Kansas City Southern's (KSU) most recent earnings results may have left some investors stunned. The company's fourth-quarter earnings were more than the past three quarters combined, and it wasn't as if the company was struggling in 2017. Of course, the headline numbers were a little too good to be true, but the railroad company's results were still impressive in their own right.
Let's dive into Kansas City Southern's most recent results as well as what investors can expect in 2018.
Image source: Getty Images.
By the numbers
| Metric | Q4 2017 | Q3 2017 | Q4 2016 |
|---|---|---|---|
| Revenue | $660 million | $656 million | $598 million |
| Operating income | $422 million | $233.8 million | $387 million |
| Earnings per share (diluted) | $5.33 | $1.23 | $1.21 |
| Free cash flow | $157 million | $112 million | $78 million |
Data source: Kansas City Southern earnings release.
Kansas City Southern's earnings per share result likely has investors euphoric, but it should also have investors a little curious. In a slow-growth business like railroads, a more-than-300% improvement in earnings per share isn't possible. This was all attributed to the changes to the U.S. tax code and some of the deferred tax liabilities on the company's books. With a lower corporate tax rate, the company's future tax obligations are about $480 million less than before. When combined with the taxes it has to pay on its fourth-quarter results, the company netted a $359 million income tax gain. One-time gains have been a recurring theme among the other railroad companies that have reported earnings thus far.
This shouldn't be the only story for Kansas City Southern's earnings, though, because these results were still admirable absent this one-time gain. Revenue was up 10% compared to this time last year as every business segment posted a year-over-year increase. The best-performing segment was its chemical and petroleum product segment, which benefited from increased shipments of refined petroleum products to Mexico.
Source: Kansas City Southern earnings release. Chart by author.
Even more impressive is that Kansas City Southern reported further improvements in costs and operational efficiency. In the fourth quarter, it reported an operating ratio -- operating expenses divided by revenue -- of 64%. The company was able to achieve this despite delays and other operational hiccups related to Hurricane Harvey in the U.S. and flooding in Mexico in the quarter. Sixty-four percent is by no means the best in the business, but it's encouraging to see the company improve its operating efficiency. These results all led to an adjusted earnings per share result of $1.38. So even if we don't count the tax gain, this was a good quarter for Kansas City Southern.
What management had to say
CEO Patrick Ottensmeyer was upbeat in the press release about the company's most recent results. He also hinted at 2018 being an even better year.
Despite the impact of Hurricane Harvey in the third quarter, strong topline performance, led by our Energy, Automotive and Chemical & Petroleum business units contributed to record full-year adjusted diluted earnings per share of $5.25, an increase of 17% over 2016. Looking ahead to 2018, we believe KCS is positioned to maintain its growth momentum driven by unique franchise opportunities, a strengthening economy and a focus on cost control. We expect to continue leveraging the investments made in our network to grow our business, ensure good customer service and maximize shareholder returns.
According to the company's forecast for 2018, there are a lot of factors working in its favor. Reforms to Mexico's energy sector and new petrochemical manufacturing facilities in the U.S. Gulf Coast should significantly boost its chemicals and petroleum business. The company also expects improvement in its intermodal and automotive segments. The one segment that could struggle is energy, as management anticipates lower volumes of coal shipments in Texas from lower demand and fewer deliveries of hydraulic fracturing sand because of new sand mines opening up close to demand centers in West Texas.
What a Fool believes
Investors have to be happy with Kansas City Southern's most recent results as well as some of the tailwinds benefiting the company in 2018. With so much manufacturing capacity coming on line on both sides of the U.S. and Mexican border, it seems as though increased cross-border traffic is extremely likely in the coming years. This bodes well for Kansas City Southern, as the railroad is inexorably tied to cross-border shipments between the U.S. and Mexico.
The big unknown, of course, is how the recent negotiations of NAFTA will impact its future business. Management has tried to show on previous occasions that much of the company's traffic falls outside the NAFTA agreement and that the business ties between the two nations are so high that it won't lead to a complete breakdown of trade. However, it's not hard to see how a tightening of trade rules could have a significant impact on the company's future.
