An 11% jump on Monday was enough to make shares of Kansas City Southern (
NYSE: KSU) among the best performing of US equities. The catalyst for the move, which sent shares of KSU to all time highs, was the news
over the weekend that Canadian Pacific Railway (
NYSE:CP) is set to buy them for $25 billion.
While still awaiting final approval from the US Surface Transportation Board, Kansas City Southern shareholders were surely popping bottles on Saturday night. For all that though, more than a few eyebrows have been raised at the $25 billion valuation, which is at a significant premium to KSU’s pre-news market cap of $20 billion. Their Q4 earnings from the end of January had revenue falling 5% on the year while both top line and bottom line numbers missed analyst expectations. Can a railway company, arguably one of the more archaic industries still publicly traded and with revenue contracting, really be worth that much?
Signs Were There
For the bulls the answer is yes, and they’ll point to the plethora of reasons that have made getting long Kansas City Southern a good idea in recent months. For example, US rail traffic finished 2020 at close to pre-pandemic levels, a metric that no doubt played a significant role in Kansas Southern’s 30% end-of-year rally. BMO had pointed out the opportunity when they upgraded the stock to Outperform, noting at the time that "the implementation of precision scheduled railroading enables growth at very low incremental cost, supporting margin expansion and above-average EPS growth in the coming years, as well as improved cash conversion and an expanding ROIC."
As that rally was getting started in November, management saw fit to increase the company’s dividend, one of the most compelling and bullish signals they can offer investors. In the same breath, they announced a fresh $3 billion share repurchase program, suggesting they considered the existing share price to be trading well below fair value. They followed this up in February with another dividend raise, giving investors on the sidelines even more of a reason to get involved.
Getting Involved
As Saturday’s big news continues to be digested, the initial sentiment is mostly positive. JPMorgan believes Canadian Pacific is the best positioned of the major railways to squeeze the most synergy out of a Kansas Southern acquisition. They “remain constructive on Canadian Pacific and the long term potential synergies of the deal, which are muted in the near term by the purchase price paid and the regulatory uncertainty.”
Loop Capital Markets upgraded Canadian Pacific stock to a Buy on the news, which carries a bit of weight considering their stock fell 5% during Monday’s session. It remains to be seen how much a stellar success Canadian Pacific can make of the combination, but for investors who want to steer clear of tech stocks for now, there are worse places to park some cash than in a safely defensive industry.
Kansas Southern shares pulled from their daily highs into yesterday’s close so watch for an entry as shares are still well below where Canadian has valued them. Tt may take a few sessions for the news to be fully considered, and so similarly any further weakness in Canadian’s stock could also be considered attractive.
We’re looking at a combination of two of the continent’s leading railway companies, who were both trading at all-time highs before the news and are still likely to continue trading up thereafter it as well.
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