The broad market’s activity since the beginning of October has put a lot of investors on edge. The major market indices all dropped back near to the 52-week lows they set earlier this year and marked a second drop into legitimate correction territory for the year. That has been increasing concern and speculation that the economy and the market could finally be set to turn over and give up the ghost on the longest bull run in recorded history in the United States. While the market’s decline and uptick in market volatility over the last two months is a sign of increasing risk that should make you more cautious about jumping into new positions quickly, and conservative about how much of your investing capital you should have in the market right now, or in any one position, the flip side of current market conditions is that there is also increased opportunity amid signs the end may not be as inevitable, or immediate as we might be tempted to believe.
Dow Theory is a concept that has bee around for more than a hundred years. To some, that might suggest that it’s an old, antiquated idea that doesn’t have a place in an economy and a marketplace that is worlds different than a century ago. Here’s the thing, though, about a lot of “old” theories you still hear analysts and market wags talk about: the get old not just only because of the passage of time, but also because the ideas that they are based tend to hold up over time. Dow Theory is one of those ideas that is still around because no matter how much we talk about how technology changes things, or how the market evolves to newer and better ideas, the truth is that the economic segments that Dow Theory is based on – Transports and Industrials still make up the sectors that a massive number of other sectors and industries are built on.
The Transportation sector is an interesting example of what I mean. As measured by the S&P Transportation SPDR ETF (XTN), the sector hit its 52-week high point in early September and had already begun retracing before the broader market started its slide at the beginning of October. Transports led the market lower, with XTN correcting about 18.8% – just shy of actual bear market territory – by the last week in October. From that point, the sector has again led the broader higher, rebounding almost 12% since its late October low point, while the S&P 500, the Dow, and the NASDAQ all began staging their own rallies off of correction-level support through this week. If the market manages to sustain yet another rally, Transportation stocks could be some of the best places to pay attention to. Kansas City Southern (KSU) is a smaller player in the sector amongst large-cap stocks like Union Pacific (UNP) and CSX Corp (CSX), but they are also a company with a very interesting fundamental profile, along with a strong value proposition.
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 $10.3 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew 16.3% while revenue growth grew almost 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 very healthy operating margins, since Net Income for the past year was nearly 38% of revenues and 25% for the last quarter.
- Free Cash Flow: KSU’s free cash flow is modest but adequate, at a little over $375 million. This is a number that is significantly higher than its low in late 2015, when it was below 0; but it has decreased in the last two quarters from a high above $455 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. Liquidity could be an issue if operating profits begin to deteriorate, since the company only has about $107 million in cash and liquid assets against about $2.6 billion in long-term debt.
- Dividend: KSU pays an annual dividend of $1.44 per share, which translates to a yield of about 1.4% 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. That number increased more than a dollar in the last quarter and translates to a Price/Book ratio of 2.04 at the stock’s current price. Their historical average Price/Book ratio is 2.98, which provides a strong basis for continued long-term upside for the stock. A move to par with its historical average would put the stock above $149 per share. That would mark a new all-time high, but given the company’s overall strength, it does offer a very attractive target that is nearly 32% above the stock’s current price.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The stock’s decline from a fresh 52-week high around $120 at the sector’s peak in early September to is decline to a new 52-week low around $97 is hard to miss. I’ve drawn horizontal lines on the chart above to emphasize where I think the stock’s most important support and resistance level lie right now. The stock is sitting just about at the halfway point right now between its immediate support and resistance levels. Resistance at $105 (red line) marks the level the stock would have to break above to stage a legitimate reversal of its current downward trend, while a drop below $99 (green line) would increase the likelihood the stock will extend that trend into an intermediate time frame. The yellow line at $112 and the purple line at $120 point to intermediate and long-term technical targets in the event of a break above $105 to stage a new upward trend. A drop below $97 would confirm that extension and offer a signal that downside risk remains very high.
- Near-term Keys: Short-term signals for the stock don’t really offer good signals right now for either a bullish or bearish momentum-based trade. A break above $105 could offer a nice bullish opportunity for a momentum or swing trade with call options, or buying the stock outright, with a nice intermediate-term target in the $112 range. The only really useful bearish signal, for shorting the stock or working with put options, would come if the stock breaks below $97, since that would signify a break to a new 52-week low and would signal significantly more downside risk than the chart above demonstrates. The long-term potential remains very attractive at the stock’s current price, however, which means that KSU is a stock value-oriented investors would be smart to keep paying attention to.