investor parlance, “rail regulation” has to do with issues and conflicts
with (often quite large) shippers and rails over market power (price/service/access/”revenue adequacy”
and the like….and that (Big Shipper or Industry vs Big Rail) is simply not partisan. Nor will the incoming
Chairman, Mr. Oberman (D) be any more skeptical about PSR nor more interventionist than however, I
have gotten some pushback from friends and contacts in DC who note that in other types of rail
regulation under the broad rubric of safety things could get somewhat complicated, and the Dems’
historic connections to organized labor (if not what it was) means that interpretations of what is safe
could lead to operating challenges from the FRA (on CBR, say – which could also be impacted by green
interests, or train length even). And Amtrak could gain more power over the Class Ones whose track the
mostly run on in discussions about service windows, “blocked crossings” and the like….
Two great appointments to shout out:

  • Dean Piacente, ex-CSX, has taken the top job at the short line holding company Omnitrax (as
    Kevin “Shotgun” Shuba was promoted up into the Broe Group); his merchandise experience
    makes this a star pick.
  • And speaking of the FRA, probably its most beloved (and accomplished) Administrator ever, has
    joined the board at another SLHC, RJ Corman.


Kansas City Southern regains its “Hard Luck” crown but once again, perseveres ….and it’s not just the
Chiefs (sorry guys). Observers may forget that KCS (or, by symbol, KSU) over its modern history seemed
to be periodically beset by bad luck all the time, from partners (in Mexico) who turned out to be lousy
and litigious to FX fluctuations to arbitrary taxes or government reviews (also south of the border) to a 2
year battle to re-write NAFTA into (for rails, anyway) the same thing now called “USMCA”. And the
latter was north of the border. But in 2019, then they passed that pinball crown to CN. Well, by the end
of 2020 they had seized it back….Yes, everyone saw the impacts of the pandemic but at KSU they added
in:

  • Rather, um, arbitrary leadership of both of the countries that they operate in, with 2 of the top
    5 worst pandemic impacts globally.

    • When AMLO announced that he – too – had Covid-19, the NYT commented that “it is
      undeniable that he has presided over one of the worst outbreak responses anywhere in
      the world”
    • AMLO’s attempt to steamroll the economy with his nationalism took a setback when the
      Supreme Court of Mexico ruled that giving priority to the state-owned utilities over
      private companies were unconstitutional – nonetheless AMLO’s support of Pemex,
      unbound by economic or business considerations, remains a threat to KCS.

  • Rail-line blockades by groups uninterested in the railroad or its issues – as with CN in ’19, but in
    this case teachers blocking lines by the Port of Lazaro Cardenas – this cost a full point on the OR
    and over 5 points on volume and revenue growth
  • “elevated casualty expense” cost the OR 160bps – not sure whether to give them a pass here; in
    fact 3 of the first three that reported showed some form of this….
  • A write-off of software development costs – repeated efforts to understand this better met the
    Heisman stiff-arm; given the importance of technology development to the rails’ future, and
    KSU’s recent forward-thinking in this space, it’s at a minimum curious. KSU management didn’t
    discuss it much on the webcast (although they said it was ~7% of their CAPEX spend – or about
    $50mm – and implied that they would hold to that despite PTC being in their rear-
    view). Perhaps we can earn more when Chief Innovation Officer Brian Hancock keynotes the
    Progressive Railroading magazines’ rail tech webcast on February 17….
  • New bad phrase – “guardrails” (don’t ask….)


Nonetheless, KSU still improved its YOY OR by 220 bps to 60.2% (adj, of course) and EPS by 4% (ditto),
though a penny or so below consensus. Despite the 59-day blockade and the derailment they improved
in 8/10 operating KPIs shown and generated $96mm in productivity savings from what they term PSR
Phase Two in 2020. Led by the irrepressible Sameh Fahmy, Chief PSR Officer, they are still stepping their
foot to the peddle. Phase Three, this year, is about pivoting to growth yet they still anticipate in $50mm
in productivity. In Q4/20 they reduced crew starts 14% on the 3% decline in volumes – crew starts are a
key lever especially south of the border given the work rules. ESG got it's by now usual charge, and
covered all three letters but highlighted the success – and opportunity remaining – in fuel efficiency,
more difficult in their tougher grade Mexican side (and still a tactical, time-limited opportunity).

Fighting with the army you have: On the marketing side, it was hard to fully parse the results but for sure
the presentation helped. Intermodal volume declined 4% and revenues by fully a fifth – but ex-Lazaro
(whose IM numbers fell by 88%! - those numbers were +11% and +3%. Chemicals and Petroleum, a
critical driver for KCS, grew 18%/15%, helped by the 87% increase in refined products. What they label
as “Mexico Energy Reform Volumes” jumped 65%. Cross border revenue, the crux of the KCS case, grew
17% (IM by 11%).


And boy, howdy! KSU restored guidance:

  • Double-digit revenue growth in 2021
  • OR improves to “~57.5%” in ’21 and 55-56% in ‘22
  • EPS jumps to $9+ (2021G) and $10.50-11 (‘22G) from $6.96
  • Capex ~17% of revenues, leaving FCF at $700mm for ‘21G – and also ‘22G (and they also just
    increased their DPS by just under 25%)


They expressed their confidence that they had weathered their storms (some literal) and were stronger
for it. We haven’t seen much hard evidence of near-shoring but perhaps with a new administration, they
will….It will also be interesting to see how the massive changes roiling the auto industry shakeout in
Mexico. True, they did leave some questions open (technology but we get that next bite at that apple in
2 weeks) and safety, but if 2021 is the year they shed the “hard luck” label it will be an excellent new
base year for their growth plan. To my mind they are persevering against things they can control,
thanks to an excellent PSR rollout amongst other things, leaving only the things that they cannot, and in
’21 there are certainly fewer of those (their biggest wildcard resides in the Presidential Palace).

Finally:

  • Not our fault! In the 2/1 Journal of Commerce report on the “Sustained Import Surge and Labor
    Shortages (that) Worsen LA/LB Congestion”, you will not see the word “railroad” at all….
  • Another Mea-Sorta-Culpa: More evidence about why the railroad “moat” that is their self-financed network/infrastructure is so important comes from the Senate confirmation of DOT
    Secretary Buttigieg (from the NYT): At his hearing, he entered into politically fraught
    territory by not immediately ruling out an increase in the nation’s gas tax to refill the
    dwindling pot of money for highway improvements, saying that “all options need to be
    on the table.” After the hearing, a spokesman said Mr. Buttigieg opposed increasing the
    tax.

 

 

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com 
abh18@mindspring.com 
Twitter @ABHatch18