Kansas City Southern covered wagons - 31 Oct 2007 Randy Guttery.

14 May 2013

CN Rail and CP Rail Should Consider Buying Kansas City Southern - Analyst

Toronto Ontario - Both Canadian National Railway Co. and Canadian Pacific Railway Ltd. should consider buying Kansas City Southern, the largest railroad in Mexico, according to Desjardins Securities analyst Benoit Poirier.
 
He thinks a potential acquisition could be on the Canadian railroads' radar screens and outlined the rationale for such a transaction, assuming a final offer price of US$131 per share (a 17 percent premium) for Kansas City Southern.
 
In fact, Mr. Poirier thinks a deal could create $17 per share in value for CN and $15 per share for CP.
 
So while the analyst has no evidence to suggest an acquisition is imminent, or even likely, he believes the timing is right given the competitive landscape and the recent changes for CP's management team.
 
"In view of CN's and CP's strong balance sheets entering 2013 as well as the ample growth opportunity and positive market dynamics in Mexico, we believe both companies have a significant opportunity to create shareholder value by gaining access to the Mexican market through a takeout of Kansas City Southern (KCS)," he told clients.
 
In order to maintain an adjusted debt to market cap ratio of approximately 45 percent, Mr. Poirier noted that CN would have to do a deal that includes 65 percent debt and 35 percent equity.
 
"Given the early stages of an economic recovery and CN's strong cash position, we believe the timing is also right for CN to start considering a potential deal," he said.
 
Since CP's balance sheet is more leveraged, the analyst suggested it would need to structure a deal comprised of 50 percent debt and 50 percent equity.
 
"Since being appointed CP's president and CEO in June 2012, Hunter Harrison has already led the company to an impressive turnaround. With the significant build-up of cash expected from a drastic improvement in the operating ratio, management plans to pay down debt, invest in the network, and eventually increase its payout," Mr. Poirier said. "While these are valid options, we believe economies of scale should prevail in the long term, underpinning our thesis that CP should ultimately consider acquiring KCS."
 
Of course, such a transaction would not be without risk. The analyst highlighted KCS's expensive valuation, political risks in Mexico, and how the deal is perceived by various regulators, ratings agencies, and shareholders.
 
"Although current valuations look rich based on current prices, we expect both companies to be disciplined, and to consider all options and assess the business case before making such a significant move," Mr. Poirier said.
 
Kansas City Southern had a market cap of US$12.28-billion as of Monday's close.
 
"Mexico has achieved notable success in the automotive industry, which we believe could extend to the aerospace industry over time, especially in light of rising transportation costs (China is becoming less attractive) and Mexico's membership in NAFTA," Mr. Poirier added.
 
He also noted that Desjardins expects Mexican GDP growth to outpace that of the U.S. and Canada.
 
Jonathan Ratner.

Vancouver Island
British Columbia
Canada