Kansas City Southern's run for the border pays off

A railroad based smack in the center of the country isn't the most obvious play on globalization. But tiny Kansas City Southern ksu is emerging as a major beneficiary of surging trade between the USA and an increasingly prosperous Mexico.

With the U.S. economy verging on recession, rail lines responsible for moving goods and commodities around the country are certain to absorb a financial blow. Already, Kansas City Southern says the amount of paper, forest and metal products it shipped in the fourth quarter fell more than 10% from the same quarter a year earlier, due to the collapse of the housing market.

But CEO Michael Haverty, 63, says Kansas City Southern is well positioned to ride out weakness in the U.S. economy, thanks to its south-of-the-border foothold. About half of the company's $1.7 billion in annual revenue comes from its wholly owned Mexican subsidiary and a 50% stake in a small rail line adjacent to the Panama Canal.

"We feel pretty good about this year. … If we went into a deep recession, that would certainly cause me concern. But we would probably be affected less than others would be," he told USA TODAY in a telephone interview.

Investors seem to agree. So far this year, shares of Kansas City Southern are up 11.6% vs. 2.9% for the Dow Jones Transportation index. Earlier this month, the company reported better-than-expected earnings of $49.9 million vs. $35.7 million in the final quarter of 2006. Revenue was $460 million vs. $442 million in the year-earlier period.

Southern exposure

Dating to 1887, the venerable Midwestern line, headquartered in Kansas City, Mo., is the smallest of the seven major North American railroads. Its 5,850 miles of track, sprawling across 10 U.S. states and deep into the Mexican heartland, are dwarfed by Union Pacific's 32,300-mile coast-to-coast network.

Kansas City Southern's involvement in Mexico dates to the mid-1990s, when it purchased a 49% stake in a Mexican rail operator. By 2005, Haverty had bought out his Mexican partner and established full control of a Mexican line, renamed Kansas City Southern de Mexico.

Today, his rail cars head south bulging with soybeans, grain and auto parts and return with completed vehicles and 20-foot shipping containers full of consumer goods. In recent years, the auto business has been a particular bright spot. Several automakers, including Detroit's Big Three, are expanding production in Mexico. General Motors, for example, is building a $650 million plant in San Luis Potosi.

But Kansas City Southern also expects to benefit from China's initial move into North American auto production. One of that country's leading manufacturers, Changchun-based First Automobile Works, is establishing a joint venture plant with Mexico's Grupo Elektra, which will be located adjacent to one of Kansas City Southern's tracks. The plant is scheduled to begin producing cars for the Mexican market in two years.

"A few years ago, I had people tell me I'd made a mistake investing in Mexico because everything was going to go to China. That has not happened," Haverty says. "Now, we're seeing China investing in Mexico."

Through November last year, U.S.-Mexico trade in vehicles and parts was running at an annual pace 34.3% higher than in 2000, according to Commerce Department statistics. And U.S. vehicle-related exports over that period rose more than twice as fast as imports (57% to 25%).

A rail link into the port of Lazaro Cardenas, on Mexico's Pacific coast, also puts Kansas City Southern in position to capitalize upon increased trade flows from Asia to the southern USA as well as Mexico's own economic growth. The port is 400 miles closer to Houston via rail than is the port of Los Angeles, where most Asian cargo lands in the USA.

Stiff headwinds

Still, Haverty, a fourth-generation railroad man, concedes he's got plenty of work to do before his Mexican and U.S. tracks are knitted into a seamless network. The company this year plans to reduce its number of locomotive models from 18 to two in a bid to boost efficiency. Mimicking cost-conscious Southwest Airlines, Haverty also wants to shave turnaround time, so that trains spend more time hauling cargo and less time parked in the yard.

With the U.S. economy near stall speed, analysts worry that Kansas City Southern's southern exposure won't be enough to offset its dependence upon industries that rise and fall with the economy. Only 40% of the railroad's revenue comes from businesses that are insulated from short-term economic ups and downs, such as coal for electricity generation or farm products. Burlington Northern Santa Fe bni, in contrast, derives 72% of its revenue from products that are sheltered from economic storms. "We believe the company will face stiff headwinds over the coming quarters," analyst Lee Klaskow of Longbow Research wrote in a Feb. 6 note.

Any U.S. downturn eventually will spill across the border and depress growth in Mexico. But assuming that the USA escapes with nothing worse than a couple of quarters of weakness, Kansas City Southern is betting that its trade ties will pay off.

Says Haverty: "Free trade has been great for our country. … We are clearly tied to that global traffic more than other railroads."