Q3 2020 Kansas City Southern Earnings Call
Good morning, and welcome to the Kansas City, Southern third quarter 2020 earnings Conference call. All participants will be in listen only mode should you need assistance. Please.
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After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad to withdraw your question. Please press Star then two please note. This event is being recorded.
It's now my pleasure to introduce you to actually Thornton, Vice President Investor Relations for Kansas City Southern.
Thank you Andrew Good morning, and thank you for joining Kansas City, Southern third quarter 2020 earnings call before we begin I want to remind you that this presentation contains forward looking statements within the meaning of the Securities Exchange Act as amended.
Actual results could materially differ from those anticipated by such forward looking statements. As a result of a number of factors are combination of factors, including but not limited to the risks identified in our annual report on form 10-K for the year ended December 31st 2019, and in other reports filed by US with the <unk> Securities and Exchange Commission, including our quarterly.
For the quarter ended September Thirtyth 2020.
Forward looking statements reflect the information only as of the date on which they are made yes does not undertake any obligation to update any forward looking statements to reflect future events developments or other information and with that it is now my pleasure to introduce Kansas City, Southern President and CEO Pat Ottensmeyer.
Thank you Ashley and good morning, everyone I will just skip over slide for the presenters and participants on the call are the same as in prior quarter. So lets go directly to slide five with a quick recap of the third quarter and a bit of a preview.
What we see in the in the in the period ahead.
As you saw in the press release, our third quarter results revenues were up 12% lower than the previous year on on volume reduction of 4%.
Third quarter operating ratio of 58.8 was an all time best for Kansas City Southern.
Hundred 90 basis point improvement over the prior year on an adjusted basis third quarter earnings per share of $2.01, a 11% above prior year on an adjusted basis, primarily foreign exchange, which Mike will talk about later.
Dollar 96, which was 1% above 2019, the headline story for this quarter is a is clearly operating ratio and more specifically our ability to hold the P.S. are driven efficiency improvements and cost savings generated over the prior year and a half as our vault.
James and revenues experienced a truly and present unprecedented roller coaster ride with the steep decline in the second quarter and then the very sharp recovery and growth during the third quarter.
The fact that we were able to hold these operating efficiency and cost improvements and produce a meaningful reduction in operating ratio versus last year, and a 640 basis point reduction in operating ratio from the second quarter of this year is solid validation of this substantial insist.
Staying nimble improvements to the way we run our network that have resulted from our P.S., our transformation Sammy and Mike Upchurch will get into more detail about those improvements in a in a few minutes.
Looking ahead, we are we are reinstating and in flight, we improving our outlook for on a on a number of topics as you see on the bottom half this slide.
Our 2020 Capex guidance will remain as it has in the previous quarter of 425 million with the outlook for 21 and 22 at roughly 17% of revenue.
We are increasing our guidance for full year 2020 free cash flow from 500 million to 550 million.
Which as Mike Upchurch will cover later on is a 30% increase in free cash flow from from 2019.
We are now expecting full year, adjusted EPS to be slightly higher than last year.
And we're very pleased to announce this morning, an accelerated share repurchase agreement for the repurchase of approximately $500 million then a key issue shares to be executed as part of our previously announced $2 billion share repurchase program.
Oh really looking at our performance for the quarter, our recovery in business our confidence in the sustainability of our operating efficiencies and the outlook for our business and coupled with our outstanding liquidity and cash position financial position that.
There we're taking this step to announce this 500 million dollar accelerated share repurchase program.
Program.
So with that I will turn the presentation over to Jeff Songer, and then be back for some concluding comments in a few minutes.
Okay. Thank you Pat and good morning, I'll start my comments on slide seven with a quick update on our COVID-19 status we.
We continue to operate with only minor impacts to our workforce and continued to manage as diligently as we have since the outset of the pandemic.
We are maintaining a close focus on safety of our workforce as we enter the fall season and feel positive that our efforts will continue to show good results.
Moving to key operating metrics for the quarter velocity of 14.5 miles per hour improved 4% year over year, but declined sequentially.
Well at 22.9 hours increased 13% year over year and sequentially to pay.
Two primary factors affected the sequential performance of our key performance metrics and dwell in particular first a rapid shift in volumes, which ended the quarter, 60% over the Q2 trough the red.
The Red line added to the key metrics chart illustrates the pronounced swings in volume we have seen throughout the year we.
We've responded to these extremes throughout the year by Rightsizing resources continually evolving our service plan and maintaining our daily focus on execution.
Second we incurred back to back Hurricanes in the Gulf region during the quarter as we've seen in prior years. These events led to outages across several segments of the network and created a backlog of traffic the impact.
The impact was more pronounced on cross border traffic traversing this Gulf region comp.
Compounding the hurricane impacts again, where the rapid rebound and cross border traffic with those volumes up 34% sequentially and 10% over prior year.
We are confident that ongoing and future PSR initiatives that Sami will describe in detail will allow for continued improvement in key metrics as the network stabilizes.
Turning to slide eight progress against overall keep PSR goals was mixed.
Well in velocity were challenged during the quarter as I previously described while train length and fuel efficiency are exceeding their goals.
We're very pleased with how quickly the team has responded to rapid swings in volume over the past few months by rapidly incorporating changes in our service plan, we have been able to make significant strides in areas such as train length train start reduction in fuel efficiency in a short amount of time.
These improvements are reflected by the outstanding cost control performance that Mike will review in his presentation.
Ongoing capacity investments will continue to support network fluidity, and we have accelerated work on several siding extensions and yard expansion projects. This year, some of which will be complete by years end to early 2021.
Finally, you may have seen during the quarter that we have secured a us presidential permit for construction of a second international rail bridge at the Laredo, and Nuevo Laredo Gateway while.
While there are many other steps in the Mexican and general construction permitting processes. This is a positive first step and we have started preliminary design scheduling and cost modeling for the project.
I will now turn the presentation over to Sam.
Yes, Thank you Jeff good morning.
So like Jeff said this this was a very exceptional quarter.
That swing volume.
Unprecedented 60% increase in in a very very short period of time.
And then compounded at the same time was back to back Hurricanes. So it was the equivalent of like an 80% increase in volume that we have to absorb in a very short period of time and it's a testament to the resilience of off of the case, yes team headed by.
Steve through it all our VP of transportation, who he and his team worked diligently and very very hot including the long Labor day weekend day and night.
Any color from had again, Laura which caused us washouts for about four days bought outages, which collapse you name. It. So we had like four days essentially when you're going on driving traffic.
On the on the very critical you know our stylists adversary between us and Mexico. So we the team managed to get through that velocity is back on that book actually this morning, the velocity in the U.S. has 17 miles what Ilo. So we are back to where we need to be we still have room to grow as a way to expand in a few moments.
But the team did a great great job and they did it without.
So the temptation of just you know putting it.
Good morning ill, bringing.
Bringing in assets from storage, bringing locomotives.
Adding crews and.
In disproportionate numbers, which is the typical way that railroads have had always done it before before BS are you you are measured in your response and you do it the right way and you are right size and and keep rolling and address the problem not the symptom. So you will to the bottom of the problem and.
So assets added so the team did all this and managed to to get through it and we maintain the learnings that they did during the pandemic, which is very important and you can see it on the grass.
The the volumes have dropped only by 4% June Street against Q3, and yet the crude stocks have dropped by 23%.
23% drop in crude starts and when you look at the headcount, which is reflective of this the headcount in the U.S. run down by 18% in transportation and even in Mexico, where we you know those are different but we used attrition.
Got it actually went down by 8% so talk on between US and Mexico, that's down from transportation, one down by 12% and that translated into a $16 million reduction compared to the previous year. If you. If you go to that now with a steady state because I am using actually September numbers, which are well have the volumes are thank you much.
The same as they were last year.
52 million dollar reduction in cost you know on a on an annual basis. So the team did that you look at the local malteser locomotives.
Our down by 15% in spite the again the volume is only down by 4%.
And that you can see at the mechanical headcount for the shops mechanical is down 8% again, 18% in the us the headcount reduction in mechanical and 2% domestically, but again, we have we have limitations the train lengths, which is the technique that allowed us to do all this one pop by 16% that's it thanks.
Solid Asian, and getting smarter about the way you do service design and how you combine the topic and why do you do it and I will expand on that on the next slide which is slide 11.
Where do we see what room is available now for us to grow and to and to keep getting better like we are at 58.8% operating ratio, but you still have a lot a lot of work ahead of us and on a lot of opportunity.
The number one is we are spending a lot of time now onto plan compliance we are measuring that traffic.
Customers and the connection times on are they missing the connection in oil from train two train when you go down from the U.S. with intermodal traffic and connect in San Luis Potosi, and then go on another train and connect again in Escobedo you know for some of our key international customers, we are monitoring that and not only that but we've been better.
We'll now so that the feed can react. So we don't have to wait until lets say Atlanta has failed and say well you know we missed it they can actually add Ben expedite the traffic and that will help us grow the revenue because kfcs is unique in its opportunity for growing the revenue and like Pat said it many many times from the beginning of TSR <unk>.
Steve Service Begets goals and it's very clear you do provide this service and we came in first in a shipper survey.
Casey asked did on service. So it's a testament of the work we are doing another big area is balancing reducing the switching and balancing it it's it tends to be lumpy as far as the same way as you have the principle of train lengths. The other big thing is on the car level reduces switching Don switch to many.
Times, the same car and tried to do within the smartphone yards. So you don't want right now we have.
Like Monterrey, Monterrey has a lot of customers hundreds of customers and the art has type configuration at the same time, thanks, Chaz, which is our minority in across the board. There is a very large yard where we have a lot of opportunity. So something we started doing in the past two months is that we that Sanchez.
The building blocks for the Monterrey customers before the train even leaves Sanchez the water mom today, So I think thats. The mom today on today has less switching to do otherwise that cause that switched in Monterrey got switched four times because attracts our short that beyond this is Ben it's packed in which case.
It's a captive network. So you have to switch many many times. So you reduce that we had a yard in the center of Mexico like we had some issues about the about two months ago.
Two months ago, and actually we shutdown that yard and we distributed the work to San Luis Potosi in the South Escobedo get Antero. These audiences in the south and on and on Arsenal able to handle and and and you know the issues doctors all been that yard and we went back to it but we learned a lot.
When when we did this is our size we know that we can do a lot of that blocking at origin and do the classification of the origin and when we definitely think about that again as as we move forward.
Last example, you know off of blocking traffic in the right places. We are we are upgrading actually at the end of this month the capacity of our trains and Victoria selling units, which is a big intermodal terminal in the Monterrey area and that will allow us to do blocking of traffic for our interchange railroads.
The north instead of doing it in Sanchez and that will free up capacity in such asked to do more work for Montenay that I described earlier and actually more water for Nuevo Laredo, which is a very small yard just before the bridge and that's not the case why do you want to do classification and get things to do a lot of work because if you. If you wish anytime you list the fit you Miss the.
Famous windows, which are a limitation on the bridge six outlets the Illinois, six Dollarstwo thousand any ski flip flopping was the windows and if you Miss the window by half and I'd like to expand on our earning call. Then you are waiting for six hours. So we love to move away from that job as much as possible, but not only that we are working very hard.
On the moving the windows completely altogether.
And we are very very close to it.
Some breaks will happen. This this week and we believe that we are very very close to eliminating these windows in which case. If you have dual northbound you'd let them go that is a solid bomb you. Let it go south and you keep flip flopping without without having to wait for static windows up six hours.
The other thing that has to have an impact on all these efforts and we started like Jeff mentioned is.
Putting money in infrastructure, where it is complementary and synergetic was what we are trying to do with disease switching and locking in the in the property are and also in continuing our strategy of increasing the train lengths on consolidating trains so invest in London signings, we have dual sidings after expedited this year.
In spite of the improvement in cash flow and the reduction in our capital envelope, we actually manage to squeeze in two more siding extensions in very critical locations between Benjamin Mendez M&A as well we have a lot of train meets up long trains and we are doing improvements in our yards in Sanchez our configuration.
And because it's a big yard important job, making along their switching leads so that when you are switching it on blogs them in line and we're doing the same thing in San Luis Potosi. So these things are all parallel day, and well thought out and they are all happening at the same time and these things will allow us to go out of our train lengths right now is 7000 feet I'm not happy.
About that ramp up by 16%, but this is very far from where we can be if you look at the rest of the industry, we consider it Solomon.
No.
For for train lengths the same way as by the way for the velocity. We you know all these things are going to have velocity. We are that we are at 14, and 15 modest but dollar and really didn't back up I mean, we had the hurricanes that affected us obviously and we are beginning to roll back to our normal speed, but even at 70 miles an hour.
Let's take on board to Plenti, one might put dollar.
Well for the rest of the industry is so we have an opportunity that and not the least opportunity is the fuel efficiency fuel efficiency. We are up 1.25, which is a great improvement from when we started VSR. When it was 1.45, yet even though the U.S. portion of Casey asked is that 0.97.
The the Mexican portion is that 1.55, it's a very very that's gallons per kg TM.
The number of the worse you are so we can bring that down and that average up 1.25 should be able to get to be driven down to something like yes, maybe 1.1 or may be lower and that would have that would help us get to.
To whether we should be so that is still a lot of opportunity and I can go on and but I don't take anymore time I think at this point I would like to turn it to do.
Mike Nets, Mike.
Hey, Thank you Sandy and good morning, All I'll go ahead and begin my comments on page 13.
Overall third quarter revenue was down 12% year over year on a 4% decline in volumes.
As you heard Pat say, we experienced the strong sequential volume recovery.
Third quarter volumes rising, 30% from the second quarter levels.
We experienced a very nice closed the quarter with September volumes rising 2% year over year.
Looking at the performance by business unit, you may observe that quarter to date revenue declines generally outpaced our volume declines. This can be explained a at least in part by the art.
ARPU reconciliation in the upper right portion of the slide.
You will see that lower fuel prices and FX together accounted for the preponderance of the decline in our revenue per unit as you.
As you know we have offsetting cost benefits that go along with a declining peso in declining fuel costs.
If we were to hold the FX and fuel price constant revenues would have been down about 7% year over year.
Business volume mix, including disproportionate growth in our domestic and franchise cross border intermodal business. For example contributed to a lower our ARPU as well so.
Literally mix also contributed to a shorter length of haul in some segments and was another contributor to the decline in ARPU.
It's important to note that a decline in revenue per unit does not imply we pricing nor a lower profitability.
In our results clearly indicate that.
Returning to the business unit chart.
Few brief highlights by business unit.
Chemical and petroleum volumes increased 5% driven by strong growth in our refined products business, which was partially offset by lower LPG volumes, which experienced a shift in sourcing patterns.
Industrial and consumer segment saw volumes fall, 9% driven largely by weakness in our metals business. We continue to see lower demand for drilling pipe of course due to the oil market collapse and for metals products, which are used in infrastructure projects.
The good news is that sequential volumes were up 8% in this area and we're looking for continued improvement.
AG and Min revenue was down 6% on a 3% decline in carloads sequential volumes were up 11% here well grain volumes were flat year over year ores and minerals volumes were down driven by weather related infrastructure delays.
The energy business unit carloads were down 20%, which resulted in a 28% decline in revenue I think you're all familiar with the story Frac sand crude oil and coal were all down due to weak demand in the case of coal lower natural gas prices.
Intermodal carloads were up 2% with cross border franchise and domestic markets, both seeing near 20% year over year growth in volume this was.
This was driven by inventory replenishment ecommerce demand and tightening truck capacity.
Unfortunately, due to the weaker peso and strong truck import competition. These gains were largely offset by our lower last row intermodal volumes.
And lastly, our automotive volumes were down 18%.
Did see a strong sequential recovery as the plants continue to ramp up during the quarter. The improvement continued through the quarter in September volumes were only off 9% year over year.
Healthy U.S. demand and low finished vehicle inventories across many of the Oems provide us with some optimism looking forward.
Similar to the second quarter core and contract pricing held up well as we continue to execute with discipline pricing strategies.
Turning to page 14.
You'll get a better visual representation of our recovery overall total daily carloads ended the quarter up 60% is my colleagues mentioned from second quarter lows and were above pre coded levels. This is.
This improvement was led by key strategic growth segments, which have performed well since bottoming out in the second quarter and these segments are actually growing on a year over year basis, highlighting our unique market position.
Specifically, our cross border franchise volumes were up 10% demonstrating the unique role that we play in facilitating trade between the us and Mexico.
The Mexico energy related business rebounded with revenue is rising 17% on a 34% increase in volumes.
You think about it this is really quite impressive when you consider refine product demand remained soft as a result of the COVID-19 situation.
And we've already discussed the automotive and intermodal business. So looking at page 15 I wanted.
I wanted to provide you with a bit more detail on our growing cross border refined products business.
Year over year third quarter revenues were up an impressive 55% on a 61% increase in carloads again.
Again, considering the cobot driven weakness in fuel demand is particularly noteworthy are you in.
Our unit trains as you can see in the map I'm sorry.
Our unit train business remains strong and Weve seen excellent growth in our manifest business.
Now as you can see on the map, we are uniquely positioned to move refined product from the Gulf coast into Mexico, and we look forward to growing this opportunity along with our customers.
In summary, the recovery has been remarkable, albeit a bit uneven while certain business segments, such as crude remain under pressure and a covert a resurgence is a risk we do have good reason to be optimistic.
Based upon customer feedback and low inventories across many of the business segments. We expect the economy will continue its steady sequential recovery.
You asked trucking demand has been improving we are seeing tightening capacity improved pricing power.
The Port Arthur drew bit project continues on schedule and is expected to be operational in the second half of 2021.
We continue to believe near shoring opportunities hold promise in the long run and both of Us and Mexico and.
And we absolutely value our customers and look forward to working with them as the economic conditions continue to improve and the supply chain continues to change.
And with that that concludes my comments I'll turn things over to our CFO, Mike Upchurch, Mike. Thanks, Thanks, Mike and good morning, everyone I'm going to start my comments on slide 17.
Compared to Twoq Q, we saw an improving demand environment and combined with our structural improvements to our operating costs helped deliver I think terrific financial performance in the third quarter and positions the company incredibly well for improved profitability as we expect continued volume improve.
Moved into Fourq, you and into 2021.
Although third quarter revenues, and carloads dropped 12, and 4% respectively. The permanent improvements to our cost structure help jcs post a record operating ratio of 58.8% 190 basis point improvement over Q3 of 2019.
An increase in quarterly volume of nearly 30% led to sequential incremental margins above 70% strong evidence our cost actions are contributing to a greatly improved operating ratio and ever increasing cash flows.
Reported EPS was $2, a one cents adjusted EPS of $1.96, which was up 1% over prior year.
Reported and adjusted earnings per share includes a 20 cents benefit from new tax regulations issued in July that provide an exemption to certain aspects of the guilty tax based on.
Based on these final regs, we are lowering our adjusted effective tax rate guidance for 2020 from 29% to 26%, which includes a retroactive adjustment of $18.7 million as a result of the new regulations. We're also lowering our adjusted tax rate.
The guidance going forward to 28%.
On slide.
19 or 18.
Adjusted operating expenses declined 15% quarter over quarter, I think terrific cost.
Cost management by everyone on the team expire.
Expensive expense reductions were achieved across all operating expense categories other than depreciation and again I think evidence of really strong cost management.
Our compensation expense declined by 18 million as a result of reduced head count and the benefit of fewer hours worked that is mainly attributable to fewer train starts from our PSR train consolidation efforts at Sammy discussed.
Fuel expense declined $32 million from price declines lower fuel consumption and fuel efficiency improvements.
I'll cover comp and benefits and fuel in a bit more detail on the next slide.
We also saw repairs and maintenance expense declined $5 million as reduced mechanical expenses benefited primarily from a reduction in our active locomotive and freight car fleet.
Finally peso depreciation during the quarter drove 11 million in year over year Opex benefits offset.
Offsetting these reductions is approximately 4 million of higher expenses, driven by COVID-19 impacts.
During the quarter, we incurred approximately $2 million in incremental compensation expense due to COVID-19, requiring employees to be off from work either due to illness or quarantine protocols.
Additionally, we incurred another $2 million in cleaning sanitizing and other health related expenses to keep our employees safe during this pandemic.
Finally, we remain solidly on track to deliver the previously announced 2020 PSR savings of $95 million.
Moving to slide 19, let me.
Let me cover comp and benefits and a little bit more detail along with fuel overall, we saw comp and benefits expense declined 13% driven by an $18 million reduction from lower headcount in work hours as I mentioned on the prior slide our COO.
Our quarterly average head count was down 9% driven primarily by the furlough actions in the us and the voluntary separation program we.
We also experienced a 19% decline in transportation compensation and benefits expense at K. CSM from lower work hours. The result of reduced crew starts and train starts that Sami discussed.
This reduction to comp and benefits from lower headcount and work hours is an excellent example of how PSR actions that we've taken during the second and third quarters have benefited our cost structure and we expect to retain those benefits going forward.
These reductions were partially offset by wage inflation of 4 million.
Moving to fuel fuel expense declined 42% in Q3 as reductions to fuel price drove $18 million in savings, while lower consumption drove 10 million in savings.
Most importantly, we also achieved a $4 million benefit from improvements to fuel efficiency as a result of running longer and more fuel efficient trains both.
Both compensation and benefits and fuel are excellent examples of how variable costs have scaled down quickly and meaningfully with volumes. During this downturn and the Sammy indicated we plan to keep many of these efficiencies and cost savings as volumes return.
Finally, moving to slide 20.
I wanted to discuss our capital allocation highlights our year to date free cash flow is up 28%.
Excluding a $78 million or locomotive lease buyout, we executed back in January our free cash flow would have increased 52%.
And as Pat noted, we have increased our full year 2020 free cash flow outlook from 500 million to $550 million, a nearly 30% increase over 2019.
Our year to date Capex is down 38% driven primarily by the 139 $9 million of locomotive purchases that we experienced in 2019 and we were.
And we remain on track to spend $425 million or less on capital this year.
Finally year to date shareholder returns are up 50% year over year.
Led by a 70% increase in share repurchases.
As noted on the second quarter earnings call, we did resume share repurchases beginning into Q as we felt more and more comfortable that volumes were sustainably improving after having bottomed in April and early may.
Additionally, this morning, we announced a new 500 million dollar accelerated stock repurchase program utilizing proceeds from our April 20 debt offering.
The $500 million as are we expect to have consumed.
1.4 billion of our 2 billion dollar stock repurchase authorization approved by our board of directors less than a year ago in November 2019.
With additional visibility to the recovery from the pandemic and confidence in our ability to continue delivering superior revenue growth.
Margin improvement and increasing free cash flow, we also plan to reassess our capital structure and shareholder allocation goals with our board before the end of the year and with that I'll turn it back to Pat for some closing comments. Okay. Thanks, Mike just a couple of quick comments I think the most impact.
In fact, we will slide in the presentation you just saw was.
Mike map. This slide 14, if you and of course I know everyone on the call is aware of this.
Second quarter volumes down, 20% third quarter of 30% by the.
By the end of the quarter, we were running 60% above the trough on a daily basis.
Really just a remarkable story and a remarkable roller coaster the choice.
The challenge of course was too as we.
As we were coming out of the depth and as we were seeing recovery in business coming back was to balance the.
The bringing bringing back resources, bringing back introducing service.
Meeting, our customer demand, but being very thoughtful about maintaining the operating efficiency and the cost efficiency that our PSR efforts over the last.
Two a year and a half.
We have created.
I think we did an outstanding job balancing that in the face of uncertainty as to exactly how this recovery was going to play out.
Did we execute flawlessly from a customer service standpoint, no but.
But again I think our our.
Our results were improving over the course of the quarter. The Sami mentioned compared to data that we have about other rails and rail service in general feel pretty good about that but we are very focused on customer service and service metrics as we now operate from this.
From this new level going forward, we are extremely focused as an executive team and all throughout the company and making sure that we are meeting our customers expectations.
A final comment I know a lot of employees on this call and I just want to re.
Reiterate the comment that I made in the press release about the performance this quarter and really over the last two quarters of the amazing resiliency and the tremendous discipline and focus of our employees throughout the company.
Just for the for the effort that they put in.
In addition to the roller coaster of volume in the rapidly changing business conditions throw in a couple of hurricanes and it was truly remarkable what our employees were able to accomplish we are so proud of what our workforce has produced here and feel that we're in great shape going forward.
With the talent that we have on the team.
Before I turn it over and open up the my two questions and answers is the little friendly guidance on questions. We we will we will not entertain questions about M&A I know, there's still probably some unresolved questions about that we have not commented on any of the rumors that are in the market and we don't intend to so you might want to just.
Save your questions for something that we will respond to and then finally on guidance Weve updated some areas of guidance, but we are not in a position today to give any guidance on volume and revenue as we get through the year and we tightened our forecasting and our budgets for 2021 and beyond we may.
We may be in a position to provide some additional clarity in January so with that I will be happy to answer or open the call for questions.
Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone if you.
If you are using a speakerphone please pick up your handset before pressing the keys.
Drawing your question. Please press Star then too.
Students the number of participants on this morning's call management will limit your questions to one.
At this time, we will pause momentarily to assemble our roster.
The first question comes from Allison Landry of Credit Suisse. Please go ahead.
Good morning. Thanks.
So just given the dramatic change in volumes throughout the quarter could you give us a sense for how our trended maybe during each of the month and specifically where you ship out in September.
I guess, what I'm trying to expand it theres some upside to that Q4 and full year our guide.
To the extent that current volume trends hold thank you.
Yes, good question Allison.
Definitely we saw an improvement throughout the quarter.
Volume in September was up 2% with.
With volume increases you get that added benefit of incremental margins on that volume and so I would tell you generally we trended better.
Throughout the.
Quarter.
Okay, great. Thank you.
The next question comes from Chris Wetherbee of Citigroup. Please go ahead.
Hey, Thanks, good morning.
I know you guys don't want to address anything from an M&A perspective, but I think there's maybe a topic around longer term or that can help us kind of think about how you view the potential of the business, which would be helpful.
Yeah, obviously year to date, you had a couple of very good quarters in a challenging one in the context of Cove into Q.
Running in sort of the higher Fiftys now what is the longer term opportunity. The business. If you can kind of see where you are today volumes have not fully recovered, but potentially on good track to do that.
Where can go and if you're not comfortable given that today sort of when should we expect you to kind of lay out for that longer term plan to give us a sense of what you guys think you could do.
Yes, Chris This is Mike I'll take that one.
The year, if you look at it 59 dot seven in one Q.
65 Dot two I think it was in Twoq, you and now 58, Dod eight you know you just kind of wonder what could the year have been.
Without the pandemic.
Clearly.
But below 60, which was our guidance for 2021, when we started the year in January so we're trending.
Certainly well below that number here in the third quarter and have a very very constructive outlook on our ability to continue to manage costs down and now that we're beginning to see a volume environment that is actually showing growth.
Incremental margins in the quarter.
Yes, when you look sequentially were over 70% and we think that that model is going to be alive, and well with volume growth and so while there is still little bit of uncertainty in the macro.
We do believe volumes are getting better and better and.
It will be nice to begin seeing some consistent growth, we're going to stop short of giving you know our number for 2021, we'll do that in in January as Weve typically done.
But by issuing a full set of guidance.
Okay, but just one piece of clarification on that when you think about maybe longer term to just 2021 I think there is sort of the view of potential.
Good improvement from here is that something we can also expect in January or is that something that we have to wait a little longer for.
Yes, no I think we will give some some longer term outlooks just like we did in in January of this year and remember we have said for a long time, we don't see any reason why we can't have the best operating ratio in the industry, obviously, everybody else is not standing still either but.
That's certainly our position.
Okay understood. Thank you.
The next question comes from Jon Chappell of Evercore ISI. Please go ahead.
Thank you good morning.
Maybe a little bit of change of tone as rich as it relates to autos I think is one of the conferences in September there was some cautious tones about the medium term outlook for automotive just given things like work from home and unemployment, but Mike Nats was was pretty optimistic and we've seen some favorable saar numbers as well as some depleted inventories. So just wondering how you're thinking about.
So for the next six to nine months or so maybe we get to a normalized inventory situation what are your thoughts.
What are your customers, telling you, but also how do you feel about your your your customers in Mexico is ability to produce given all the co bid situations and the ramp up back to kind of normalize and what that means for the cross border.
Well this is Mike Thats I'll go ahead and take that one yeah generally speaking we've been pleasantly surprised with the recovery on the auto business. There are certainly some segments of the economy in some aspects that unemployment that remained but vehicle sales have remained strong.
And the inventory levels remain low.
And Thats why I said, we are optimistic.
We are getting.
Getting some mixed signals, but generally believe that auto levels should get back to more historical levels by the end of Twentytwenty one.
And with respect to Mexico is ability to produce the vehicles down there I can't speak directly for the Oems of course, but I believe that they have been taking the necessary precautions to make sure that those plants continue.
Continue to operate as smoothly and efficiently as possible and we generally seen that.
We were not aware of any specific plant shutdowns.
That have resulted as.
From from Cove. It here recently, and we are optimistic that that's going to continue as well.
Okay, great. Thank you Mike.
The next question comes from Justin Long of Stephens. Please go ahead.
Thanks, and good morning.
Hi, good morning.
Hey, just wanted to follow up on some of the service commentary, obviously, we've seen a substantial improvement there I wanted to ask about how that's impacted truck to rail conversions and the network is there any way you can help us think through that tailwind that you are seeing today to volumes and going for.
Forward is there a framework that you have in mind for conversions and and how that could contribute to volume growth going forward, whether that's 100 basis points or 300 basis points would love to just get your high level thoughts on that.
I think we're probably going to fall short of giving specific guidance.
As specific as you just suggested but.
I'll ask Mike Matt comment generally about the.
The the trends in capacity issues are seeing in intermodal.
Well I'll sort of refer to an example that we've used in the past.
And we believe that we have a nice opportunity to convert.
Cross border.
Truckload business over to rail, we currently have 1% or less of the truckload volumes that are moving across.
Radio are moving on rail. So we think we should be able to eat into that so long as a service performance.
Is acceptable to the marketplace.
We see a lot of upside there and clearly we're seeing that in our domestic and.
And cross border intermodal volumes here in recent months.
So we remain bullish on that front.
Okay. Thank you.
The next question comes from Amit Malhotra of Deutsche Bank. Please go ahead.
Thanks, Operator, hi, everybody congrats on the quarter Mike.
Church I just wanted to follow.
Follow up on the sequential margin question.
If I think about the operating cadence of the business Threeq to Fourq, you revenue will be up probably nicely, let's call. It 10% seems like a reasonable estimate as you look in threeq to Fourq you the implied kind of sequential.
Incremental margins to get to kind of a low 60. So ours is only like 40% on that revenue growth number. So I. Just wanted you to address a kind of a wonky question, but I think it's important in terms of trying to think about the operating momentum that you have seems to be improving as you go on so why should incremental step down sequentially and then and then just.
Good My second part of my first question. The Capex is 17% of revenue you guys decided to give it out all the way to 2022.
I mean that will catch you be basically be the most capital intensive rail in the industry sorry, the most capital intensive use rail in the industry with all the stuff that you're doing that effectively creates capacity from a PSR perspective, why isn't there a lower capex number as we look out to 21 22, if you can address those two questions.
Thank you.
Yeah, well I'm I'm not going to take the bait on your revenue.
Number there, but I would just say I think the twoq to Threeq you performance speaks speaks for itself and we have strong conviction that incremental margins are going to continue to stay.
Very strong you know what we don't know is the volume environment that but right now we've got a constructive outlook on that and we think we'll see a little bit of growth from three.
Threeq into Fourq, you just like we've seen throughout the third quarter.
On the Capex question that you asked you know, 17% is kind of our target going forward.
We have clearly significantly outgrown the industry in volume.
You don't do that without some incremental capex investments to improve your capacity Sammy talked about a number of projects to improve the fluidity on the network in terms of yard expansions in siding expansions to be able to run longer trains and.
We think that has a just a terrific payback.
Expanding train length, and we do need to make some investments to do.
To do that with with siding extensions and Thats the plan for 21 and 22.
Okay, all right I'll leave it there thank you.
The next question comes from Ravi Shanker of Morgan Stanley. Please go ahead.
Thanks, Good morning, everyone.
So maybe this question little bit unfair, but probably I'm going to do.
This does show is the high bar you guide to set yourself I think by your own definition, you guys had a mixed operating quarter in Threeq you, but they're also wore a couple of unusual items like the hurricanes in such I didn't hear any quantified as Scott are you able to quantify kind of ex coal bed if they ever.
Sure I didn't Miss is that kind of core results this quarter and kind of what the metrics sort of look like or what the or red looked like without things at the Oregon, and the strike and such.
Yes, right Ravi I mean less than we had a rough quarter with with Hurricanes and we did incur some incremental expense, but but we typically haven't quantified that.
You know, it's just part of doing business in the part of the country. We operate in and I think the only time that we have ever talked about in any kind of substantial incremental costs is related to.
No hurricanes like like Harvey in 2018, or Alex and.
2010 that were $50 million to $75 million in costs, we did not have those kinds of costs, but understand that operating in that kind of an environment, where you're moving equipment out of harm's way and.
Waiting for the storm to pass and then having to deal with clean up and ballast.
All those other issues that come along with it I think Sam we gave a pretty good description of all of that yeah. There were some incremental costs and you know.
You know that's that's not just physical damage its.
Trying to reposition equipment and your fluidity isn't as good and it takes a little bit of time to recover but we're not going to.
Talk about any kind of specific number there just say, it's a few million of incremental cost in the quarter.
Okay fair enough if I can just sneak in a quick follow up to the incremental margin question. The biggest one is that.
Can I ask their different way do should we expect the incremental margins to be strong as now as we are coming off of the very bottom or do they get better as we go along I know with commitment volumes picking up momentum or something do you expect the strongest incremental margins now or kind of clubs.
18 months from now.
We're going to continue to try to improve our incremental margins every single quarter.
And I think we're going to leave it at that we we've given guidance here, we improve that guidance for year to the low end of our 60 to 61 range and.
We're going to stick with that commentary.
Great. Thank you.
The next question comes from Tom.
Yes. Please go ahead.
Hi, yes, good morning.
So I just wanted to see if you could offer some thoughts on what you might be most optimistic on four if you look to like 2021.
Which segment.
We've had the best potential for growth you, obviously talked a bit about refined product kind of hard to.
I guess, it's hard to know like what are the catalysts from the current elevated level of refined products is that going to go more you know are there kind of other catalog.
Other catalysts and other business segment, so it's kind of a 2021 frame and.
You think are the kind of most powerful volume growth drivers.
My math, you want to take that question.
Im sorry, Pat could you repeat the question please.
What.
Yes. The the question was basically 2021.
What do you think are the most powerful volume growth drivers I know you spent some time on refined products kind of where do you think you go from here and also whether it's intermodal or other segments, where do you have the most visibility too.
And growth when you look at 2021.
I continue to believe that the cross border business will remain good and that will be comprised of a variety of different components, including the intermodal business and including.
Adding including a continued recovery in auto.
Grain, we will continue to be good moving across the border as well. We also expect that we'll see some lift in manufacturing inputs as the economy would continue to improve so that would include products in our industrial and consumer segment.
Would you expect further growth in refined products from where we are.
All depends on how things.
How things go in terms of Colgate people returning back to work in the economy, but given the current trends I would expect that that would continue to improve.
Great. Thanks.
The next question comes from Jason Seidl Oh. Please go ahead.
Thank you operator.
Pat.
Mike and Sammy team good morning.
I wanted to talk a little bit because I think the word roller coasters been mentioned so many times I think we're at six flags right now so when you're when you're thinking about a more normalized operating environment sort of where should we see the benefits of that going forward, especially on the on the cost side. So in other words.
Where did that roller coaster hit you guys. The most on cost in 2020, and what types of improvements should we see in a more normalized operating environment.
I I can I can take that Jason like you saw you saw the impact.
Of that not only of the role of course, but unfortunately, you know that being compounded by the heavy gains.
You saw it in the dwell in off in yards.
And that is a number that that Tony will improve you know as as time progresses now that we don't have hurricanes and now that we stabilized.
Like the volumes are improving they continue to improve but not not in that same percentage that we saw the abrupt sub an increase of 60%. So we should see an improvement in a in the dwell and an improvement in the velocity, which means you know it continued reduction in the assets.
Or keeping the same assets to generate more revenue.
You know a very good example that the that that has you was also in the past as a cloud of Saipem on green Okay.
The site the Rand cycle.
Was was at the beginning of September definitely softened, especially from the Hurricanes and then in the back end of September It was incredible like the you know we we got to about 18 day CCAR cycle and all this is now from Kansas City, all the way to Mexico City and back.
Including the loading and unloading.
You know this number used to be 29 days before PSR. It went down to 18 like we have now 1.6 cycles for months and it used to be one cycle of hormones and that generates revenue add.
At the same cost increase revenue and the revenue is that like like Mike touched on it might mess.
The demanding.
Rain is is substantial like I think last the last months for.
111 particular customer we we are very close to a record.
Rather loads and actually fourth quarter for October the number that is targeted that is forecasted is is an old an all time record in AWS and.
And we we are quite confident that would meet that so ill answer your question. Jason once we we read out in all the the hurdles that went through in Q3, and we are removing them, especially you know any ours and all that service design stuff that I talked about you know justification why do you do the classic.
You shouldnt be smart.
What do you do the switching and all that and improve the other velocity and that is going to translate into.
So hopefully a higher revenue without increasing the cost or if need be then you can reduce the cost. So I. That's what I think we are going to see well then see a big big improvement.
Okay, well, assuming obviously credit to your team for handling just very difficult operating environment here in 2020, producing results like throw one more in you guys mentioned train lengths and that you have plans to even increase them further as we look in 2021, you were above I think your goals for 2020 already what type of improvements whether it be on that.
Total foot basis or percentage basis should we expect in 2021.
Hi, Anthony.
That that I mean, we we are continuing while continuing to improve let this morning as an example.
Both us and Mexico on that seven to 300.
Train lengths. So we will have a lot while watching that love love to Hawk looking while not well I'm not going to go backwards I went to keep going up now and I'll, let Mike I'm sure said, we want to provide some guidance Jason in in January and that going to be on many things you no longer train lengths are probably trend.
It starts and velocity.
You know I mean, a conservative way about both train lengths would be would be at a minimum in line improvement and additional improvement of 5%.
And that does not does not is not asking for a lot and as we as we do more on the siding extensions in order to allow more places where long chains can meet.
Now that is going to enable us to do more and more off longer trains.
Without that you have the whole trains for a long time and location lab you have the 10000 feet on the plugs thousand feet lengths.
So on 10 until the other one passes through and then then you take the train out of up in the siding. So so it's very critical that we deploy a well site.
The siding extensions and we have we haven't had big Big plan for Florida siding extensions I believe the total is it something like 17 siding extensions I thought in the plan and I went to finalize that at the end of this year as to the pace of deploying them.
Okay, well listen I appreciate the color that's great update and appreciate the time as always gentlemen.
Thank you Jason.
Operator, do we have another another question.
Did we lose the operator.
Anyone is out there standby, we're trying to reach the operators see what has happened.
We'll do.
Excuse me this is the conference operator.
Just wanted to check.
Are you able to hear me.
I'm able to hear you, yes, do we have more questions in the queue.
Yes. The next question comes from Scott Group of Wolfe Research. Please go ahead with your question.
All right. Thanks morning, guys. So for Mike Mike Upchurch, you mentioned the capital structure in revisiting. It maybe can you just talk about do you feel comfortable running the railroad. It at three turns of leverage would you go above three turns of leverage and then separately you took out the PSR saving slide maybe just.
An update there.
Do you have an early look on 21 for PSR savings is there more to go on on the absolute savings or is it more just about operating leverage from here. Thank you.
Yeah, Let me take those in reverse order you will note on the slide that we discussed expenses. We indicated we are still on track for $95 million of PSR savings for.
For 2020 and.
We are continuing on track with a 150 million of annualized savings.
For 2021, so so that is alive and well.
Youre going into 2021 with respect to the capital structure. You know we've had a longstanding target of low twos leverage ratio.
You know I think at this point in time given the.
Given the interest rate environment, and kind of the mix of equity and debt in our capital structure.
We are going to have some conversations with our board about potentially moving that but but I wouldn't.
Commit to anything until after we've had those discussions with our board.
Which we do expect to occur here before the end of the year. So just know we're looking at it we understand it's been a conservative management of the capital structure that was intentional but.
But given the operating cash flows that we're generating in this business and the free cash flow we.
We feel just terrific about about the prospects of the business and feel that so.
Some adjustment there upwards is probably warranted.
Okay. Thank you guys.
Scott.
The next question comes from Allison Poliniak of Wells Fargo. Please go ahead.
Hi, good morning.
Just want to go back to the comments on chip Chip plan can finance you know relative to your customer service commentary it sounds.
It sounds like already taking steps on the cross border traffic is there any way to give us some color on kind of where you are today, particularly the cross border relative to your photos and how do you. How quickly do you think you can achieve that target, particularly in a normal environment here any thoughts there.
Hi, Matt do you want to answer that question.
Mr. Nuts. Your line is open.
Okay. It appears that we've lost.
We've lost answer on Nance.
Okay.
In Mike's absence.
I would like to go back I think.
Mike May have misstated, a number on the on the market share the current market share and the opportunity we see for intermodal in particular and as we stated earlier the cross border intermodal continues to be a very solid growth area and that is certainly one area where.
Service and.
Trip plan compliance is.
Is.
Yes more.
Much more of a consideration in terms of growing given the premium service sensitivity that business. So.
We feel very good about our position in terms of the routing options that we have for our cross border product. The the customer base that we have as you know we're a wholesaler in the intermodal space. So our customers are the big Guy Mcs and.
We have service options.
Specifically, meaning enter interline service with.
All of the other class one railroads that really give us an opportunity to serve any customer regardless of their preference or commitment to I am Si partners and rail partners.
So the focus is to continue.
Continue to build out those trains continue to improve our consistency and reliability.
Those numbers are improving and I think we have.
A pretty good visibility to two particularly as we have come through this year.
Use the term once again this roller coaster.
Of of decline.
Declining and then rapidly recovering volumes.
To get to a excuse me.
More.
Kind of more normal steady state and baseline to grow from this point.
Feel good about the commitment that our customers have made in terms of providing resources, specifically equipment containers into this market I think they all see the opportunity and some of the things that we are doing at the border specifically related to use.
Using technology as Sami mentioned, eliminating the windows at the bridge some issues with international crews and then ultimately building the second bridge across the Laredo.
New wave of Laredo Gateway are all going to contribute to just.
Overtime steadily increasing capacity and improving resiliency and consistency of rely and reliability of service, which is really the key factor for those intermodal and automotive customers as well as all other commodities, but.
No doubt that the.
Consistency and reliability.
Is is of the utmost concern to the intermodal and automotive customers. So.
I don't know if all of that adds up to a good answer to your question as far as the opportunity we have.
We think we are in the 5% to 7% market share range today. So.
So clearly there is a lot of opportunity for grow if we do the things that I described earlier add capacity continue to work with our partners and improve consistency and reliability of the service. This is an opportunity, particularly in the intermodal space, where we could see.
Market share and growth.
Over a very long period of time.
And may make maybe if that to add to add to this like like I mentioned, we monitor. This every day. So so we do have numbers and.
And you know right now the trip plan compliance on that traffic is about 60% and definitely we have room to improve.
And we know we know where the connections that get missed happened like I said on my.
My section.
Connecting train some in all at S&P soundly purple seal or a disco battle we understand.
Well the connections.
Can have can have issues and were working on that and the definition by the way of topline compliance on this traffic is his vehicle delays of hours, which would stein of non typical typically you have to have a little bit of love to do it. If you if the traffic makes it was in two hours as an example, it is it would be too.
We did as a success, but in in many of the cases that we looked at was with some specific customers, but is not even a two hour.
Margin in also so you know 60%.
60% is is not great.
But it is it is quite decent considering what we have been through doing during this quarter.
And now with our eyes also very focused on it with our.
Between commercial and operation.
And was the regular review every week plus the review every every morning call. These.
These numbers will improve.
Okay and the last question today will come from Ken Hoexter of Bank of America. Please go ahead.
Sure. Thank you.
Great. Thanks, and thanks for squeezing me in good morning, maybe just a little bit on your thoughts about costs coming back on locomotives and employees as volumes ramp and then just to clarify your comments on margins do you see nothing structural in terms of given your more regional intermodal moves on a margin potential versus rails with longer haul I just want to.
And your thoughts on on attaining that best in industry potential. Thanks, Yeah can you you know in terms our costs coming back on I mean, I think any way we look at it we've just had terrific cost.
Performance here and maybe this will help a little bit I think threeq to Fourq you as we look at expenses.
Yeah, a lot of its going to depend on volume, but we're kind of looking at flat flat to slightly higher expenses.
Across the board I think you may see a little bit flat to low single digit on the comp line item, just given some expectations around better volume growth.
I think equipment and materials and other purchased services are all going to be in the flattish current kind of range.
Which I think rates you know good optic for incremental margins.
This is obviously a.
Question, everybody has got some interest and so let me let me just go out there and say we had a 70 plus percent.
Incremental margin Twoq to Threeq, you I think we can see something similar threeq to Fourq you will see.
We'll see what the volume environment looks like but I think that that's pretty reasonable.
You know in terms of longer term the structural points that you referenced I mean, there's pluses and minuses there yet yeah sure Weve got maybe some shorter haul, but we make that up on our cross border, which looks a lot more like a larger class ones and given the kind of growth we're seeing in Q.
Ross border. That's that's good for margins out long term, that's that's our sweet spot or our crown jewel.
We obviously have better labor costs in Mexico.
That will continue to give us some favorability and then some minor offsets going the other way around security costs and and the concession fee that we pay too.
The government based on revenues that but net net you know.
Theres nothing that I believe that that would prevent us from having the best operating ratio in the industry.
Thanks for the time appreciate.
Okay operator.
Thank you Sir I'd like to turn the call back over to you for any closing remarks, Sir okay.
Okay, well, thanks, a apologize for some of the clunky Miss here, but that's an indication that we are taking distancing seriously here. So.
Thank you all for your attention and we'll look forward to updates as they occur at conferences and getting back together in January for our fourth quarter and into.
Additional commentary about where we feel 2021 looks like thank you all very much.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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