A revenue decline in all but one commodity group, including a precipitous drop in energy revenue, resulted in a difficult second-quarter 2105 for Kansas City Southern, the railroad reported on June 17, 2014.
Revenue of $586 million was a decrease of 10% compared to second-quarter 2014. Adjusted operating income was $187 million, which, excluding lease termination costs in 2014, was 13% lower than a year ago. The operating ratio was 68.1%, compared with 68.3% in second quarter 2014, but excluding lease termination costs in 2014, the adjusted operating ratio was 69.4%. Adjusted diluted earnings per share were $1.035, a 15% decrease.
Net income in second-quarter 2015 totaled $112 million, or $1.01 per diluted share, compared with $130 million, or $1.18 per diluted share, in 2014, a 14% drop, but still slightly ahead of Wall Street estimates. Excluding the impacts of foreign exchange rate fluctuations and lease termination costs, adjusted diluted EPS for second-quarter 2015 was $1.03, compared to $1.21 in 2014, a 15% decline.
Overall, KCS’s carload volumes were 6% lower than in second-quarter 2014. Excluding the estimated impacts of lower U.S. fuel prices and Mexican peso depreciation, revenue declined 2% compared to the prior-year period.
Revenue declined in all commodity groups except Chemicals & Petroleum, which grew 1%. Energy revenue declined 46%, driven by lower volumes in utility coal due to lower natural gas prices and in frac sand volumes as a result of the significant decline in U.S. drilling operations.
Operating expenses in the second quarter were $399 million, 8% lower than 2014 when excluding lease termination costs in 2014. Excluding the estimated impacts of lower U.S. fuel prices and Mexican peso depreciation, operating expenses declined 1% compared to 2014, when excluding that year’s lease termination costs.
“KCS continued to scale its operations in both the U.S. and Mexico and has made strides in improving its network fluidity,” stated KCS CEO David L. Starling. “Our actions contributed to the company attaining a solid second-quarter operating ratio despite volume challenges, particularly in its Energy commodity group. We expect our system performance and operating metrics to continue to improve throughout the remainder of the year. As evidenced in the weekly industry carload data, there are still uncertainties in many of the primary markets served by rail. However, KCS’s average daily volumes increased each month throughout the second quarter, and the initial results from the first few weeks of July suggest the positive trend may be continuing.”
Cowen and Company Managing Director and Railway Age</> Wall Street Contributing Editor Jason Seidl sees the silver lining in what appears on the surface to be KCS’s dark clouds, citing “rays of light breaking through.”
“KCS’s slight EPS beat was aided by below-the-operating-line items, but second-half 2015 should see a notable sequential improvement, as pricing gains momentum and a number of commodities should see improved traffic levels,” said Seidl. “We are encouraged by management’s optimism, particularly on the pricing side.”
“Excluding the impact of currency translations and lower U.S. fuel prices, revenue was roughly 2.0% below last year,” noted Seidl. “The adjusted operating ratio (OR) deteriorated 110 basis points year over year—10 basis points worse than the implied consensus OR, but 100 basis points better than our assumption. The y/y deterioration was partly attributable to service issues in the Mexico cross-border business, which negatively affected volumes and productivity and was primarily due to what management admitted was under-hiring.”
“The second half should see a notable sequential improvement,” said Seidl. “Coal outages in this year’s first half and easier comparisons should pave the way for better coal traffic results. The first quarter’s tough grain comps should improve in the second half. Crude oil shipments have already seen a notable improvement in the third quarter, partly as a result of the opening of a rail origination terminal and completion of some rail facilities. Mexico cross-border businesses should benefit from increased equipment and a hiring plan (250 employees, 25% hired and in service, 50% hired and in training, and 25% in fourth-quarter 2015 for attrition and growth). The company anticipates it will regain much of the business it lost to other railroads due the Mexico service issues. Pricing was the most decisively positive aspect, and management fully expects the strength to continue and even gain more momentum. Both same-store sales and contract renewals increased in the mid-single-digit range (largely in line with our 2Q15 Rail Shipper Survey), and both posted sequential increases from the prior quarter.
Seidl said that Cowen and Company is raising its 2015 and 2016 EPS estimates to $4.55 and $5.25, from $4.50 and $5.15, respectively, “to reflect the 2Q15 beat and improved outlook. Our price target rises from $98 to $100, based on the same 19x multiple and our new 2016 EPS estimate. KCS continues to have excellent long-term growth prospects, in our opinion, but despite the recent improvement in outlook, there is still enough uncertainty to keep us on the sidelines for now. For the sector as a whole, we believe most investors did not have high expectations from the quarterly results but hoped the carriers would speak of some improvement going forward, something that has thus far materialized in commentary by CSX and KCS.”