Q3 2021 Kansas City Southern Earnings Call
Okay.
Good morning, everyone and welcome to the Kansas City, Southern third quarter 2021 earnings Conference call.
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It is now my pleasure to introduce you to Ashley Thorne, Vice President Investor Relations for Kansas City Southern.
Thank you Jamie good morning, and thank you for joining Kansas City Southern's third quarter 2021 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 risk identified in our annual report on Form 10-K for the year ended December 31, 2020 and in other reports filed by US with the SEC forward looking statements reflect the information only as.
The date on which they are made casey's 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's, President and CEO and fire.
Thank you Ashley and good morning, everyone. Thank you for joining us for third quarter earnings call.
I'll just start.
Start with slide four.
Thank you.
Most everyone here is well known we did ask Adam got her to join US today our.
General counsel in the event, we get into some detailed questions about the.
<unk> timeline.
We'll probably all notice the absence of Sami Fannie from the agenda today.
Many of you probably saw the press release that we sent out last week announcing that Sami would be leaving the company between now and the end of the year.
We had originally thought that this earnings call was going to be last week Sam.
Sami had planned some very well deserved vacation.
That that he continued to follow through on I don't think Sammy has taken more than two consecutive days of vacation for the last almost three years. So Sam he is not with us today.
Just to reiterate what I said in the press release and what we've said.
On other occasions.
Really cannot say in.
That's about what Sammy brought to the company over the last.
Almost three years.
Enthusiasm his focus is.
His passion those of you who know Sami you know that passion really is probably the one word that describes him better than any others has been of tremendous value to us over the last almost three years. He has built a lot of very strong.
Just tone across our organization with people that were here before and are here now to carry on our focus on <unk>, our disciplines and very importantly, he helped recruit and strengthen our team.
And most noticeably with the presence of John or who you'll hear from later in this presentation.
We again will.
Have the opportunity to celebrate Sami and his contribution to Kcbs in November next month at the rail trends conference that I know a lot of you attend.
We are going to be having a reception for Sammy on Thursday November 18th in New York in connection with the real trends conference.
And I know Sami is very much looking forward to seeing everyone, there and having the opportunity to chat with some of his.
Closest friends in the investment community. So if you haven't already be become aware of that Mark Your calendar for November 18th in New York City.
With that I will turn to slide five I think the most important thing we will probably cover here in questions in.
In this call is the path forward on the Canadian Pacific, Kansas City Southern merger.
We continue to make very good progress toward closing our transaction with Canadian Pacific.
As you know to create the first single line rail network linking U S, Mexico, and Canada truly a north American rail franchise.
We and Canadian Pacific have filed with the SEC registration statement and proxy statement for use in connection with the shareholder votes. On this transaction. Following completion of the SEC review process, we will announce the meeting date for our special shareholders meeting.
And mail proxy materials to our shareholders.
We currently expect the special shareholder meeting for both <unk> and CP to occur by the end of the year.
As you know <unk> shareholders will receive their full consideration upon closing into the voting trust, which we expect in the first quarter of 2022.
Closing into the voting trust is subject to Casey's and CP shareholder approvals and.
And satisfaction of other closing conditions, including Mexican regulatory approvals, most noticeably the Copa say antitrust agency.
Just as a reminder, walk acs's in voting trust, our existing management team and board will continue to run and lead the business.
And former Casey's CEO, Dave Starling will act as the independent trustee.
While entrust, we will retain both full independence and the ability to manage capital investments.
According to our plan capital program, we anticipate receiving full STB merger and control approval and other applicable regulatory approvals in the second half of 2022.
After which the voting trust will be terminated and CP would then have full voting rights and control of Casey's.
In advance of this milestone we are working very closely with CP on the integration planning process and merger approval process.
Following STB control.
We intend to implement these integration plans and begin to unlock the full potential of our networks our markets and our people.
Be happy to answer any questions in the Q&A section of the call later on.
Moving on to slide six I'll, just briefly cover our results for the quarter.
Revenues were up 13% from last year.
Or 6% after adjusting for FX and fuel volumes were down 3% from last year.
We continue to operate in challenging commercial environment.
With auto plant shutdowns.
Cause by the global micro chip shortage that everyone is very well aware of.
Teacher strikes and disruption of service in the stretch of our railroad between Ladbroke hardness in Mexico City.
And <unk>.
Finally increased regulation of refined fuel product shipments into Mexico.
That have that has resulted in supply chain disruptions.
In that area of our business.
Masking, some bright areas and improvement operations and customer service, which we will hit on shortly we're very very pleased with the improvement that we've seen in our service metrics.
And certainly customer feedback, which.
Again, Mike and John will talk about later on.
Second quarter reported operating ratio of $66 one.
And diluted earnings per share of $1 71, both of which includes the impact of merger related costs. Our adjusted operating ratio of 61, two and adjusted EPS of $2.02 is a bet.
<unk> view of our underlying results for the quarter.
These results are.
Fallen short of our expectations and previous guidance due primarily to the commercial challenges that I mentioned a moment ago.
Additionally, we deployed.
Incremental resources in the second quarter.
To improve our service restore network operating performance.
And be prepared for the return of some of the revenue shortfalls.
That we experienced earlier this year.
In addition to addressing service.
We did expect demand to improve more quickly than it did which has created pressure on our productivity, particularly early in the third quarter.
John will talk a little bit about the performance over the course of the quarter in a couple of minutes.
We're the first to admit the visibility on the commercial side is limited.
Given these challenges and therefore, we are suspending guidance at this time until we get a better feel for the duration of the chip shortage teacher strikes and refined products supply chain disruptions.
Moving on to slide seven we're pleased with the improvements we've made from a network perspective.
The $15 three mile per hour gross velocity was the best ever for a third quarter and dwell returned to more historical standards.
Particularly encouraged by the sequential improvement throughout the quarter and into October.
We exited the third quarter with gross velocity at $16 four mile per hour and dwell of 19 hours.
Our U S operations led improvements in the early part of the third quarter in a sustained and built upon that over the course of the quarter and into October.
Mexico demonstrated accelerated improvement in the second half of the third quarter as well.
I'm going to invite John or at this point to make a few comments while this slide is still up on the screen.
And you're all hopefully looking at it.
Just to touch on a few more details and some of the initiatives and momentum.
We continue to see in our key operating metrics and then cover network performance on the following slide as well so John if you'd like to make some comments here.
Thank you Pat.
As you said, there's a lot of encouragement from a network perspective with gross velocity and dwell.
In the range of first.
Q3.
At this point as you said the sequential improvement.
Gross velocity and dwell moving into the third quarter and the first three weeks of October is very promising.
As you said the U S led.
In the early part of Q3 the transformation.
Gross velocity and dwell were 30% and 10% better respectively in Q3 Q2 levels.
And in Mexico.
Again as you said the second half of Q3 was where we really start to see the traction for gross velocity and dwell and fill.
<unk> finished the quarter, 18% and 23%.
Respectively, and the Q2 levels a strong performance is continuing into Q3 and as our velocity and dwell are in the 16 to 19.
Range.
What's really encouraging is the run rate improvements are continuing well into October.
I feel particularly good about our resource levels.
A more fluid network and we're seeing improvement in utilization.
The motive center crews.
While our average locomotive fleet is up year over year, it really doesn't quite tell the full story.
Began the quarter with an active fleet one.
1047 locomotives and through improvements and initiatives and a lot of I'll call. It sweat equity we were able to park will return over 170 units, we exited the quarter with an active fleet of 860 units.
And the average count in Q3 was 7% lower than what we saw in Q2.
And we're continuing to push.
More of our fleet and as of this morning.
Our range was in the 840 locomotives.
Our <unk> head count is.
Year over year, and we brought back our crews from furlough and we've added key in select locations to meet the current demand and as you said for volume.
Our current utilization and GTS per crew start improving.
And re crews were down to the lowest levels of the year in September.
In the U S. For example, pre cruise were down 60% <unk> zero percent.
Versus may of 2021.
I believe we're well positioned from a resource and capacity perspective.
Very very successful peak season.
Locomotive discipline will afford growth at low.
Maintenance costs and through better yield and reliability.
Our crew utilization initiatives are changing behaviors, resulting in metrics that are very healthy with GTS for crew starts well above historic levels.
Fluid capacity and inventory levels are well understood and the team is reacting in real time to ensure train counts and other controls are adjusted accordingly.
If we could move to slide eight.
Here, you can see the positive impact that additional resourcing and optima.
Optimum operating initiatives have on gross velocity and dwell despite the broad and well documented challenges at the North American global supply chain.
Significant improvement and execution at the field level, driven by Tim Livingston, and thus the MLC level, Mike Walter are foundational to the improvements in our operating metrics.
On time origination of the network improved to 87% versus 77% a year ago.
And within the overall network.
The execution in Mexico really stands out.
Great car train improvements.
From 82% to 82% versus 77%.
Last mile first of all performance has improved 80, 683% versus $83, 78% beginning in 2021.
One of the barometers.
Our organizational health is the cross border shuttle types.
And our cycles for the most recent 20 days.
Is approximately 15 days versus 2007 days in the early spring.
We implemented daily MLC led cross functional cross border Green calls earlier this year.
Or are we drilling to train and terminal operations to accelerate and optimize handoffs across divisions and interchange partners.
The team measures themselves against offline and online destination performance time distance standards, mechanical reliability and readiness and they make tactical decisions necessary to optimize the cycles.
Given that these are some of the longest.
Runs on Tcs from southwest, Illinois in Kansas City into Central and Southern Mexico.
And to reverse areas that we've talked about in the past this congestion points Houston trackage rights.
Orders.
In the Monterey area.
This is one of the best examples I can give you of the disciplined and adaptability that the team has been able to implement over the past several months.
Structural improvements include rationalizing some of our early network some of our Mexican network and removing all of the workload.
Yards and Ocado.
Acus in the wafer Laredo.
These moves were the key catalysts to unlocking velocity improvements in Mexico, and driving the dramatic reduction in 12.
As we mentioned.
Exiting them has strengthened the skill of the team and requires a sustained level of rigor and responsive to executing.
Yes.
If I could add customer facing metrics and performance improvement as followed the broader network trends.
Our overall trip plan compliance.
That measures.
<unk> capability.
Reliability of our customer service is at the highest levels in over a year and has sequentially improved since July.
Coordination and communication between sales and marketing and operations is much improved.
As part of the motor.
Moderate engagement efforts.
We've embedded our customer solutions into the operating control our team.
Real time issue identification and decision, making are optimizing customer solutions and our very key market.
And this is delivering world class first mile last mile execute execution in this complex.
Industrial.
Homeless.
These are really the highlights of Tcs as mature into any product global view of PCR or <unk>.
We are focused on our customers with a bias towards growth through maximizing use in reliability of our assets and investing in resources to deliver reliable customer service.
To deal with increased complexity of the Tcs and global supply chain.
Most encouraging is the lateral and vertical alignment within operations and across our commercial and financial groups that is creating a cohesive and sustainable momentum and very favorable results for our customers and stakeholders.
Service.
I'll turn things over to Mike Upchurch.
Thanks, John and good morning, everyone I'm going to start my comments on slide 10.
I'll cover revenue and volumes and a little more detail on the next slide but overall quarterly revenues grew 13% on a 3% volume decline.
Our report.
Reported operating ratio of $66. One includes $37 million of merger related costs that we incurred during the quarter.
Excluding those merger costs, our adjusted <unk> was $61 two a 240 basis point increase year over year and flat.
And when Chile.
As Pat mentioned, we had several discrete commercial challenges and increased costs from network congestion that I'll discuss in more detail on the next few slides, but let me cover a few of the key expense items in the quarter that contributed to the adjusted or.
We incurred roughly 10.
<unk> dollars are a 130 basis points of incremental expense in the quarter from resources that we deploy to address the service challenges we were experiencing earlier in the year.
May remember that last quarter, we referenced approximately 200 basis points of headwind from costs attributable to congestion.
So the good news is these costs have come down as we've progressed through the third quarter and as John indicated our networks running about as good as we've seen in a long time.
The improved trajectory along with significantly improved service gives us a level of confidence that we will be able to leverage our resources.
<unk> deployed going forward and achieve better productivity.
We also incurred $6 million.
Or an 80 basis point higher year over year derailment and casualty expense and as we discussed on the <unk> call, we incurred $4 million in the quarter.
Forces, a 50 basis point impact from Mexico outsourcing reform and I'll cover that in a little bit more detail on the following slides.
Our overall reported diluted earnings per share were $1 71.
Adjusted for merger costs and foreign exchange.
<unk> adjusted.
Diluted earnings per share was $2 <unk> up 3% from a year ago.
Continuing on slide 11, this quarter, we generated 13% revenue growth from a 3% decline in car loads.
On a fuel FX constant basis, our revenue growth was 6%.
As a reminder, fuel and foreign exchange impacts are generally operating income neutral over the long run, although we did experience a 50 basis point negative impact to or in the quarter largely due to higher fuel prices.
Our revenue per unit was up 16%.
We.
We had some mix issues with intermodal carloads down 13% that ended up positively impacting overall RP you well.
We also benefited from positive pricing and length of haul increases in the U S.
There were primarily within our higher revenue per unit chemical and petroleum.
<unk> and industrial business units. In addition to seeing overall increases in revenue per unit from fuel and FX.
Regarding price, we're keeping an eye on the recent uptick in inflation or Q3 pricing results were consistent with what we've seen in.
In previous quarters, this year, but rising inflation is increasingly concerning.
We are carefully monitoring inflation as we work with customers to manage their overall transportation costs as.
As we review contracts and head into a heavy renewal season in the first half of 2022.
Two and specifically we have roughly two thirds of our business that will get repriced in 2022 with almost half of that being in the first quarter, we're certainly going to be mindful of the need to ensure pricing adequately covers inflationary costs.
Turning to volumes.
As Pat mentioned earlier the.
Q3 volume decline was primarily due to three key areas segments.
Auto plant shutdowns, driven by the global Microchip shortage and.
Obviously overall volume.
Related to finished vehicles was down about 30.
<unk> ascent.
We saw some additional pressure on the intermodal auto parts business that we move southbound into Mexico, and other supply chain impacts, including plastics and metals that are inputs into auto production.
Currently it's unclear when the supply chains will normalize, but we are working closely.
<unk> with our customers to understand timing and we stand ready to support them as their production normalizes.
Service interruptions at <unk> due to blockages, resulting from the teacher protest have impacted our volumes for more than 75 consecutive days now.
In <unk>, we were essentially operating trains only in the month of July with no traffic in August or September.
During the quarter the blockage of our line resulted in approximately $25 million of lost revenue of 100 basis point negative impact to operating ratio and about <unk>.
<unk> <unk> negative impact to EPS.
These blockages resulted in about 67% lower volumes for Lazar intermodal as well as negative impacts to our heavy fuel oil moves for Pemex, along with some metals volumes.
As we discussed last.
<unk>, our refined fuel product shipments have been negatively impacted by increased government regulation in Mexico, resulting in certain supply chain disruptions.
These temporary regulatory impacts resulted in 18% lower energy reformed volumes.
However, we continue to expect.
Quarter that these impacts are temporary as we continue to help the government ensure customer compliance with the new regulations.
The underlying market dynamics remain unchanged, mainly that two thirds of Mexican gasoline and diesel demand is being supplied by the import market.
<unk> is obviously extremely well positioned to bring that product from the U S Gulf coast into Mexico to help cover the supply shortfall.
While there is some evidence that there's been a shift in fuel importation from rail to truck. We continue to believe rail is far more efficient motive.
Transportation and that we will see.
<unk> to rebound.
Strengths, we're seeing in energy industrial and consumer and AG and men.
Energy carloads were up 43% driven by low coal stockpiles steady.
Steady demand.
<unk> has obviously been helped by high.
For oil gas prices that have been hovering between five and $6 along with the startup of the dru bit Port Arthur terminal.
Industrial and consumer carloads were up 7%.
This business unit benefited somewhat from easy comps a year ago, but also healthy industrial demand.
<unk> steel production facilities that we've talked about for a while that have come online and we still have a few new plants that will open up.
Later, this year and into 2022.
And then finally, our AG and Min carloads were up 5% on steady demand and the improved cycle times.
And that John mentioned earlier.
As Pat mentioned, we withdrew our guidance due to certain uncertainty related to the micro chip issue will Lazarus blockages in the refined fuel supply chain disruptions. However, we do believe that these are transitory in nature and our medium.
Medium to long term outlook for those business units remains unchanged.
Moving to slide 12.
Given that the expense we incurred to recover from our service challenges and other drivers in the quarter, such as fuel price FX, Mexico outsourcing reform.
<unk> and higher derailment in casualty expenses, we saw an overall, 18% increase in operating expense.
Fuel increased $20 million from price and $3 million from consumption, primarily driven by fuel price increases in both countries and higher GTS in the U S.
Some increased bulk shipments.
We also saw an $11 million increase in expense from foreign exchange, but that was more than offset by a $12 million increase in revenue from FX.
We experienced a $9 million increase from headcount and hours worked which I'll talk a little bit more on about.
Slide.
Along with a $4 million increase from wage and benefit inflation, which was partially offset by a $7 million reduction in incentive compensation.
Additionally, as we signaled on our second quarter call.
We incurred incremental expense in Q.
And that related to Mexican outsourcing reform.
And specifically, we saw comp and benefits increased $5 million, but that was partially offset by a $1 million in lower purchase services from the in sourcing activities for a $4 million net year over year increase.
Looking forward.
Three we would expect to incur an additional 3 million dollar expense increase due to the outsourcing reform, but believe the impact will be immaterial in 2022, as we fully realize the savings of in sourcing vendor services.
We also.
Third we had a $6 million increase in materials and supplies primarily from the increased locomotive fleet that John referenced however, as we go into the fourth quarter, we should fully expect to see those cost declined given the decrease in the active locomotive fleet.
Primarily due to higher derailments, we saw $6 million increase in casualties.
We also saw $4 million increase in property tax, but thats, a negative year over year comp because of a $3 million credit we recorded in <unk> of 2020.
We had a 4 million.
Increase in employee expenses, as we incurred higher lodging and taxi costs for our <unk> crews, resulting from higher crew starts and finally, a $4 million year over year reduction in car hire driven by supplier incentives and improved cycle times from.
Pigment and velocity.
And then finally on slide 13, let me cover comp and Ben and fuel expenses real quickly comp and benefits expense increased 14% or $16 million in Q3 9 million from the head count in work hours.
Imprudent by a 3% increase in head count, which does exclude the impact of in sourcing that we've provided more information on the slide.
The increase in head count and crew starts were almost entirely in the U S. As we brought on resources to improve service and address of 6%.
<unk> volume growth that we saw in carloads.
In the U S, which would have led the industry.
As discussed on the prior slide we did incur incremental expense in the quarter and comp and benefits on Mexico outsourcing, but as I indicated earlier, we saw some benefits in purchased services.
And expect that impact going into 2022 to be immaterial.
We also had a $4 million impact from foreign exchange of $4 million from wage and benefits and then those increases were offset by a $7 million decline in incentive comp as we lowered our.
Our accrual for annual incentives.
Compared to <unk> of 2020.
And then finally fuel expense increased 53% in the quarter drew.
Driven by a 42% increase in fuel price foreign exchange and the increase in consumption.
Sure.
As I've done in prior quarters, maybe just a quick summary of the quarter, obviously, a very tough quarter from a demand perspective, largely transitory type issues.
We did have some cost creep.
But we think we're getting much better there, particularly on the equipment.
<unk> side as we execute here and <unk> had some negative fuel price impacts in Mexican labor law impacts.
And then from a sequential perspective, despite a decline of <unk>.
4% in volumes, we saw a slightly improved.
<unk> operating ratio and three Q. So we think the setup.
<unk> and going into 2022 will be better than what we saw in Q2 and Q3, so with that I'll turn the call back to Pat.
I think my summarized the quarter really well just a couple of things that I would add and that is.
Hi.
I like the way he referred to the setup.
We were we were we were quite intentional during this quarter to bring resources back to deal with network congestion some unexpected things related to the fuel.
<unk>.
Find fuel issues.
In Mexico, the permitting requirements et cetera.
I think slide eight that John went through is really one of the most impactful here in our.
Our presentation today, just the magnitude of the improvement in some of our service metrics, we're seeing this down to the customer level as well.
Well and.
We still believe that the revenue headwinds the areas that Mike touched on are transitory maybe.
Maybe we can debate how long transitory covers what timeframe.
Our crystal ball is no better than anybody else's staying.
Staying really close to our customers, but <unk>.
Certainly in markets like the auto finished vehicles that business will come back and I think we are set up again using mics term very well for recovery when that business does return.
Hopefully soon hopefully in the fourth quarter, but.
Certainly early next year.
And then obviously the the focus on the merger.
Making great progress there and I think we see a clear path to.
To getting all of the regulatory and shareholder approvals and concluding that transaction in and.
The next few months, so with that the whole team.
Available for any of your questions.
Ladies and gentlemen, we will now begin the question answer session.
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Due to the number of participants on this morning's call management would like to add to limit yourself to one question at.
At this time, we will pause momentarily to assemble the roster.
Our first question today comes from Chris Wetherbee from.
Please go ahead with your question.
Good morning, Chris Good morning, Good morning, guys.
Maybe I could just ask about the operating ratio. So you talked about sort of the setup going forward and maybe some improvement sequentially and how things are going but we also talked about sort of some resource addition to be able to catch up on some of the service.
Service metrics that youre, highlighting so I guess, maybe two part question here for the fourth quarter do you think you can get back to year over year operating ratio improvement and then as we think out beyond 2022 I. Appreciate your 2022 and beyond I. Appreciate that you are pulling guidance because of a lack of visibility, but what do you think we have to have.
<unk> rebased higher sort of our expectations for operating ratio and then we can improve upon that or do you think there's the ability to catch up if what we're seeing is actually transitory. So just want to kind of understand <unk> and then how do you think the setup might progress as we move out into next year.
Wow, there's a lot in that one Chris but I'll take.
Establish.
Stab at that our goal is always to improve operating ratio and I do have some confidence here that from a cost perspective.
We're progressing pretty well, particularly on the equipment side I think we've still got a little ways to go on labor productivity and fuel efficiency.
But lots of focus on that and I think a lot of it is just going to depend on the demand environment.
Lazar of situation is very frustrating.
We can't predict accurately when that relieves itself.
Refined product we continue to have.
A lot of confidence.
<unk> in that market, there's a huge.
GAAP in supply and demand that has to be fulfilled by importation and we're incredibly well positioned and you'd like to think that auto begins to show a little bit of.
Strength is the chip issue resolves itself, but.
If there's one thing we all know the entire auto sector has been wrong about how long. This chip issue is going to last so we're just going to have to wait and see and then as we set up for 2022, I mean, we still feel incredibly good about this business.
Comment.
Comment about medium and long term, we don't see the growth prospects having changed at all.
Having gotten over the hump now on some of the service challenges.
It's incumbent on us to get productivity back to some of the levels that we saw earlier, but as you see in the data.
Our velocity and dwell and trip plan compliance and all those other metrics. We track every single day are improving and I think that sets us up reasonably well going forward.
Great. Thanks for the time I appreciate it.
Our next question comes from.
Ken <unk> from Bank of America. Please go ahead with your question.
Hey, Pat and Mike and team just if I can follow up on the on some of these network issues. What resources do you have to protect yourself in Mexico, I mean, you've been dealing with the strikes.
Especially the teacher strikes for a really long time here.
No.
It doesn't seem like I don't know if theyre impacting other industries or do you need the government to come in and shut down I mean, it seems to be more of a permanent ongoing impact maybe talk about what you've been doing and how you can control that if at all possible and then same thing in the energy reform It sounds like you've got something going on that's been impacting.
And externally talk about your time frame for resolution on those both thanks.
Just on the teacher strikes this is ernie.
<unk> followed us for many years it is a chronic issue in this part of the country.
<unk> certainly gotten worse here recently.
Particularly.
Because of some of the politics and the rivalry between the state level leadership and the federal level.
We did have a a transition in the leadership of the state of Michigan Con in October one.
We were very hopeful and optimistic that.
That would be a breakthrough we still think it will be a breakthrough.
Longer term, but.
The fact remains that the tracks aren't clear the teachers haven't been removed.
The issue is we need the government to enforce the law and remove the protesters.
And the blockage of our of our property.
Not law enforcement, we're not going to do that and we are we lobby very aggressively with all levels of state and federal Oscar spends a lot of time talking to government officials in Mexico trying to make sure they.
They understand the economic impact of this I wrote a letter two days ago to the finance Minister.
Reiterating the impact of this not just on us on our customers on on citizens of Mexico, who are employed by these companies. It does affect other businesses the economic losses.
Is.
It's very substantial.
They do also blocked the highways from time to time, so it tends to be.
And equal opportunity disruption, but.
The fact remains the government is responsible for law enforcement and we just need them to do that.
Our optimistic certainly.
It will get resolved we have.
Reasons to think that payments are being made thats, what its all about with the teachers.
Restoring.
They're or addressing their their complaints about compensation.
And we just hope that the change in administration will lead to some longer term piece.
That is in that region that will allow us to.
Get back to sustainable operations.
On the refined.
I don't know.
That's a mouthful I don't know that I answered your question.
As I said it may not be a very satisfying answer, but that's the answer that we got.
On the refined.
<unk>.
The third quarter I think we got we got surprised in the.
In the second and third quarter, because the rules changed the the pipeline was.
And in terms of originations coming out of U S. Gulf Coast, We're we're humming along at very.
<unk> fuel attractive levels and then.
When the when the product was on the railroad moving into Mexico.
We noticed that the government was cracking down on some of the permits and inspections.
And that caused kind of a double whammy not only to slowdown or our.
Supply chain and the flow of that product, but it caused some.
Unusual.
Congestion in our yards that rippled into.
Added cost and service disruptions across our entire portfolio.
That piece of it.
Congestion and service.
Our owned and from a broader perspective, I think we have feel like we've really resolved during the quarter.
But the.
The heightened permit and inspection rules for this product are going to continue for some time that Mei Mei.
Have the impact of.
Disruption in our growth and our opportunities there, but I think.
We now know what the rules are we're working very productively with the government. We know that the demand for these products is going to continue to be strong.
And hopefully get back into a more normal predictable cycle.
Cycle.
Of damper of how we can move this without the kind of interruptions that we've seen.
Mike if you have anything to add to that.
I guess, the only thing that I would add is to the extent that product continues to move in some of that product is moved over to truck.
We're confident that that eventually we will move.
The rail because it's easier to administer from a regulatory perspective, and quite frankly, it's a more cost effective and efficient way to move the product into the country.
Great. Thanks, Pat Thanks, Mike.
Okay.
Our next question comes from Amit Malhotra from Deutsche Bank. Please go ahead with your question.
Thanks, Good morning, Pat.
Hopefully sticking with Mexico for a second.
Hoping you can give us an update on the approval process in Mexico I know.
You don't really expect any insurmountable hurdles, but obviously you're progressing down that path. If you can give us any additional color then Mike Upchurch.
And maybe Mike Thats obviously.
I'm wondering if you can kind of <unk>.
Expand on the pricing.
Opportunity you noted in your remarks, obviously capacity is constrained just wondering if you can kind of compare the pricing opportunity today to maybe past periods of constrained capacity.
Before we all forget your question will go to the <unk>.
Our application is in.
<unk>.
The ball is in <unk> court to come back with a request for information.
So it's fairly early but I think we learned a lot about the Prost.
<unk>.
Through prior experience here over the last several months and.
So I think.
This should be maybe a little bit easier, but until we get requests for information from coast to say, we're not exactly sure what that process is going to look like.
There are certainly should not be an issue here.
As everyone knows from an antitrust issue Canadian Pacific terminates in Kansas City, They don't have any duplicate operations.
So we think this is a fairly straightforward case.
But we also know the Coca say.
There has been.
Challenged with staffing and resources.
So they're just normal backlog seems to be moving a little slower than.
Then we might like but.
Based on what we've heard so far based on the feedback we've gotten from our advisers we.
We don't see any real difficulties with the case and hopefully.
Can get approval in a matter of a few months.
I think on the pricing side of the house.
As Mike mentioned earlier, we have.
Attractive pricing environment right now certainly inflation is.
Say that we're watching youre seeing.
High incremental cost and pricing and other modes of transportation.
We're certainly seeing inflationary pressures in the real world and the railroad and we basically will hold the same premise that we've had in the past which is that we.
Will be.
Something being at or above inflation levels rail inflation levels moving forward.
But isn't there isn't there an opportunity to price well above inflation levels given.
How constrained capacity is I'm, sorry to ask a follow up but just talk about your ability to price to the market rather than just price too.
Price inflation given constrain.
Constrained the capacity next year.
Youre seeing that to the extent that we have the opportunistic.
<unk> the price those are certainly things that we'll be taking into consideration as we negotiate our contracts.
Okay. Thank you guys I appreciate it.
Okay. Thanks.
Two.
Our next question comes from Brian listen back from Jpmorgan. Please go ahead with your question.
Hey, good morning, Thanks for taking the question I just wanted to come back to the refined products and energy reform more broadly.
Can you just comment what's the net effect when when the regulatory side settles down a bit on the imports.
Do you expect more to go to unit trains as you could probably get a little bit of consolidation on the permitting side I guess I'm, a little surprised to see that truck is able to pick up some capacity here.
If you can comment on that and then secondly, we've seen more comments about the LPG pricing caps I know thats.
The smaller part of energy reform, but I guess, if you can comment on that as well because it was a little surprising I think thats. The first move we have seen on pricing.
When against the energy reform.
If you can comment maybe on the implications of that what the impact has been on the market as well that'd be helpful. Thank you.
Alright, I'll go ahead and start with.
With respect to the comments on the refined products unit versus manifest trains are unit train business has been fairly consistent we haven't seen the same magnitude of disruption that we've seen on the manifest side of the house.
We do expect that.
As the regulatory environment.
And supply chain issues.
I guess more into a normal activity, we do expect that the manifest fuels will pick itself back up it's that manifest business that is largely migrated to the trucking.
A portion of the business.
Where products are.
Taking a short haul over the Mexico.
Border into the northern Mexico.
Central Mexico marketplaces.
With respect to the LPG.
Not sure that I entirely understood the question, but.
Obviously.
Lee.
Mexico has indicated that they are going to try to contain pricing.
On behalf of the consumers in Mexico.
That may resolve result in Mexico effectively subsidizing the.
The LPG cost.
Move forward.
But again this will be ultimately become a supply and demand question with respect to LPG is moving into the country.
Okay.
Thank you for the question was about the pricing caps at the Craig put on.
A couple of months ago, which is the first time we've seen.
2017, but it sounds like you aren't seeing too much of a volume impact from that and I was just curious if there's other implications of capping here that might translate to other products, but theres caf theres going to.
In your markets.
Alternative markets that those products can go to.
That since those products are probably going to migrate into those other marketplaces.
Brian just to put it in perspective, though.
We're moving two to 3000 carloads of quarter.
That are tied to Mexican energy reform, so, it's a pretty pretty small part of our business I wouldn't expect it to have a big impact.
Okay. Thank you guys appreciate it.
Our next question comes from Justin Long from Stephens. Please go ahead with your question.
Thanks, and good morning.
To ask another one on refined product. So Pat earlier, you mentioned that the permitting and inspection requirements could.
Act a headwind for some time.
Does that mean that you are viewing this as a structural change that youre going to have to overcome or do you think there is potential for some of these regulations to get pulled back and I guess, if it is a structural change how does that influence the way you think about incremental margin.
<unk> and returns in this business.
I think it's maybe a little too early to know and I'll take a first shot at this and then maybe.
Like an Oscar.
What I what I meant is.
There is obviously a heightened level.
Level of scrutiny, not only on us, but some of our customers.
For permit compliance for inspections and.
And so some of the disruption that we're seeing here we've seen in the recent past and still experiencing.
Is affecting the business because.
As the players in the market us our customers are having to adapt to really.
A different compliance set.
Set of expectations.
Once we worked through all of that.
I don't know.
Exactly how this is going to play out would it result in <unk>.
Some of the smaller players some of the smaller participants and maybe some of the smaller terminals and receivers.
Siding that they.
They don't want to be in this business.
And how that's going to play out.
Out in terms of the number of customers the number of terminals we can serve.
<unk>.
The.
The density.
<unk> small terminals versus large terminals.
I don't I don't think we know how thats going to play out longer term, but I would say this in.
Mike Oscar I think you guys can maybe add to this that.
At this moment, we definitely have seen fewer.
Receiving terminals because of the.
The change in the requirements and.
I don't know, Mike if you have.
Thoughts or opinions about whether we will see all of those customers and locations come back or some consolidation that could actually have.
A benefit in terms of efficiency of the way, we serve them and cost profile.
Versus a more.
Disparate type of a market.
I guess with respect to the receiving terminals Pat in those facilities my numbers won't be exactly right here, but they should be directionally correct I would say.
As a result of the.
From a going in on a regulatory basis, and reviewing licenses and permits and proper operation.
The number of servicing facilities has declined by about half.
We expect that that number will slowly rise.
As these entities get there.
Business.
Regardless in order, if you will but of course it is going to depend upon.
The regulatory authorities approving those things.
To the extent that we're dealing with.
Fewer entities.
There are operational benefits to us.
In dealing with.
Somewhat.
How old are cool.
Because there's more efficiencies, we expect to move more quantities into fewer destinations.
And just keep in mind, the overall market dynamics still suggest that two thirds of the demand in Mexico needs to come from other countries.
Small, namely the U S to make up the.
The shortfall in demand here and rail is going to be much more efficient than truck and if you think about compliance with regulations much easier to inspect with rail operations and it would be with trucks.
Given given the nature of our operations. So that's why we still feel good about this market as it settles back out.
Okay. Thanks, everyone I appreciate the time.
Thank you.
Our next question comes from Tom White with.
UBS. Please go ahead with your question.
Okay.
Hi, yes, good morning.
Not going to ask you about refined products, but.
The.
Let's see Pat I wanted to get your sense of kind of a longer term thought on outsourcing interest I mean, the supply chain disruption we've seen this year.
<unk> has been.
Remarkable.
And.
Certainly the cost of importing from Asia have skyrocket in terms of container rates do you have any.
Kind of.
What are you seeing from customers that would point to long term opportunities.
For kind of.
It is.
Outsourcing from Asia to Mexico are there any customer types or things that you'd say well. This is kind of interesting from I know these things would take time, but from a longer term basis. If you have any thoughts.
Related to the dramatic disruption we've seen this year in supply chain.
Youre right these things take time.
As we've said in the.
Recent past there we can't.
We can't show you a long list of announcements of new plant locations.
Whether it's in Mexico or across North America, obviously.
<unk> combined CP Casey's North American network.
Is going to benefit and hopefully help drive some of these decisions across the entire continent.
I think the thesis is still very much alive.
The supply chain issues, the prolong supply chain issues that.
That everyone is very well aware of or certainly.
<unk> is.
Doing nothing but fuel some of those decisions.
And but there's a lot of work to do in terms of thinking up in implementing U S. MCA resolving differences between the three countries.
Specifically between U S and Mexico on.
Certainly a lot of issues.
Make sure that our our government policies don't don't.
Diminish to a large extent the opportunity that really north America should be having.
We had Mike Nance and I am not going to over overplay. This it was very.
But we had a discussion last week with a very large discount retailer that was talking about resourcing.
Virtually all of their material and production from from that they currently are sourcing from from Asia coming into the West coast.
<unk>, Mexico. This isn't a manufacturing company to retailer, but they were talking about significant volumes of product coming up from Mexico, changing their vendor supply network away from Asia to Mexico.
Substantial volume that.
Available too for us intermodal.
And some of it.
Truck, obviously, but that was certainly an encouraging sign and kind of validates the thesis that.
The supply chain decision makers are in fact looking to de risk global supply.
It would be.
Again, I don't know that they have.
<unk>.
Anything terribly specific beyond that Mike I don't know if you have anything to add.
But you said it well.
Okay, great. Thanks, Matt appreciate it.
Yes.
Chain. Our next question comes from Scott Group from Wolfe Research. Please go ahead with your question.
Hey, Thanks. Good morning, guys. So can you just review the for the merger timeline. When do you think you'll know if we'll get an expedited <unk>.
A review of the full merger by the STB and then separately pad.
Not sure. If you guys are going to be doing a another earnings call early.
Early next year or not but maybe for the year or so you guys are owned in <unk>. Maybe can you just outline what your key priorities are for the business as it network operations is it growing the business is it earnings cash flow just what are you going to be focused on for that.
Understood.
I don't think it's going to change too much from what we are doing now which is just <unk>.
Improving network operations being prepared to do.
To really take advantage of all of the growth opportunities that we we believer in front of us whether it's for the next year.
Year, or so that were in trust or whether it's way way beyond that.
Certainly.
The story of the CP Acs merger thesis, it's all about growth. So we want to do everything we can to get our network prepared.
To handle our part of that.
<unk>.
I think fuel and <unk>.
Mike said it well we're set up for that we really believe that.
Some of the revenue headwinds that we've been experiencing are still transitory.
We can argue about how long a period of time, you are able to declare something.
Something transitory, but.
Certainly the auto industry no doubt that's going to that's going to return and we get 16 auto plants in Mexico and.
When that business comes back it could come back very strong. So I think it's going to be capital efficiency, it's going to be.
Improving the performance.
<unk> of our network.
<unk>.
And doing all the things that we can.
Certainly.
Dusted off the service begets growth mantra for the last few months.
Kind of getting through Covid.
To that.
That.
Seem to fall.
Paul by the way side, a little bit but.
I don't know.
Don't think theres going to be any other than obviously dividend and capital allocation in terms of share repurchase in that type of thing.
That will change, but I think in terms of focusing on the core elements of the business and and John and the operations.
Team continuing to just get better and.
Capital expenditures, where we think we really need them to.
To be prepared for growth. The good example is the second bridge at Laredo.
We're definitely full steam ahead on that project because.
We think thats going to be necessary.
As far as the first question about the expedited merger review I don't I don't know when we will I'm looking at Adam got us here.
When we might have more clarity on whether the STB is going to.
Except that timeframe.
Scott This is Adam.
That's exactly right I don't know that we have a good answer for you right now obviously, we're working on the merger application.
And I think we're in good shape to file that in the very near future, which will then really start that clock on the process for reviewing the full merger with the STI.
I think we're still sort of holding true to the.
Projection that the final merger.
Approval, if you will will be obtained there in the second half of 2022, but at this point that's the best guidance, we can give.
Okay. Thank you guys appreciate it.
Thank you Scott.
Our next question comes from <unk> majors from Susquehanna. Please go ahead with your question.
Yes. Thanks for taking my question clearly you're optimistic that a lot of the volume challenges are going to come back in your resourcing appropriately.
Can you talk through maybe parts of your business, where you think.
Demand.
Man has been law semi permanently or permanently just trying to think about where you are less optimistic about a snapback.
And our mid term timeline. Thank you.
I guess I'll start with that one.
<unk> has been very good to us here recently.
Demanded.
The higher natural gas prices and supported.
Use of coal, but as you know that is something that tends to be very volatile.
Even though it's a small portion of our book.
And we're optimistic on that certainly going into the first half of next year.
I would say that some of the.
The coal tailwind that we've had.
Our at risk in moving into the future.
Thank you.
Sure.
Our next question comes from Brandon <unk> from Barclays. Please.
Go ahead with your question.
Hey, good morning, everyone and thanks for taking my question Pat I guess, if we can just follow up from Scott's question about priorities in 2022.
It seems like some of these issues can be recurring especially at the teachers strike and obviously you don't know like what regulations can change your end markets, but how do you build in more resiliency.
And variability in the model such that you can maintain operating ratio improvement going forward.
I think I'll, maybe take a stab at that and ask ask John to comment on that but.
I think it's just the improvements that we've made.
And some.
Some of the fundamentals and the focus on the way we operate.
We needed to clear out some of the congestion in the.
The issues that really caused us.
To get choked up.
But I would say now that we really believe a lot of that is behind.
And us.
And we're in a position where the network is.
Is performing extremely well the one statistic that John mentioned was the grain cycles.
And 15 years I've been here I don't think we've ever seen grain cycle times for cross border grain going from west.
Western Illinois, all the way into deepened in Mexico have ever been this is good so as the volume comes back I think we are in really good position to handle that.
And handle it very efficiently.
The.
The things.
Things, we did during the third quarter to get get the network back to <unk>.
John in terms of resiliency and ability to handle these.
These events and growth in the future I don't know if you want to add to that yes.
It's a great question and the <unk>.
He is in the rail industry.
Transportation ecosystem is always something going on somewhere.
Either a headwind or tailwind.
The development of the team and the capability of perspective execution.
Capacity and deliverables are what separates.
Leveraging up on them.
Spot opportunity or dealing effectively with interruption.
Teacher strike.
Refined fuel product issue and.
Even some of the weather issues that we've had to deal with.
We're not unique.
Specially to Tcs to happen they happen across a lot of rallies, but the for me. It's the resilience of the team vertical and lateral alignment of operations the commercial team and our finance team to always be working on continuous improvement as the starting point.
And you're right part when I look at the the principles and the discipline that surround the improvement on the <unk>.
Green Cross border grain supply chain.
It down from 2007 days to 15 days over the course of five or six months.
Really.
Team diving into every segment of that supply chain.
Offline partners first mile terminal last mile terminals across across two countries and across the border and breaking it down into manageable incremental improvements.
And setting standards, it's the same.
Same through through any asset allocation.
People people monitoring people.
Support and in making that happen so from my view.
We're looking at what we've learned from continuous improvement where the barriers and we've got in our catalog.
Capacity improvements for the next three to five years based on a reasonable projected growth based on the sum of the two.
Headwinds, we've bumped up against through the course of this continuous improvement agenda.
And when we look at it from a product level end to end view from CSR, making.
So that we focus on growth.
That we are maximizing the use and more importantly, the reliability the health of our assets the strength of our people to deliver reliable customer service that creates that resiliency.
Some of the early onset initiatives from slide eight.
Manifest themselves into the continuous improvement on dwell and velocity.
We're the establishment of institutional.
Playbooks that.
Standards for terminal activity or.
How we see crews and crew management, where our next level of improvement is from a.
Sure the perspective from a.
Collective bargaining perspective.
It just takes us along that continuous improvement continuum.
<unk>.
That's what I would say the health and strength of the team from a network perspective down to the field maintenance of way in engineering, creating reliable sustainable.
Pavel.
Value proposition for our customers.
It can't be missed.
There is.
From operations commercial and the financial group being cohesive and aligned and sustaining this momentum.
Early builds that constructive tension within the organization.
<unk> keep our elbow sharp and R. R.
Well positioned on what our values are and deliver a safe reliable customer service proposition.
So even when we go somewhat long on assets like a locomotive sweating them, making sure. They are actually working and if theyre not putting them in a position.
Sure.
We've reduced some of the fixed.
Fixed costs and variable costs, so that they're ready when we need them.
To me is that discipline I'm seeing across the operating team.
Thank you.
And ladies and gentlemen, our next question comes.
So Jeff Kauffman.
Hello, Thank you for taking my question.
In light of some of the operating challenges.
With the autos.
With what's going on in <unk>.
Has there been any thoughts about the capital budget and term.
Terms of network investment or are we still sticking with the same numbers that were out there and I guess I was just wondering how your thoughts are shifting on that given the.
The environment in some of the supply chain challenges.
Yes, we're not changing our focus on the.
Required capex spend to support the growth in the business.
Much longer term thinkers than just a quarter ahead.
We have a lot of confidence we will continue to grow this business post combination with CP.
A lot of revenue synergies available to the combined network here that would suggest to us that we keep.
Our plan is intact and make sure that we can handle the kind of volume that we've historically been able to deliver on this network. So no change at all.
Okay. That's my one thank you.
Thank you.
And ladies and gentlemen, with that we.
We will be concluding today's question and answer session I would now like to turn the conference call back over to Mr. Meyer for any closing remarks.
Thanks, everyone for your attention, we'll do our best to keep you all posted as things develop on the merger timeline front.
Front.
Look forward to seeing you all at <unk>.
Conferences around.
Around.
The.
The market here in the future. Thank you.
And ladies and gentlemen that will conclude today's conference call. We do thank.
Thanks for attending today's presentation you may now disconnect your lines.