Is Kansas City Southern on Track to Stock Market Catastrophe?
Those who doubt that American stocks might be in a potentially catastrophic bubble need to take a look at the Kansas City Southern (NYSE: KSU). The railroad makes little money, yet its stock is dangerously overpriced.
Kansas City Southern (KSC) shares were trading at $104.94 on 21 November 2017, yet the railway reported revenues of just $2.521 billion and an income of only $539.90 million on September 30, 2017. To add insult to injury there was a free cash flow of $134.60 million at the end of third quarter 2017.
Investors did not get much for the $104.94 a share at the Kansas City Southern. There was a market capitalization of $10.87 billion and an enterprise value of $13.62 billion on 21 November and assets of $9.1 billion on 30 September 2017. Nor was there much money on hand, the railroad reported cash and short-term investments of $88.40 million and $943.40 million on 30 September.
The Opposite of a Value Investment
With little value and no float, the Kansas City Southern looks like the opposite of a value investment. It also seems to be the poster child for what’s wrong with the U.S. stock market right; overvalued, unsustainable dividends, and a stock price sustained only by market momentum.
Particularly problematic is the dividend at Kansas City Southern; a 36¢ cent payout is scheduled for 28 December 2017. That is actually an increase over the 33¢ paid out in June. That might be good for shareholders but not for the company because an obvious question comes to mind where is the Kansas City Southern getting the funds to pay the dividend?
The obvious answer is money that should be reinvested in the company to improve its operations. One reason why there’s no cash at the Kansas City Southern despite a reputed profit margin of 19.69% for 3rd Quarter 2017 is that management is using the cash to raise the dividend in an effort to jack up the share value.
This casts serious doubt on the 13.12% return on equity KSU stock provided on September 30, 2017. It also raises serious questions about Kansas City Southern’s sustainability as a publicly-held company.
Is Kansas City Southern Sustainable as a Company?
The sad part of this little drama is that Kansas City Southern is not necessarily a bad company. It owns a lot of pretty good railroad track including lines connecting the gateway to America’s rustbelt Kansas City, with the drug-gang infested Mexican port of Lazaro Cardenas, Michoacán.
More importantly, Kansas City Southern owns a transcontinental rail line with a direct connection to the industrial heartland of the United States. There’s also a direct link to the Canadian Pacific’s line to the West Coast, and lines to ports on the Gulf of Mexico. All this provides direct connections to several ports including Houston, New Orleans, Mobile, Lazaro Cardenas, Veracruz, and Ciudad Madero.
There’s also track running right through Mexico’s industrial heartland. All of those ports are assets given Mexico’s industrial growth and booming auto industry.
Will Berkshire Hathaway buy Kansas City Southern?
There is one investor for whom Kansas City Southern would be a smart buy; Warren Buffett. Adding the Kansas City Southern to the Burlington Northern Santa Fe (BNSF) owned by Berkshire Hathaway (NYSE: BRK.B) would make a lot of sense.
It would provide a direct connection between Mexican factories and BNSF’s lines to Chicago, Los Angeles, Portland, and Seattle. Since the BNSF and the Kansas City Southern already have an intermodal deal in place some of the ground is already in place. The deal allows seamless shipping of freight on both railroads’ tracks. The deal centers on 53-foot long intermodal containers that will interchange at Robstown, Texas, according to a press release.
One big advantage to a KSC acquisition would be to give the BNSF track in Mexico. Another would be to free the Kansas City Southern from paying that dividend. Since Buffett likes railroads, and the KSC is an unsexy but money making company it seems like a good fit for Berkshire Hathaway (NYSE: BRK.A).
The Kansas City Southern would be a bargain for Berkshire even at the current share price because the enterprise value is low, just $13.62 billion on November 21, 2017. Nor would buying it have much effect on Berkshire that company reported cash and short-term investments of $109.30 billion on September 30, 2017.
There are other high profile investors that might consider buying the KSC including Buffett’s bridge buddy Bill Gates. Gates already owns a big piece of the Canadian National (NYSE: CNI) and he has plenty of extra cash lying around.
The Kansas City Southern would be a shrewd purchase for a big-time value investor like Gates or Buffett. It would be a lousy investment for the average person. Stay away from this stock unless you plan to short it. Expect the Kansas City Southern to survive, and get acquired real soon.