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Throughout the year, transportation stocks have mostly lagged the rest of the market. There are multiple reasons that just about anybody could point to – increasing fuel costs, broad-based market uncertainty and volatility related to questions about the economy’s health and rising interest rates, and certainly questions about ongoing trade tensions – but the truth is that investing in this segment this year has translated to some tough sledding. Interestingly enough, however it looks like this is a sector that is starting to move into favor. The Dow Transportation Average is up almost 2% since last Friday, and almost 5% after rebounding off of support from its 200-day moving average line earlier last week. That momentum has given a nice push to a lot of well-known, large transportation names like Union Pacific (UNP) and CSX (CSX). If this momentum holds, those stocks could keep pushing to new all-time highs, but my bet is on the smallest Class 1 railroad in the United States. I think Kansas City Southern (KSU) is a stock you should be paying attention to.
Trade tensions between the U.S. and its allies are a concern, and the truth is that KSU is exposed to a significant amount of trade war risk, since the railroad focuses on the north/south freight corridor that connects the central and southern areas of the United States with northern Mexico. NAFTA-related concerns have mostly taken a back seat in the national narrative about trade, as tariffs against China and the European Union have dominated headlines; but the fact is that the same kinds of questions exist for the U.S. with Canada and with Mexico. In KSU’s most recent quarterly report, however, management reported a 19% increase year-over-year in cross-border volumes.
Management seems to believe that trend will continue, as their CEO stated on the earnings call that he expects volume growth to continue through 2019. Yesterday President Trump announced an agreement with the European Union to halt further tariffs on each other, and to work on reducing existing tariffs – including those on steel and aluminum – and increase trade on U.S. goods like soybeans and liquified natural gas. That news didn’t include Mexico, or relate directly to questions about NAFTA, of course, but the idea that the U.S. is going back to the negotiating table with the E.U., rather than continuing to escalate trade tensions, seems to be giving the market at large some hope it will do the same for its other trading partners. That is a dynamic that I think will continue to provide some uncertainty and volatility to stocks like KSU for the time being, but more positive trade developments could also add an extra boost of bullish enthusiasm to the stock’s price activity.
Fundamental and Value Profile
Kansas City Southern (KCS) is a holding company. The Company has domestic and international rail operations in North America that are focused on the north/south freight corridor connecting commercial and industrial markets in the central United States with industrial cities in Mexico. The Company’s subsidiaries include The Kansas City Southern Railway Company (KCSR) and Kansas City Southern de Mexico, S.A. de C.V. (KCSM). KCSR serves a 10-state region in the midwest and southeast regions of the United States and has the north/south rail route between Kansas City, Missouri and various ports along the Gulf of Mexico in Alabama, Louisiana, Mississippi and Texas. KCSM operates a corridor of the Mexican railroad system. KCSM’s rail lines provide rail access to the United States and Mexico border crossing at Nuevo Laredo, Tamaulipas. KCSM also provides rail access to the Port of Lazaro Cardenas on the Pacific Ocean. KSU’s current market cap is $11.9 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew almost 16% while revenue growth great about 4%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize business operations. The company also operates with healthy operating margins, since Net Income for the past year was 36% of revenues and almost 22% for the last quarter.
- Free Cash Flow: KSU’s free cash flow is healthy, at almost $455 million. This is a number that has increased steadily since late 2015, when it was below 0.
- Debt to Equity: KSU has a debt/equity ratio of .54. Their balance sheet indicates their operating profits are more than sufficient to service their debt.
- Dividend: KSU pays an annual dividend of $1.44 per share, which translates to a yield of about 1.24% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KSU is $48.85 and translates to a Price/Book ratio of 2.37 at the stock’s current price. Their historical average Price/Book ratio is 2.98, which to provides a strong basis for continued long-term upside for this stock, since a break above its 52-week high makes it difficult to forecast new resistance levels. A move to par with its historical average would put the stock above $144 per share. That would mark a new all-time high, but given the company’s overall strength and the momentum the sector appears to be drawing right now, it also looks like a reachable long-term target price.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: It’s pretty easy to see what the broader momentum and interest in the transportation sector has done for KSU over the last several days; the stock bounced off of range support last week, and used that bullish momentum to break above range resistance around $113 this morning. Swing and momentum traders like to see this kind of break, since it can act as a very good signal for a short-term trade.
- Near-term Keys: If your prefer is to work with a short-term trade, this could be a very good signal to buy the stock or to work with call options. The stock’s all-time high was reached in late 2013 at around $124 per share, and so that price level could provide a good target point to exit a swing or momentum trade. If you’re willing to take a longer-term view, however, buying the stock gives you the opportunity to draw its dividend and hopefully take advantage of a value-based opportunity that offers nearly 25% upside potential. Risks to either kind of a trade – short or long-term – are related primarily to lingering trade questions. It isn’t a given that yesterday’s positive news with the E.U. will carry over to Mexico or NAFTA concerns, and that means that you have to be willing to accept some price volatility if you decide to take a position in this stock. Also, if the stock starts to lose bullish momentum and drop back down, watch the $104 price level. A drop below that price would mark an important break below range support and could force the stock into an extended downward trend.