KSU:NYSE

The views expressed below are those of Anchor Capital Advisors, LLC (‘‘Anchor’’) as of the date written and are subject to change at any time. They are based on our proprietary research of the stated company and the following is a summary of the primary factors that support our beliefs and rationale for investing in the company. Please see additional disclosures at the end of this publication.

KSU:NYSE

Kansas City Southern is a railroad network with 6,700 route miles.[1] It serves 12 Gulf Ports, 1 Pacific Port, and 181 interchange ports.[2] KSU links Mexican trade with all Class I rails, offering a single connection from Mexico to all major US/Canadian markets. The company was founded in 1887.[3]

Investment Thesis

In our opinion, KSU should grow above the rail industry and the Mexican US corridor of trade. There is a runway for margin expansion to continue thanks to precision scheduling railroading, or PSR (which is explained in the footnote for those interested).[4] Additionally, we believe the company has room for growth, which has high incremental margins.

Confirmation through Research

It is our opinion that KSU benefits from the secular trends associated with e-commerce and decarbonization.[5] Railroads, such as KSU, compete with trucks for transporting volumes of goods. Trains are more energy efficient when compared to trucks, and states, like California, have begun taxing trucks for their emissions.[6] This tax leads trucks to cost more, which makes rails more competitive, and have even greater pricing power.[7] E-commerce has also led truck drivers to see large demand for short haul transportation, with less truck drivers willing to go long distance.[8] This will continue to lead long distance hauls to cost more over the long run (as not enough drivers will be willing to do it), which make rails in the long haul have less competition, and achieve additional pricing.[9] KSU has seen above industry growth thanks in large part to the fact that they have a large exposure of tracks associated with cross border trade with Mexico. [10] Since 2009, the company has grown revenue 7% and car loads 4%, which is above industry average.[11] That has been helped by the fact that cross border revenue from Mexico to the US is up 11% per year in that time.[12] Over the last 4 years, PSR has helped KSU bring margins up by over 400 bps.[13] We believe they will be able to bring those margins up another 500 bps over the next 5 years, based on similar comps long term goals such as Union Pacific.[14] Further, the company should see 50% to 70% incremental margins on revenue, even after PSR is done, thanks to volume growth and the rails fixed cost nature. [15] Between the 500 bps in margin expansion, and the mid-single digits growth, we see a potential path toward the business seeing a double in free cash flow and earnings per share over the next 5 to 6 years.[16] After that, we see the business continuing to grow mid-single digits, producing strong cash flow and EPS growth thanks to incremental margins and buybacks.[17]

Variant Perception

We do not believe the market is assigning fair value to the business considering the companies secular trends in energy efficiency/e-commerce, their above industry growth, potential for margin expansion, and their ability to double free cash flow and earnings over the next 5 to 6 years.