Kansas City Southern's deleveraging largely done, will focus on growth

By Paul Deckelman

New York, July 17 - Kansas City Southern successfully completed its refinancing of what had been $275 million of 8% senior notes due 2015 during the second quarter and now believes that it has investment grade-worthy credit metrics.

Having taken out those bonds and lowered its interest costs accordingly, the Kansas City, Mo.-based U.S. and Latin American freight railroad operator feels it can now turn some of its focus to areas other than its balance sheet.

"Having largely completed our deleveraging and debt-restructuring goals by calling the 8% notes in June, our focus will begin to shift [to] investing in our growth opportunities and providing further returns to our shareholders," the company's chief financial officer, Michael W. Upchurch, said during Tuesday's conference call following the release of results for the second quarter ended June 30.

"You can see we've significantly reduced our interest expense through a combination of debt reductions and refinancing activity, and we believe we fully have credit metrics that meet the criteria of an investment-grade company," he added.

As of the end of the quarter, the ratio of the company's trailing 12-month funds from operations to debt stood at 35%, and debt was 2.l5 times EBITDA on a last 12-month basis, according to a company presentation that accompanied the release of its results.

Takeout a major transaction

According to its latest 10-K report filed Tuesday with the Securities and Exchange Commission and covering the second quarter, total debt at the end of the quarter stood at $1.62 billion including $1.57 billion of long-term debt and $52 million of debt due within 12 months. At the end of the 2011 fiscal year on Dec. 31, 2011, total debt stood at $1.64 billion including $1.60 billion of long-term debt and $36 million of short-term obligations.

The key focus during the period was refinancing the 8% notes at a lower rate and pushing out their maturity. The company first tendered for all of the notes in late January, taking out nearly $175 million of those bonds tendered by the holders before the offer wrapped up in February, and then it called the remaining $100 million of the bonds for redemption, which took place on June 1.

Kansas City Southern funded the takeout of the 8% notes by entering into an agreement in February with its existing term loan A facility lenders for $275 million of additional borrowings under the same terms - effectively pushing out the maturity of the debt being taken out by a year-and-a-half to Jan. 15, 2017 from the bonds' June 1, 2015 maturity and lowering the cost of funds from the bonds' 8% to the term loan's 125 basis points over Libor.

Upchurch said on the conference call that while the company did incur a $5.9 million charge during the quarter for debt retirement costs related to getting rid of those bonds, it expects to reap annual interest expense savings from that refinancing of about $17 million.

Interest expense for the second quarter declined to $25.3 million from $32.4 million in the year-earlier quarter, a reduction of 22% year-over-year. The CFO pointed out that since the company's peak interest expense back in 2009, it has managed to reduce its total interest costs by about $74 million, a more than 40% reduction.

He projected that annual interest costs for the full 2012 year should come in at about $100 million.

Solid free cash flow, liquidity

On a year-to-date basis, free cash flow as of the end of the second quarter was $57 million - nominally down from a $92 million figure a year ago. But Upchurch said that excluding some unusual items - including the fact that the company started paying dividends this year, which it wasn't paying last year, and last year's figure was artificially swelled by proceeds from an insurance recovery - "when you kind of look at it on a run-rate basis, we're really over $100 million year to date and about $60 million a year ago, so that's a pretty substantial increase in free cash flow."

The company's priorities heretofore have been deleveraging the balance sheet, investing in the business and providing for shareholder returns, but the latter two are expected to get more attention going forward.

Consolidated cash and cash equivalents stood at $105.5 million at the end of the second quarter, versus $72.04 million at the end of 2011. Total cash and cash equivalents held outside of the United States in foreign subsidiaries - the company runs an extensive freight railroad network in Mexico and a smaller one in Panama - was $51.3 million. That cash is available to fund company operations without incurring additional income taxes, the company said in its 10-K report.

The company entered into a $200 million five-year revolving credit facility in June 2011, carrying an interest rate of 175 bps over Libor. During the 2012 first quarter, the company repaid the $50 million outstanding balance under that facility.

In September 2011, its Kansas City Southern de Mexico SA de CV unit entered into a $200 million five-year revolving credit facility at an interest rate of 100 bps over Libor.

Total available liquidity - the unrestricted cash balance plus revolving credit facility availability - was $505.5 million at the second quarter's end, according to the 10-K filing.

The filing added that based on current expectations, the company believes that cash and other liquid assets, operating cash flows, access to debt and equity capital markets and other available financing resources will be sufficient to fund anticipated operating, capital, debt service and other commitments in the foreseeable future.

Strong quarterly results

For the second quarter, the company reported record revenues of $545 million. It said that operating income was $204 million, and adjusted operating income was $161 million - also a record for the second quarter.

Upchurch and other company executives on the call such as president and chief executive officer David L. Starling noted the strong revenues the company generated bringing raw materials to, and carrying finished products from, a growing string of steel and automobile assembly plants that companies have established in Mexico, where Kansas City Southern has the sole major rail connection across the border to the United States.

It notched diluted earnings per share of $1.09, versus 64 cents in the second quarter of 2011, while its adjusted diluted earnings per share of 85 cents in the latest quarter were up 20% from 71 cents a year earlier.

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