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One of the leading and oldest freight railroads, Kansas City Southern (KSU - Analyst Report) has increased its dividend by 10% to 21.5 cents per share on its common stock. The increased dividend is payable on Apr 3, to stockholders of record on Mar 11.

Moreover, the company also announced a dividend payment of 25 cents on its preferred stock. This dividend will be paid on Apr 2, to the preferred stockholders of record on Mar 11.  

Historically, the company made dividend payments only on its preferred stock until last year, when it initiated dividends on its common stock. On Apr 27, 2012, the company paid a dividend payment of 19.5 cents.

We believe the increase in dividend payments on the company’s common stock stems from its stellar earnings performance and encouraging outlook for the rest of the current year. In fourth quarter 2012, the company reported an earnings growth of 19.5% from year-ago results driven by higher freight rates and volumes. For the full year, the growth rate was 14.3% year over year.

Similar to the other railroads like CSX Corporation (CSX - Analyst Report), Union Pacific Corporation (UNP - Analyst Report) and Norfolk Southern Corp. (NSC - Analyst Report), Kansas City Southern has exercised a strong pricing discretion. This has led to average pricing gains of nearly 4–5% per annum, and a subsequent double-digit profit margin.

Apart from strong pricing fundamentals, we believe an improvement in business volumes and effective cost-control measures remain the 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, Kansas City Southern 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. Despite the ongoing economic uncertainty, management is still committed to achieve the same goals that include an operating ratio in the low 70s over the long term.  

However, the company faces significant competition from various transportation providers including railroads along with motor carriers that operate on 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 the economy that will affect business volumes may impede growth in the future.

Kansas City Southern retains a Zacks Rank #3 (Hold).

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