Kansas City Southern has long been knocked by rating agencies for being regionally focused, carrying a heavy debt load and posting volatile earnings. As a result, it's been saddled with speculative credit ratings for over a decade.
The railroad, however, has been working to answer critics, chugging along with consistent improvement in areas like debt-to-capital levels, margins and its railroad network.
In the third quarter alone, profit doubled on record revenue, further fueling an already strong 2011 performance built on price increases and record carloads.
And the company is squarely focused on debt reduction. Before the year is over, Kansas City Southern will use nearly two-thirds of its cash, or $140 million, to pay down cumbersome high interest rate debt well before its 2013 maturity.
Even though its credit ratings have been on a steady uptick in recent years the 124-year-old railroad remains mired in junk status while many companies have more favorable debt terms.
Competitors have used this environment to slash borrowing costs and push out maturities, dramatically improving their capital structure. Kansas City Southern could stand to take full advantage of this environment, as S&P Capital IQ estimates the company now pays $130 million annual interest costs -- equal to about 7 percent of its 2010 annual revenue.
Kansas City Southern's competitors include Union Pacific Corp , CSX Corp , and Norfolk Southern
With shares up 35 percent this year, far outperforming the 5 percent drop in the Dow Jones Transportation average, Wall Street has noticed Kansas City Southern's momentum. But it may be a longer haul for ratings agencies.
Waiting Period
"Just because our metrics look like an investment-grade company doesn't mean that the rating agencies are going to immediately move us to that level," Mike Upchurch, the company's chief financial officer, told analysts on the recent third quarter conference call. "I would expect that there might be a bit of a waiting period."
Ratings analysts say Kansas City Southern's promotion to investment grade is going to take some time. Despite ongoing improvement, they seek more growth on a sustained basis.
"With a Ba3 rating and a stable outlook -- a rating upgrade is not imminent," Moody's Credit Officer David Berge said.
"We have mentioned that a number of their credit metrics have improved to those of their investment-grade brethren over the very recent past," he said. "When they show that they've removed the element of volatility and can keep growing and start matching the size and scope of the other Class One (railroads), then I think we can start to consider higher ratings."
Anita Ogbara, director of corporate ratings at S&P, said the firm looked at Kansas City Southern's ratings in September.
"They need time for those metrics to show some consistency."
COMPETITORS GETTING CHEAP FUNDING
To explain the company's urgency, analysts point to the difference between the interest rates attached to some Kansas City Southern shorter-term notes and the terms enjoyed by its three larger publicly traded competitors, which are all investment grade and sold long-dated debt in recent months.
Union Pacific and CSX recently sold 30-year debt with 4.75 percent coupons. Norfolk Southern sold 100-year, or century, bonds with a 6 percent coupon.
Those rates are far below the 13 percent on Kansas City Southern's notes due in 2013, and its 8 percent note maturing in 2015. The company will retire the 2013 notes this year, but it is unlikely to match its rivals if it raises new debt.
"Some peers have been floating notes in the 5 to 6 percent range, and that cuts interest expenses in half," said Kevin Kirkeby, S&P Capital IQ equity analyst.
Kirkeby said that m
