Drip Portfolio Report
Thursday, October 9, 1997
by Randy Befumo (TMF [email protected])

ALEXANDRIA, VA (Oct. 9, 1997) -- Before Jeff started to jam on healthcare for umpteen days, we were going to take a good, hard look at KANSAS CITY SOUTHERN (NYSE: KSU). Specifically, the railroad side of the house. On September 19th, September 22nd and September 23rd we took a look at Kansas City Southern and determined the trailing revenues, operating income and earnings before interest, taxes, depreciation and amortization (EBITDA). Over the next few days, we will advance this analysis.

Since Kansas City Southern is both a railroad and an asset management company, we determined that to value the company we would have to value the railroad and asset management company separately. Patiently teasing these numbers out of Kansas City Southern's financial statements, we are ready to take the first major step toward doing this -- determining what the financials of Kansas City Southern Railroad (KCSR) have been over the last twelve months. 

Just to recap, here are the numbers we got:

12 Month Revenues             = $506.1 million
12 Month Operating Income     = $75.3 million 
12 Month EBITDA               = $132.2 million

The next step is to take these numbers and compare them with other "substantially similar" railroads. Although we will not necessarily get an exact match, it is important when doing a comparative valuation like this that you look for companies that are pretty close to the one you are valuing or the whole exercise is worthless. Although we certainly should not use comparative valuation as the only guide for the "fair" price of Kansas City Southern, it will help to put some boundaries on the analysis.

A lot of people out there did their homework, looking for companies that were "substantially similar" to KCSR. As a north-south railroad, one of the few other public companies that is substantially similar is ILLINOIS CENTRAL (NYSE: IC) --- which is the answer most came up with. Others suggested that WISCONSIN CENTRAL (NYSE: WCLX) might make a good comparison. With all the consolidation that has gone on, though, one reader wrote to me, the industry is down to a few heavyweights in either the east or the west -- there are not a lot of north-southers left. "AMcClymont" added that CSX (NYSE CSX) and NORFOLK SOUTHERN (NYSE: NSC) also look like they might qualify as "north-south" railroads, but their geographic coverage seemed to mesh less with KCSR than did Illinois Central and they also have significant operations beyond just railroads.

Although Illinois Central is the best fit, though, we have to be careful. Illinois has one of the best "operating ratios" in the industry (a measure of profitability) and the company gets a premium valuation for that. Its track is laid out in a very similar way as that of KCSR and they have roughly the same amount -- in ballpark figures. By finding out the valuation of Illinois Central and Wisconson Central, we can then apply a fair and reasonable valuation to the KCSR assets and be able to back this out of the Kansas City Southern value as a whole, allowing us to move on to the financial asset management business.

Illinois Central has 62.25 million shares outstanding currently. With the stock at $37 5/8, this means the company has a market capitalization of $2.34 billion, or $37.625 * 62.25. The company also has $599.0 million in long-term debt. As anyone who bought the whole enterprise would not only pay $2.34 billion for the stock, but assume the debt, the enterprise value of the company is $2.94 billion. With $679.2 million in revenues over the last twelve months according to the last two 10-Qs and the last 10-K (available at www.freeedgar.com), this means that Illinois Central is now trading at 4.3 times sales. Looking to the income statement on the last 10-Q, we can see operating income over the past six months was $127.7 million and $116.7 million in year ago period, an $11.0 million difference. This means that if we add $11.0 million to the operating income shown on the last 10-K, we have operating income for the last twelve months. In this case, it is $252.2 million. This shows that Illinois trades at 11.7 times operating income.

Finally, to figure EBITDA we simply add depreciation and amortization (D&A) to operating earnings. On the statement of cash flows last quarter, D&A was $20.8 million over the past six months versus $18.0 million last year, a difference of $2.8 million. We can just add this to the $39.3 million in D&A the company had for all of last year and find that D&A is $42.1 million. Simply adding this to the operating earnings, which are earnings before interest and taxes, we get $294.3 million. Taking the enterprise value and dividing it by the EBITDA of $294.3 million gives us an EBITDA multiple of 10.0. Rather than belabor the analysis, lemme say that for Wisconsin Central the price/sales is 6.21, the price/operating earnings is 27.3 and the price/cash flow is 22.3.

Tomorrow, we will discuss in detail how to use these comparitive valuations to figure out what the heck KCSR is worth. Be sure to be there, folks.

TODAY'S NUMBERS 

  
              Stock   Close   Change
              Intel   $94 5/8   +1/16        

            Day   Month Year  History
        Drip:    +0.00%   0.00%  0.00% 0.00%
        S&P:     +0.00%   0.00%  0.00% 0.00%
        NASDAQ:  +0.00%   0.00%  0.00% 0.00%


        Rec'd   #    Security         In At      
       9/8/97   1      Intel         $94.69      

                          
                        Base: $700.00
                    Expenses: $ 55.50 (Moneypaper)
                   Purchases: See above
                        Cash: $549.10
                 Total Value: $652.00 apprx.

The portfolio began with $500 on July 28, 1997, adds $100 on the 15th of every month, and the goal is to have $150,000 by August of the year 2017.