One of the leading and oldest freight railroads, Kansas City Southern ( KSU - Analyst Report ) has announced that it will start paying quarterly dividend on its common stock beginning first quarter of the year. The company’s board of directors has announced a quarterly cash dividend of 19.5 cents payable on April 27 to shareholders of record on April 16. The dividend will represent a quarterly and annualized payout of $21.4 million and 85.6 million, respectively.

Previously, KSU paid dividends only on preferred stock. Last year, KSU made quarterly dividend payments of 25 cents. Earlier, the company had projected that increased cash flows would be passed on as higher returns to shareholders through share buybacks or dividend payments.

We believe that the beginning of dividend payment on the company’s common stock stems from its stellar performance in the last quarter along with strong liquidity position with 174.6 million in free cash flows and encouraging outlook for the rest of the current year. This initiative not only highlights KSU’s commitment to create value for shareholders but also underlines the railroad operator’s healthy financial condition and confidence in its business going forward.

In the fourth quarter, KSU’s adjusted earnings per share shot up 63% year over year to $1.01 driven by higher freight rates. Adjusted earnings surged 79.6% year over year to $3.00 in fiscal 2011.

KSU has also taken significant steps in order to improve its balance sheet strength by decreasing leverage and extending debt maturities. In 2011, the company completed debt refinancing of $200.0 million, which extended debt maturities and reduced future interest expense.

Further, it redeemed the remaining $123.5 million principal amount of the 13.0% Senior Notes that translated into reduced debt carry over. In February, Kansas was granted a term loan for $275 million, maturing January 15, 2017. The company expects this loan (carrying 1.25% interest rate) to reduce the interest rate burden significantly by using it to redeem debt worth $275 million, carrying an 8% interest rate.

KSU has exercised strong pricing discretion that has led to average pricing gains of nearly 4–5% per annum, subsequently helping it to maintain a double-digit profit margin. Apart from strong pricing fundamentals, we believe an improvement in business volumes and effective cost-control measures also remain primary catalysts for the company’s growth.

Additionally, improving cross-border traffic between the U.S. and Mexico and emerging business opportunities in the Mexican market supported by its cheap labor cost will boost the company’s bottom line.

Over the past year, KSU has significantly benefited from positive rail industry fundamentals supported by truckload conversion to rail. Additionally, several cost control initiatives have led to operating ratio improvement.

As a result, management expects to post consistent operating ratio improvement, taking its U.S. operating ratio down to approximately 78.0% over the next 3–5 years. In Mexico, the company targets a sustainable operating ratio in the high 60% range, primarily driven by the significant cost differential among employees. Despite the ongoing economic uncertainty, management is still committed to achieve the same goals which include an operating ratio in the low 70s over the long term.

However, KSU faces significant competition from various transportation providers including railroads like NorfolkSouthern ( NSC - Analyst Report ) and Union Pacific Corporation ( UNP - Analyst Report ) along with motor carriers that operate similar routes across its service area and, to a less significant extent, barges, ships, and pipelines. Further, increased railroad regulation, highly unionized labor and softness in construction-related markets affecting the merchandize business may impede future growth.

Moreover, the present volatilities in the fuel market are also expected to create a cost headwind of approximately $15 million to $20 million in the current year. Additionally, we believe the weakness in construction-related markets will continue to persist this year and hinder forest products’ growth.

Consequently, we maintain our long-term Neutral rating on KSU, supported by a Zacks #3 Rank (Hold).