The market is beating up transport stocks - but that also creates opportunity

October 30, 2018

The market is beating up transport stocks – but that also creates opportunity

Back in July, I wrote about Kansas City Southern (KSU), a mid-cap railroad company that isn’t extremely well-known outside of its normal operating region. Transportation stocks were a good bet throughout the summer, but as fall set in, the market has pushed the Dow Transportation Average down a little over 14% since early September. For KSU, who is the smallest Class 1 railroad in the United States, that broader industry decline has translated to a decline in its price as of this writing of almost 18%. A big chunk of that loss has come since the beginning of October, as increasing uncertainty translates to price volatility that has weighed on practically every sector of the stock market. This is in the face of mostly positive earnings reports that continue to the economy is healthy and corporate profits remain solid even as tensions continue to mount over things like interest rates and trade.

The trade question just doesn’t seem to go away, and the truth, of course is that it isn’t likely to anytime soon – especially for as long as the Trump administration keeps putting pressure on China, who isn’t showing signs of capitulation or cooperation despite clear indications tariffs are starting to hurt their economy. So why pay attention to KSU right now, if the stock price is actually worse off now than it was a few months ago?

The company released its earnings report for the third quarter of the year a little over a week ago, and like so many other stocks during this earnings season, its results came in quite favorably – they demonstrated clear earnings and sales growth along with improving operating margins and debt management. What I like to think of as the stock’s intrinsic value is also better now than it was just a few months ago; combined with the stock’s current price, it only improves a value proposition that was already pretty compelling. Is the time right to take on a new position? Maybe not; bearish momentum is very high strong right now and is likely to keep putting pressure on the stock’s price for the time being. I do think, however that KSU is a stock to pay attention to; one politically-driven, and trade-related factor that most analysts seem to think will aid the company’s fortunes through the rest of the year, into 2019 and beyond is the recent agreement between the U.S., Canada and Mexico to renegotiate the three countries’ long-standing NAFTA agreement, which was arguably the first domino to fall in the favor of the United States and the Trump administration on the trade front. Keep in mind, too that management has reported consistent increases in cross-border volume between the U.S. and Mexico, and expects that trend to continue.



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 $10.1 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings  grew 16.3% while revenue growth was about 6.5%. 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 38% of revenues and nearly 25% for the last quarter. All of these metrics – earnings growth, sales growth, and operating margins – improved over the last quarter.
  • Free Cash Flow: KSU’s free cash flow is adequate, at a little over $375 million. This is a number that has increased steadily since late 2015, when it was below 0, but did decline from the first quarter of 2018 off of a high at more than $450 million.
  • Debt to Equity: KSU has a debt/equity ratio of .53. 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 1.45% 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 $50 and translates to a Price/Book ratio of 1.98 at the stock’s current price. Their historical average Price/Book ratio is 2.98, which continues to provide a strong basis for significant 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 at around $149 per share. That would mark a new all-time high that in my opinion isn’t likely to be reachable for as long as the stock’s current bearish momentum persists, but still offers compelling upside over the long-term.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The stock’s rally in mid-July drove the stock from around $105 to $120 per share, an increase of about 14% over that span; however since early September the stock has been dropping to new 52-week lows. Is it in freefall? Maybe, at least on a temporary basis; the stock’s next most likely support, based on previous price pivots is in the $92 to $93 level. That is a reason to be cautious and conservative about thinking about short-term trades on this stock; but any continued decline, given the company’s underlying fundamental strength is only going to improve its overall value proposition.
  • Near-term Keys: If your preference is to work with a short-term trade, the best probabilities right now are obviously on the bearish side, either by shorting the stock or buying put options. Given the slope of the stock’s decline over the last month, which points to extreme bearish sentiment and momentum, a bullish short-term trade  right now is highly speculative. If you want to take a value-based approach, the stock has on outstanding value proposition right now, that is only getting better; but the smart approach right now is to wait to see the stock show signs of stabilization before trying to initiate even a long-term trade.