Fitch Affirms Kansas City Southern at 'BBB-'; Outlook Positive
KCS's investment grade rating is supported by the company's solid operating margins, moderate leverage and ample financial flexibility. Fitch considers KCS to be an improving credit story based on the prospects of higher margin generation, continued growth out of Mexico and improving free cash flow (FCF). Fitch may upgrade the ratings to 'BBB' as KCS makes progress towards its goal of reaching a low 60% range operating ratio, as freight volumes rebound from weakness experienced this year, and as prospects for FCF improve.
KEY RATING DRIVERS
Near-term Revenue Weakness but Long-term Growth Prospects Remain Healthy:
Fitch expects total revenues for 2015 to be down in the low to mid-single digits after declining by 5.4% through the first half of the year. F/X and lower fuel surcharges are the primary driver, but volumes have also been weak, led by declining utility coal and metals shipments. Low natural gas prices are pressuring demand from coal fired power plants while crude oil prices have led to lower demand for steel utilized in fracking and for frac sand.
Beyond 2015, revenue is expected to trend positive as longer-term growth trends prevail (cross-border intermodal, port of Lazaro Cardenas, automotive). Concerns over top line weakness are partially offset by the company's continued strong margin generation. Also note that nearly the entire revenue decline is based on weaker fuel surcharges related to lower oil prices and by the impacts of a weak Mexican Peso. Lower surcharges are offset by lower fuel costs, and the weak peso is offset by lower peso denominated costs. Both impacts are largely margin neutral.
Debt Funding for Share Repurchases Contributing to Marginally Higher than Anticipated Leverage:
Fitch expects incremental debt raised to fund share repurchases to increase debt/EBITDAR by around 0.2x-0.3x by year end (YE) to roughly 2.6x. In our previous review, Fitch had forecast that leverage would decline slightly to around 2.4x by YE 2015 and decline incrementally thereafter. Fitch still considers leverage at this level to be appropriate for the current rating. Though the debt funded repurchases are a consideration in delaying a potential ratings upgrade to 'BBB'.
The company announced the \\$500 million repurchase program in May. KCS then issued \\$500 million in unsecured notes in July, around \\$290 million of which was used to pay off outstanding commercial paper with the remainder available for general corporate purposes and share repurchases.
Fitch expects that KCS will be able to fund the bulk of its repurchases in 2016-2017 with internally generated cash, but incremental borrowing remains a possibility. Should leverage rise and be sustained in the 2.75x-3.0x range as a result of shareholder friendly actions it could put pressure on the ratings. However, KCS has publicly stated that it is committed to maintaining its investment grade ratings and Fitch expects the company to manage its share repurchases accordingly.
Strong Operating Margins:
Despite recent revenue pressures, KCS's operating margins continue to improve. Kansas City Southern's operating margins have increased every year since 2006, and Fitch believes that the company has opportunities incrementally expand margins further. KCS has recently laid out a target to reduce its operating ratio to the low 60% range by 2017, which would represent several hundred basis points of improvement from current levels. Fitch views this target as achievable given the company's track record in recent years.
The company is benefiting from its ongoing program of purchasing equipment off of operating leases. Through the first six months of the year, KCS spent \\$61.3 million to purchase equipment off of lease. Margins also benefit from investments in rail infrastructure and from managing headcount. KCS's EBITDA margin in the latest 12 months (LTM) period ended June 30, 2015 was 43.9%, up slightly from 42.2% for the comparable period a year ago. KCS's adjusted operating ratio, which is a key metric observed in the rail industry, was 68.1% in the first quarter of 2015, which is comparable to or better than some of KCS's larger competitors.
Solid Financial Flexibility but Limited FCF:
The company maintains solid financial flexibility through its cash on hand as well as availability under its two commercial paper programs which total \\$650 million. Total liquidity was \\$409 million at the end of the second quarter. Cash on hand totaled \\$50.9 million plus \\$158 million in availability under KCSR's \\$450 million commercial paper (CP) program and the full \\$200 million available under KCSM's CP program. All of the outstanding CP at June 30 was paid down with the proceeds from the recent \\$500 million unsecured issuance. Upcoming debt maturities are manageable. The company has no significant maturities until KCSM's \\$250 million floating rate notes mature in October of 2016.
KSU consistently generates significant cash flow from operations but Fitch expects FCF to be limited in the intermediate term due to relatively heavy capital spending, increasing cash taxes and the potential for future increases to the dividend. KSU's capital spending through the LTM ended June 30, 2015 totaled \\$830 million or 33% of the company's LTM revenue, which represents a capital intensity ratio that is notably higher than most other rail companies. Excluding KSU's purchase of equipment off of operating leases capex totaled 29% of LTM revenue, which is still higher than the industry average.
Continued growth opportunities will likely keep total capital spending relatively high in the intermediate term. Examples include the company's recent agreement with the chemicals company Sasol to build a new rail yard to support a new ethane cracker facility. KSU will spend around \\$50 million-\\$75 million a year for the next two to three years constructing the facility which it will then operate under a long-term lease. Other growth capex will be focused on things like capacity expansion and additional sidings that will allow for more trains and more efficient operations on KSU's network. The company has indicated that total capital spending for 2015 (excluding purchases of leased equipment) is expected to equal \\$650 million-\\$670 million or roughly 27% of revenue. Over the longer term, capital spending as a percent of revenue may decline into the low 20% range, at which point Fitch would expect KSU to be solidly FCF positive. Sustained positive FCF, in the low single digits or higher as a percentage of revenue, could contribute to a positive ratings action.
Stable Credit Metrics:
Fitch expects KSU's total adjusted debt/EBITDAR to remain around 2.5x over the next one to two years. Fitch considers leverage at this level to be solid for the current rating and could consider a ratings upgrade if leverage were to be sustained below the 2.5x level (among other factors). KSU's leverage is down from as high as 5.2x at YE 2009. Coverage ratios have also improved in recent years. As of June 30, 2015, funds from operations (FFO) fixed charge coverage stood at 7.0x and FFO interest coverage was more than 13x both of which are supportive of the ratings.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Kansas City Southern include:
--Continued moderate economic growth in the U.S. and Mexico;
--Low-to-mid-single digit revenue decline in 2015 followed by modest growth thereafter;
--Operating margins expanding incrementally over the intermediate term;
--Adjusted debt levels remaining roughly flat through the forecast period;
--Modest annual increases in the dividend.
RATING SENSITIVITIES
Future actions that may individually or collectively cause Fitch to take a positive rating action include:
--Total adjusted debt/EBITDAR sustained below 2.5x;
--Sustained FCF margin in the low to mid-single digits;
--Execution on KSU's goal of reaching a low 60% range operating ratio.
A negative rating action is not expected at this time. However, a downgrade could be precipitated by more aggressive, debt funded share repurchases causing debt/EBITDAR to be sustained above the 2.75x-3.0x range. Ratings pressure could also be caused by a severe drop off in demand for cargo flowing between the U.S. and Mexico. EBITDAR margins falling towards or below the 40% range, and sustained negative free cash flows could also lead to a negative ratings action.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Kansas City Southern
--Issuer Default Rating (IDR) at 'BBB-'.
Kansas City Southern Railway Co.
--IDR at 'BBB-';
--Short-term IDR at 'F3';
--CP at 'F3'
--Senior unsecured bank facility at 'BBB-';
--Senior unsecured notes at 'BBB-'.
Kansas City Southern de Mexico
--Foreign currency IDR at 'BBB-';
--Local currency IDR at 'BBB-';
--Short-term IDR at 'F3';
--CP at 'F3';
--Senior unsecured notes at 'BBB-'.
The Rating Outlook is Positive
Комментарии