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Kansas City Southern's (KSU) CEO David Starling on Q1 2016 Results - Earnings Call Transcript

Start Time: 08:45

End Time: 09:53

Kansas City Southern (NYSE:KSU)

Q1 2016 Earnings Conference Call

Executives

David L. Starling - CEO

Patrick J. Ottensmeyer - President

Jeffrey M. Songer - EVP Engineering and COO

Brian Hancock - EVP and Chief Marketing Officer

Michael W. Upchurch - EVP and CFO

Jose Zozaya - President and Executive Representative, Kansas City Southern de Mexico

Analysts

Allison Landry - Credit Suisse

Tom Wadewitz - UBS

John Barnes - RBC Capital Markets

Ravi Shanker - Morgan Stanley

Chris Wetherbee - Citigroup

Scott Group - Wolfe Research

Jason Seidl - Cowen and Company

Ken Hoexter - Bank of America Merrill Lynch

Brian Ossenbeck - JPMorgan

Brandon Oglenski - Barclays Capital

Bascome Majors - Susquehanna International Group

Jeff Kauffman - Buckingham Research

Operator

Greetings, and welcome to the Kansas City Southern First Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

This presentation includes statements concerning potential future events involving the company, which could materially differ from events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the company’s Form 10-K of the year ended December 31, 2015, filed with the SEC.

The company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments. All reconciliations to GAAP can be found on the KCS Web site, www.kcsouthern.com.

It is now my pleasure to introduce your host, David Starling, Chief Executive Officer for Kansas City Southern. Thank you. Mr. Starling, you may begin.

David L. Starling

Thank you. Good morning and welcome to Kansas City Southern's first quarter 2016 earnings call. Joining me today are KCS President, Pat Ottensmeyer; Chief Operating Officer, Jeff Songer; Chief Marketing Officer, Brian Hancock; Chief Financial Officer, Mike Upchurch. And joining us by phone President and Executive Representative of KCSM, Jose Zozaya.

A quick look at our overview of first quarter. KCS revenues declined by 7% from a year ago. Of course a weak peso and lower U.S. fuel prices had significant impact on the top line. When you exclude those factors, our revenues were down 1% from first quarter 2015. In addition to these factors, we were hit with serious flooding on parts of our network in Texas and Louisiana beginning in mid-March, which had a noticeable negative impact on the revenues for the quarter.

Despite all of these challenges, as well as the 5% reduction in carloads, KCS posted an adjusted operating ratio for the quarter of 66.6, a 2.3 point improvement over the prior year. A few comments on the flood and impacts of three critical corridors of our railroads being out of service for over three weeks. We were very pleased with our ability to keep a lot of the trains moving during those three weeks and get our system up and running as quickly as it did. It’s a testament to Jeff Songer and his operating team and to the exceptional coordination between operations, marketing and sales personnel keeping our customers impacted on their cargo movement.

It also speaks to a high degree of cooperation between KCS and other railroads, particularly the Union Pacific and BNSF who were battling their own flood-related problems as well. We detoured trains on our own respective networks to minimize the effect to our customers. We were also assisted by Canadian National. We may be fierce competitors on most days but when hit with financial disasters, railroads work together to keep the freight moving to the greatest extent possible. It was a great effort.

My final thought is that to be able to improve your operating ratio by over 2 points while losing an important part of your rail system for nearly a month and without the benefits for incremental volume growth is a real noteworthy achievement and should give you all confidence in KCS organization and particularly our operating team going forward.

With that, I’ll turn the call over to Pat Ottensmeyer.

Patrick J. Ottensmeyer

Thanks, Dave. Good morning, everyone. I will begin my comments on Slide 7. Dave gave you a summary of our first quarter results. Jeff, Brian and Mike will get into a lot more detail on the following slides. What I would like to do in the next few slides is provide more of an assessment or evaluation of our performance during the quarter and talk briefly about our longer term outlook.

Sticking with the general theme from our fourth quarter earnings presentation, we will focus our comments this morning more on those factors that we can manage to drive performance in an uncertain and volatile economic environment; things like service, cost control, asset utilization and capital structure.

Overall, we feel that our performance in the first quarter was very good in spite of continued headwinds from energy markets, specifically coal and crude oil, fuel prices and foreign exchange, as Dave mentioned, all of which had a negative impact on volumes and/or revenues during the quarter.

In addition, KCS revenues and volumes were negatively impacted by heavy rain, flooding and service interruptions that essentially shutdown parts of our Southern region and our cross-border route in March. Jeff will have to say about that in a few minutes.

Returning to the first quarter assessment, until about March 9, we were all feeling pretty good about the pace of business this year although I would say the phrase we were using to describe our first quarter at that point was worse than last year but better than expected. Then the rain started and we experienced severe and in some regions record-breaking flooding in Louisiana and Texas.

As you will see on the following slide, our year-to-date volumes had actually crossed over into positive territory on March 9 where they were up 1% versus last year. Then we went underwater. The reduction in volumes during the last 22 days of the quarter took our volumes for the full quarter from a 1% increase at March 9 to a 5% decline by the end of the quarter. Not all of that decline was due to the flooding. There were other factors including the timing of the Easter holiday, which contributed to the weak 2016 comps.

In spite of that dramatic flood impact, our operations team demonstrated excellent performance of the things we did control such as service, cost, finance utilization to drive the 230 basis point improvement in operating ratio from last year. Again, as Dave mentioned, the other positive factor that allowed us to manage our network and keep customer service and asset utilization at reasonable levels was the degree of cooperation we saw from our railroad partners, many of whom are also affected by flooding on their network.

I don’t think it would be an overstatement to say that the level of coordination and cooperation we saw from our rail partners in Texas and Louisiana was better than at any time we can remember in the last 10 years. All of us were in the same situation and we used each other’s networks in a way that was purely focused on taking care of customers and keeping our collective networks running in the most efficient manner possible.

Before I leave this slide, I want to acknowledge the announcement we made on March 10 appointing Jeff Songer to Chief Operating Officer. I feel this organizational change whereby we aligned all of the key operation function; transportation, engineering and mechanical under a single functional unit will allow KCS to drive further improvement in customer service, cost control and asset utilization and ultimately help us achieve our long-term operating ratio and ROIC target.

I’ll come back to this theme of organizational development in a couple of minutes. Slide 8 illustrates the point I made earlier that our volumes had actually crossed over into positive territory on March 9. This chart further illustrates the significant impact that the flood and service interruption among other factors had on our quarterly volumes, which finished 5% lower than last year. I’m happy to report that this business recovery has continued. Volumes for the second quarter have returned to positive territories. You can see here, as of last Friday we were up about 3% versus last year.

I’ll wrap up with Slide 9. You may remember this graphic from our fourth quarter 2015 earnings presentation in January. At that time, which was the first time we introduced this slide, we told you that this was going to be our primary guidance statement going forward. Given the uncertainty that we continued to see in the near-term economic and business environment, the only guidance we can provide is that the long-term outlook continues to be positive driven by growth in several key market areas, positive pricing trends and sustainable improvement in service, cost control and asset utilization.

And as we see in the center of this slide, we expect to show long-term continued improvement in operating ratio, earnings per share and return on invested capital. The short-term outlook continues to be very uncertain and as a result we’re just not in a position to provide more definitive or specific guidance regarding volume, revenues or operating ratio. Growth will return. Investments in chemical plant, auto production, port terminals and now refined product facilities that has taken place in our service area is quite remarkable. Brian will highlight some very recent announcements on new business opportunities in a few minutes.

In 2016, we continue to forecast a reduction in overall capital spending but we will spend on those key projects to support the industrial development activity and new business opportunities taking place on our network. When those new plants and terminals open, we will be ready to capitalize immediately on the opportunities that we know are coming over the longer term horizon.

Earlier I said I would come back to the organizational development theme. In addition to the personnel and organizational changes that we have made publicly, there have been several other internal organizational changes involving lead or department head positions in PTC, purchasing, network design, internal audit, financial planning and tax.

I’m extremely pleased to report that each of these positions involving Vice President or Assistant Vice President level jobs was made with individuals who were already at KCS. This is a phenomenon that hasn’t always been the case here in the past as many of you have followed us for some time are aware. It is a testament not only to the quality of our people but our management commitment to develop and promote high performers to become the leaders for the next generation.

Our people at all levels of the organization match up very well with our larger industry peers and most importantly they are a talented and dedicated group and that is the critical ingredient to delivering the high performance expectations to which our customers and shareowners hold us.

With that, I’ll turn the presentation over to Jeff.

Jeffrey M. Songer

Thank you, Pat, and good morning. Beginning with Slide 11, strong operating performance in the quarter allowed for improvements in key operating metrics. Velocity for the quarter was 28 miles per hour, a 3.2% improvement over prior year and a 3.5% improvement over Q4 2015.

Overall dwell for the quarter of 21.1 hours was a 7.8% improvement over prior year. Despite significant impacts during the flood in March, we were able to achieve substantial improvements in both the operating metrics and cost control, as we will discuss. The organizational changes discussed last quarter are fully in place and we are seeing the results.

Moving to Slide 12, efforts in resource management and cost control are showing results. In Mexico, our workforce is stable and operating metrics have largely returned to expected levels. Furthermore, improved cycle times have led to reduced car hire expense. In U.S., we continue our focus on resource management. Currently, 12% of the U.S. T&E workforce is in furlough status and 12% of our locomotives are in storage.

Highlighting other cost initiatives, we have started to fuel optimization technology program and have accelerated capital funding to allow us to install this technology in approximately 20% of our road fleet by the end of 2016. We continue to improve Mexico workload allowing for crew efficiencies. Ongoing projects such as reducing crew change points in areas such as Leal, which will improve run times between Monterrey and the border and modifying operations in the Escobedo area will ease congestion and prove fluidity in this area.

In the U.S., crew management efforts such as eliminating the Jackson, Mississippi crew change and another ongoing initiatives have allowed us to reduce our year-over-year number of re-crews by 37% across the network. Additionally, we continue to improve our mechanical maintenance agreement. You will see the financial benefit of our work today in Mike’s portion of the presentation and we are working on additional opportunities notably with our Mexico car shop operations that we look to benefit from for the latter part of the year.

Looking at our major capital projects, all are progressing to plan. Our work at Sanchez continues and will complement the work completed in 2015 by adding classification tracks and more efficient maintenance facilities. The Sasol support yard project is on schedule. We have finalized the bid process. Our contract has been selected and construction is underway.

Construction of additional receiving and departing tracks in Lázaro will support improved departures, run times and length of trains originating from the yard. This additional capacity will also support APMT terminal opening later this year.

San Luis Potosi has become an additional area of focus driven by new commercial opportunities. We are in the design process for capacity improvements in this area to support recently announced facilities, which Brian will discuss.

Turning to Slide 13, I will close out my comments by providing a quick overview of the flood event in March. As you can see from the map we incurred multiple days of outages across our major East West and North South routes in between Shreveport and New Orleans, essentially the lower half of our U.S. system including cross-border operation.

I would like to recognize the coordination efforts during the flood between KCS and our connecting carriers, most notably, the Union Pacific and BNSF but also CN and CSX. I’m proud of the industry response for this event. We were able to route other carriers’ traffic on our network as we routed our trains across their networks, all in efforts of maintaining the most efficient operation for our customers.

Finally, I want to thank our operating team for the extra effort working multiple days and nights on end to restore our network after this event and for delivering strong operating performance for the quarter.

I will now turn the presentation over to our Chief Marketing Officer, Brian Hancock.

Brian Hancock

Thanks, Jeff, and good morning. To begin, and as noted earlier, the March flood in Texas and the Southeastern U.S. primarily impacted our intermodal, industrial and consumer and chemical and petroleum business segment. In spite of this disruption, our year-over-year revenue was down 1% excluding currency and fuel while our carloads for the quarter were down 5%.

In Q1, we also continued to turn to solid performance with our core pricing results coming in at 3.8%. The commercial team also expressed our appreciation for the extraordinary efforts of our operating and customer service organization for providing real-time options for our customers and closely working with our other rail partners during these extraordinary weather events.

I’ll now provide a little more detail by line of business using Slide 15 as a reference. Our chemicals and petroleum business continues to show steady growth with a 3% volume increase and 2% revenue increase driven by strength in the petroleum and plastics business partially offset by the impact of the flood.

Industrial and consumer while also negatively impacted by flooding still showed a 1% increase in volume but had a 3% decline in revenue primarily due to the impact of currency and fuel. Softness in both our metals and paper segment had a significant impact in Q1 but we’re seeing some improvements as our customers are finding new markets for their products. Additionally, we saw strength in our other carload segment.

During Q1, our ag and mineral business saw increases of 4% in both volume and revenue driven by strength in grain particularly in the cross-border business. Our energy line of business continued to be negatively impacted by volatility in coal and crude. Overall carloads were down 16% and revenue down 37% versus first quarter of 2015 with coal making up about 52% of the miss.

Intermodal volumes were down 7% with revenue decreasing 10% in the quarter. While our intermodal trains are now running at expected service levels, the volume has been slow and ramping back up. As expected, intermodal was negatively impacted by the retooling and shutdowns at a number of the automotive assembly plants, and as Pat mentioned we were also impacted by more competitive truck pricing in several markets as well as the flooding in the Southeast. These items combined with differences in holiday timing in China and North America also impacted our Q1 intermodal as well.

While the automotive segment had a number of positive events early in the quarter due to specific customer needs and unplanned movement, the planned temporary plant shutdowns were primary drivers of declines of 12% in volume and 11% in adjusted revenue, respectively. We continue to be on track with our expectations for the downtime at the automotive plant and both of these projects are proceeding as planned.

We expect that all of our customers’ facilities will be back on line in May. I want to reiterate that these outages had impacted both our intermodal and automotive business segments. After the retooling is complete, there will be a gradual ramp-up period before all of the quality and new model issues are resolved, but we continue to be optimistic about our automotive business.

On Slide 16, we have provided details on several announcements that were made during the first quarter. As we have previously discussed, the 2013 Mexico Energy Reform legislation allows companies to import refined products into Mexico beginning in 2017 under private brands other than Pemex. KCS along with several of our partners in the industry have been working towards those implementation dates.

On February 22, 2016, the President of Mexico announced the acceleration of these reforms which should allow import to begin on April 1, 2016. As a result of this announcement, WTC industrial and Watco companies announced that they will be building a liquid fuels terminal in San Luis Potosi on the KCS line. Shipments for this terminal are expected to begin in 2017.

Just a few weeks later, Rangeland Energy announced that it is developing an integrated hydrocarbon logistics facility to store and ship LPG gasses into Mexico. This facility will also begin shipping in 2017. Finally, as a follow up to our last call, Ford announced that it will be investing $1.6 billion in a new assembly plant in San Luis...


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