UPDATE: S&P Lowers Outlook on Kansas City Southern (KSU) to Stable

(Updated - May 14, 2015 12:41 PM EDT)

Standard & Poor's Ratings Services said today that it has revised its outlook Kansas City Southern NYSE: KSU) to stable from positive. At the same time, we affirmed our 'BBB-/A-3' long- and short-term ratings on the company.

We also affirmed our 'A-3' short-term rating on Kansas City Southern de Mexico S.A. de C.V. (KCSM) and our 'A-3' short-term issue ratings on the commercial paper programs issued by KCS' subsidiaries, Kansas City Southern Railway Co. (KCSR) and KCSM.

"The outlook revision reflects our expectation that KCS' credit metrics will weaken over the next 12 to 18 months due to the combination of increased leverage from its new share repurchase program and earnings and revenue pressures from foreign-exchange headwinds, volatile domestic fuel prices, and the fitful climate for energy-related commodities," said Standard & Poor's credit analyst Tatiana Kleiman. Although the pricing environment remains generally positive, we believe that the company's volume growth will be more affected by the softness in energy-related markets, such as coal, metals, and frac sand (used in shale oil production), than we had previously expected. That said, the company should continue to benefit from healthy intermodal and automotive demand, as well as its ongoing efficiency efforts and capacity/infrastructure investments, resulting in a funds from operations (FFO)-to-debt ratio in the mid-to-upper 30% area by the end of the year. Although this is lower than our previous expectations, it is still satisfactory for a 'BBB-' rating.

The stable outlook on KCS reflects that, despite headwinds from declining fuel surcharge revenue, the weak Peso, and the volatile climate for energy-related products, we expect the company's earnings and revenues to continue to benefit from the positive pricing environment and management's ongoing focus on efficiency improvements. KCS' rail volumes will likely remain constrained in 2015 due to weakness across several commodity groups (coal, metals, and sand) as well as industry-related service and capacity issues.

We could raise the rating if KCS' earnings growth causes its adjusted FFO-to-debt ratio to exceed 40% or if the company's FOCF-to-debt ratio rises to the mid-to-high-teens percentagewise and remains there on a sustained basis.

We could lower the rating if weaker-than-expected economic growth, greater-than-expected foreign-exchange translation losses, or more-aggressive-than-anticipated shareholder distributions cause the company's adjusted FFO-to-debt ratio to remain below 25% for a sustained period.

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