Coverage by: Derek Bembry, Jacob Boan, and Jared Stricklin

1. Kansas City Southern 2014 CFA Institute Research Challenge-Kansas CityTeam: University of Missouri Kansas CitySponsored by the CFA Society Kansas City Coverage by: Derek Bembry, Jacob Boan, and Jared Stricklin

2. Investment Thesis: Recommendation: • Financial Strength • Growth Potential • Mexico Story • Delayed Revenue • Growth Priced In • Risks & Drags Hold Target Price: $100

3. Industry Overview: • Key Drivers of Freight Transportation: • International Trade • Economic & Industrial production • World price of crude oil *measured in Gross Ton Miles

4. Industry Overview: • Increased regulation at coal-burning utilities coupled with low natural gas prices has led to decreased demand for coal over the long term. Source: Energy Information Administration • Ramp up in US oil production joined with a limited pipeline network has led to increased demand for crude oil. Source: Energy Information Administration

5. Industry Overview: • 7 Class I Railroads in the U.S.

6. Company Overview: • Founded in 1887 as a North-South rail line • Railroad operations in the U.S., Mexico, and Panama comprise 6,600 route miles of track • Mexican Concessions: US and Mexico rail access and Port of Lazaro Cardenas • Primarily generates revenue from six different divisions Annual Revenue Growth by Segment – ('09 – '13)

7. Company Overview: Mexico Story

8. Company Overview: Mexico Story Energy Reform: • Allows FDI through joint ventures with the Mexican government. • 1-2 years before material impact on KSU’s energy revenues. • Infrastructure build will benefit KSU

9. Company Overview:

10. Company Overview: Frac Sand Growth:

11. Company Overview:

12. Company Overview: Intermodal Port of Lazaro Cardenas • 3 Million truckloads originate or terminate in KSU target markets • KSU currently holds <3% market share. • KSU has sole concession to serve Lazaro • Bypass option for Ports of LA & Long Beach • AP Maersk container terminal expansion

13. Company Overview: Automobile “The truth is most of the finished vehicles coming out of Mexico stop at the border and get picked up by Union Pacific” -Former KSU CEO

14. Financial Analysis: Capital Expenditures: Operating Ratio: • Enhance intermodal facilities • Develop energy opportunities • Support safe and dependable service • 130 basis points of annual OR ------------improvement since 2010 • Increased volume • Technological advancements 12% 11%

15. Financial Analysis: MultiRail System: Auto Max Rail Car: Source:www.popularmechanics.com

16. Valuation: Discounted Cash Flow Modeled to progressively achieve 50/50 split between capital and operating leases by 2017. Mexico benefits; labor costs, labor pool, exchange rate benefits. Manufacturing trending toward Mexico. Energy, Automobile, and Intermodal. Lazaro Cardenas, Port Arthur, and Mexico. Operating Lease Adjustment Revenue Drivers Cost Savings

17. Valuation: Discounted Cash Flow 4 Year FCF Forecast CAGR 28% Stage 2 Growth Stair-Step Growth Rate (8%-3%) FY 2018-2027 Terminal Value 2.5% Terminal Growth Rate DCF Target Price: $94.24

18. Valuation: Market Multiples • Peer Group Selection Criteria: • Size • Location • Revenue Mix Multipliers P/E EV/EBITDA Premium 20% 20% Multiple 22x 11.9x Price Target $99.51 $106.43

19. Valuation: Multipliers Method Bull Standard Bear Current Price

20. Valuation: DCF: $94.24 EV/EBITDA: $106.43 P/E: $99.51 Equal Weighting Final Target Price: $100

21. Valuation: Valuations Analyzed Industry Multiples Linear Model AR(1) Model Current Price Target Price Historical Multiples P/E Multiple EV/EBITDA Multiple DCF Analysis $80 $85 $90 $95 $100 $105 $110 $115 $120

22. Risk Analysis: • Global GDP decline • Loss of Mexican concession for railway network • Adverse weather • Political Risk Mexico • Coal demand shift • Pricing power limitation Severity • Free trade limitation between US and Mexico • US credit downgrade • FSC regulation Major • Failure to implement positive train control technology • Improved transit efficiency by truck • New safety regulation • Loss of key clientele • Drug trafficking in Mexican ports • Peso/USD fluctuations • Litigation • Decrease in oil prices Moderate • Insufficient resources for capital expenditures • Improper growth forecasts (Auto & Oil) • Panama Canal expansion Minor Likelihood Medium High Low

23. Contraction Risks: • Being highly cyclical and growth-oriented in nature, KSU could see significant losses during the next business cycle contraction.

24. Monte Carlo Risk Analysis: Number of Iterations: 10,000 Key Variables Oil Price Fluctuations GDP Growth Rate WACC Revenue

25. Conclusion: Recommendation: • Financial Strength • Growth Potential • Mexico Story • Delayed Revenue • Growth Priced In • Risks & Drags Hold Target Price: $100

26. Presentation Slides: Appendices: • Cover • Investment Thesis • Industry Overview: Modes • Industry Overview: Players • Company Overview Initial • Mexico Wages • Mexico: Energy Reform • Natural Gas Potential • Frac Sand • Refineries • Intermodal/Lazaro • Automobile Growth • Financial Analysis • Technology Advancements • Valuation Multipliers • Valuation Multipliers Graph • Valuation DCF • Valuation DCF Target Price • Valuation Summation • All Valuation Methods Graphed • Risks Analysis • Contraction Risks • Monte Carlo • Conclusion • Balance Sheet • Income Statement • Statement of Cash Flows • Working Capital • Ratio Analysis • Summary Model • Target Price Sensitivity • WACC Sensitivity • WACC Sensitivity Continued • Linear Model Regression • AR(1) Model • Recent Correction • Mexico Story Detail • Fuel Surcharge • Forecasted Revenue Breakdown • Intermodal & Lazaro Detail • Auto Plant Openings • NA Crude Oil Basin Routes • U.S. Oil Refineries • Precedent Transactions • Takeover Analysis • CP – KSU Rail Map • Industry Overview • Freight Transport History • WTI Crude Regression • 20% Multiple Premium • Historical Growth • Capital Structure Priorities • Cost of Shipping a Container • Crude by Rail

27. Pro-Forma Balance Sheet:(Adjusted for Op. Leases) 27

28. Pro Forma Income- Statement:(Adjusted for Op. Leases) 28

29. Pro-Forma Statement of Cash Flows:(Adjusted for Op. Leases) 29

30. Working Capital: 30

31. Ratio Analysis: 31

32. Sensitivity Analysis: Perpetuity Growth Method EBITDA Multiple Method P/E Multiple Method 32

33. Sensitivity Analysis: WACC Sensitivity Test Area: Market Risk Premium Beta WACC Beta 33

34. Sensitivity Analysis: WACC Sensitivity Test Area: Country Risk Premium Risk Free Rate 34

35. ⏎ KSU saw its stock drop from $117.28 to $99.49 (15%) after 4Q earnings release. Why the Correction? 1) Actual EPS lower than consensus • Actual EPS of $1.03 vs. $1.09 estimate. • Reduction of shipments with 2 large customers in Mexico. • Flooding produced mudslides in Mexico which disrupted rail service in October 2013. • Coal volumes decrease 8%. • Grain volumes decrease 5% due to drought in first nine months of 2013. 2) The bridge to growth opportunities is taking longer than expected to cross. • New auto plants in Mexico are taking longer than expected to get up to significant production. • Higher than expected pipeline and water transport utilized for crude oil. • Developing efficient technology to heat heavy Canadian crude oil on tankers so oil can flow out of the car has proved difficult.

36. Fuel Surcharge • A mechanism to adjust revenue based on changing fuel prices. • Regulated by the Surface Transportation Board (STB), appointed by congress. • Once HDF average $2.30 per gallon, an initial surcharge of 5 cents is charged and the surcharge increases 1 cent per mile for every 4 cent increase per gallon in HDF. • At current HDF price of $3.88, the surcharge amounts to $.44 per mile per car.

37. KSU Revenue Growth Rate Outlook Source: Team Estimates

38. Mexico Story: • Labor Force • Labor costs are converging with China • Half of the population is 26 years old or less • Mexican labor is highly skilled • 115 thousand engineer graduates annually Source: Supply Chain Digest • Trade Growth • 14 Free Trade Agreements involving 45 countries • Since 2010, U.S. imports from Mexico have risen 20.8% • U.S. is one of Mexico's largest trading partners Source: Team Estimates Source: Kansas City Southern

39. New Auto Plant Openings HONDACelaya, Mexico Est. Production: 280K MAZDA Salamanca, Mexico Est. Production: 185K NISSAN Aguascalientes, Mexico Est. Production: 149K AUDI San Jose Chiapa,Puebla,Mexico Est. Production: 150K • Production ramp-up pushed to '14-15 • 1Million unit increase in Mexican auto production between '13-'17 39

40. Intermodal & Lazaro Cardenas: • Intermodal • 6% y/y intermodal carload growth • 71% y/y cross-border intermodal carload growth • - 3 Million truckloads originate or terminate in KSU target markets • KSU currently holds <3% market share. • Port of Lazaro Cardenas • - 6% y/y volume growth out of Lazaro • Bypass option for Ports of LA & Long Beach • KSU has sole concession to serve Lazaro • AP Maersk container terminal expansion Source: Seeking Alpha 40

41. Linear Model Regression: 41

42. AR(1) Model Regression: 42

45. Industry Detail: • 1980 - Staggers Rail Act • Government regulations removed • Firms now had the ability to adjust their rates and tailor services to meet shipper needs.

46. Freight Transport History

48. WTI and KSU Stock Price Regression WTI Crude Oil Regression Proximity End Users

49. Precedent Transactions: DateAcquirerTargetEV/SalesEV/EBITDAEV/EBIT 11/2009 Berkshire Hathaway BNSF 3.0x 8.4x 11.9x 04/1997 NSF/CSX Conrail 3.3x 11.5x 20.4x Mean 3.1x 10.0x 16.1x What EV/EBITDA multiple would a firm pay for an acquisition attempt at the current market price? Transaction value EV/EBITDA 10.0x 2013 KSU EBITDA 961.9 Implied enterprise value 9,619.0 Less net debt(2,071.5) Implied equity value 7,547.5 Less acquisition premium(20.2%) Plus firm specific premium 20% Implied equity value 7,534.9 shares outstanding 110.3 Implied price per share $68.31 16.6x At what market price would Kansas City Southern become an attractive takeover? <$65 Market price (3/14/14) $96.60 OVERVALUED *Due to lack of comparable deals and time period mismatch this analysis was excluded from our main valuation nonetheless the data is useful for potential takeover analysis.

50. Potential Takeover Analysis: Canadian Pacific Railroad Track Kansas City Southern Railroad Track • KSU is the smallest Class I railroad and a potential takeover target. • KSU railroad network reaches southern Mexico. • Canadian Pacific market shares at all time high. • Canadian Pacific network extends north into Canada.