Kansas City Southern
Q3 2017 Earnings Call Transcript

Published: 20 Oct 2017

[Operator:]

Greetings and welcome to the Kansas City Southern Third Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. This presentation includes statements concerning potential future events involving the Company which could materially differ from events that actually occur. The differences could be caused by a number of factors, including those identified in the Risk Factors section of the Company’s Form 10-K for the year ended December 31, 2016, filed with the SEC. The Company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments. All reconciliations to GAAP can be found on the KCS website, www.kcsouthern.com. It is now my pleasure to introduce your host, Pat Ottensmeyer, President and Chief Executive Officer for Kansas City Southern. Mr. Ottensmeyer, you may begin.

[Patrick Ottensmeyer:]

Thank you very much and good morning, everyone. Welcome to our third quarter 2017 earnings call. Sorry for the brief delay here, but I will start on Page 4. You’re familiar with the presenters, the same lineup that we’ve had for the last several quarters, so I won’t introduce everyone. Moving on to Slide 5, you can see the results for the quarter in a very high-level summary. In spite of Mother Nature throwing us almost everything she had, we had a really terrific quarter with revenues increasing 9% on 3% volume growth, strength really in most of our business units. Operating ratio of 64.4%, which was a 250 basis point improvement from last year. I want to really talk about our performance during the quarter in spite of one of the strongest hurricanes and storms we’ve seen in recent memory. The performance of our operating team and Jeff will talk more about this in a couple of minutes. But the performance of the operating team to deal with the storm and put us in a position where we could recover very quickly. The resilience of our network, the condition of our infrastructure was also a factor in our ability to recover as quickly as you’ll see in a minute. And also I want to mention the cooperation and the way the railroads work together during this situation was better than it has been in my memory. Hurricane Harvey hit Corpus Christi on Friday. On Monday, I received a call from Lance Fritz, the CEO of Union Pacific, asking how we were doing, telling me what the condition of their network was and offering to help in anyway and encouraging us to stay in touch and work with each other, because at that point we didn’t know how things were going to play out, because it was several more days before the rain actually stopped. So, the level of communication and cooperation was just outstanding and it really helps not only with our recovery, but help keep our customers served well and made it possible for us to make the most of the situation. In fact, within a few days of that phone call, we were rerouting and detouring grain trains from Kansas City to Laredo to serve our Mexican customers. So it kept us in business, kept our customer served and made it possible for us to recover much more quickly than we would otherwise. And finally, earnings per share of $1.23, on an adjusted basis $1.35, which on a comparable measure was 21% higher than last year. Switching to Slide 6, it really shows the dramatic impact of the hurricane. You can see from the red line, excuse me, we were kind of checking along at 45,000 cars before the hurricane hit dropped off dramatically, and then bounced back really rather quickly, recovered some of the lost business, because while there was some modal shifting, as you may recall during this period, particularly around the immediate Houston, Beaumont-Port Arthur area, it wasn’t just the railroads that were affected, it was the highways and the ports. So there was limited ability for shippers to use other modes without significant additional mileage in longer reroutes. You can also see from the dotted line that we were moving along at about a 6% or 7% growth rate from the previous year. Before the hurricane hit in carloads, we obviously reported a 3% gain increase in volume, so we didn’t get all of that back. But the point is that, we were moving along at a very nice growth rate for the quarter until the hurricane hit and have recovered some of that, not all of it, Mike will talk more about the financial impact of the hurricane loss in a couple of minutes. But again a testament to the resilience of our network, the performance of our operating team, and the cooperation of the other railroads to help us minimize the impact of this on ourselves and on our customers. So with that, I will turn the call over to Jeff Songer, our Chief Operating Officer.

[Jeffrey Songer:]

Thank you, Pat, and good morning. Reviewing the key operating metrics for the quarter on Slide, velocity has remained relatively consistent over the last several quarters, while Dwell for the quarter of 21.6 hours, improved 10% versus the same period last year. Hurricane-related impacts to key operating metrics were minimized, as embargo and recovery activities kept our network from becoming overly congested. As experienced in other recent weather events, we partnered well with connecting railroads UP and BN to work through service interruptions that impacted the entire region. Hurricane Harvey was different than prior events due to its longevity. The storm’s initial landfall occurred on August 25 near Corpus Christi, at which time KSC outages were first reported. Over the next several days, multiple KCS, UP and BN routes were impacted as the storm traveled north, eventually stalling over Houston where some areas received more than 50 inches of rain. As the storm progressed, tracks around Beaumont, Texas and into the Louisiana flooded on September 1, a full week after the storm’s initial landfall. Once the rains and water levels subsided, we were able to assess and repair the damage. By September 9, all KCS tracks were restored to service. Unrelated to Hurricane Harvey, other flooding impacts during the last week of September in Northern Mexico caused several days of impact to our cross-border traffic, which has been visible in early October operating metrics. We have now largely recovered from these events, and I would like to recognize our operating team for their tireless efforts during the quarter. Aside from the weather impacts, Mexico terminals showed significant improvement over the prior year. As you recall last year, service disruptions in Mexico caused multiple days of outages across the network and inflated our dwell during that period. Overall improved operations, investments and capacity and cross-border initiatives continue to have positive impacts on our performance. Turning to Slide 9, we continue our efforts to manage resources below volume, a 3% volume growth on 2% tinny headcount. I’m pleased to announce that we have started PTC revenue service demonstration on the two subdivisions in the Louisiana. We have an aggressive PTC implementation scheduled for the rest of our U.S. network over the next several months, and are monitoring resources to minimize any disruption during this initiative. Other highlights include the recent announcement of a new Health, Safety and Environmental group that will enhance our overall commitment to safety and will provide additional oversight for the safe movement of refined products as this opportunity grows. Regarding the capital program, major track work at Sanchez is complete, and we have started to shift some operations from our Nuevo Laredo yard to the new Sanchez terminal. Additional investments in mechanical and fueling facilities at Sanchez will continue into 2018 and will continue to support our cross-border capacity. The construction work at the new Sasol facility pictured here remains on schedule. We recently completed construction of the KCS terminal within the facility and the work at the adjacent Sasol tracks will be complete before the end of the year. Other highlights include the opening of Unified Cargo Processing Center at Laredo. This joint effort by U.S. and Mexico customs allows for a single point of inspection for our northbound trains and is reducing the overall transit time it will reach. This month, we should also finalize an agreement for in-sourcing additional mechanical functions in Mexico. This initiative will reduce those costs by approximately $2 million annually ongoing. Finally, I want to acknowledge those in Mexico who are affected by the recent earthquakes. While there was no damage to our infrastructure, we continue to support those families and businesses impacted by these events. I will now turn the presentation over to our Chief Marketing Officer, Brian Hancock.

[Brian Hancock:]

Thank you, Jeff, and good morning, everyone. I’ll start my comments on Page 11, where you can see third quarter year-over-year revenue was up 9% and volumes were up 3%. As discussed by Pat, volume growth was negatively impacted by several weather events in Texas and Northern Mexico. Prior to these events, volumes were tracking at a growth rate of approximately 6%. For the quarter, same-store sales as well as in-quarter renewals pricing both came in at a solid 3%. The Chemical & Petroleum business growth of 10% was primarily driven by, excuse me, by solid performance in our longer length of haul southbound LPG business, as well as our lubes and oils. This business was hardest hit by Hurricane Harvey, with the heaviest impacts being seen in the petroleum business, where customer facilities and refineries were shutdown several weeks due to flooding in Southeast Texas. Our Industrial & Consumer business also showed improvement in the third quarter with revenue growth of 9% and an increase of volume of 4%. We continue to see strength in our military shipments and our metals business was also positive due to an increased need for pipe in the energy sector. Once again this quarter, our energy line of business saw over 100% revenue growth in both frac sand and crude oil, driving an overall year-over-year revenue increase of 19% for the total energy business. We also saw an improved length of haul and attractive mix this quarter due to a larger percentage of the business having final destination in Texas. The automotive business was up 19% over 2016, driven primarily by growth in the manufacturing capacity as new model launches began to take effect. Given the number of vehicles damaged in the hurricanes and the floods, lot of industry saw an increase in sales in September, but most of that demand were satisfied through existing dealer inventories. As a result of this surge in demand, we are seeing a tightness in the automotive equipment across several regions of the North American rail network. Even with this tightness, we still expect to see solid performance in Q4 to fill this demand. We do not expect any impact from the storms outside of the third and fourth quarter of 2017. Intermodal revenue and volume increases have improved to 4%, partly driven by new business and the new cross-border services. During the quarter, this business unit was definitely impacted by Hurricane Harvey, as well as the less publicized floods in Northern Mexico. We continue to see a very competitive market due to low trucking rates in ocean shipping consolidation, but we’re positioned very well to deal with the competition. There is also a tightening in the U.S. domestic intermodal business that has impacted some of our customers. We believe and are seeing we will continue to see solid in both – solid growth in both of our major cross-border service offerings, as well as freight coming into the Port of Lázaro Cárdenas as customers continue to look for alternative solutions for their supply chain. The Agriculture & Minerals line of business revenue growth of 2% was primarily driven by grain demand. Our operating team did a fantastic job in conjunction with our partner carriers to due to much of the export grain shipments that were impacted by the flooding. The harvest looks strong for the fourth quarter and we expect to see continued strength in ag and minerals to close out the remainder of the year. On Page 12, you can see an updated assessment of our fourth quarter 2017 volume outlook. As I mentioned, we expect to see our cross-border service offerings continue driving improvement in our intermodal business in the fourth quarter. We expect growth in our Chemical & Petroleum segment due to the additional refined product shipments and strengthening in the plastics market. I want to remind everyone that the final transition date for the remaining regions impacted by Mexico Energy Reform will be November 30. We also announced during the third quarter, our planned investment in another storage and distribution terminal near Monterey that I’ll discuss later in the presentation. As I mentioned, the strong grain harvest will drive year-over-year fourth quarter Ag business, but at a slightly lower rate in 2016. This strength could be slightly tempered by volumes in our Food Products business through the end of the year. In Industrial & Consumer, we expect to see moderate year-over-year growth in both metals and paper. Our outlook in military and cement moves remains uncertain, but if we continue to see the volumes similar to what we’re seeing currently, then it’s possible we’ll have quarterly growth in this part of the business as well. Due to year-over-year change in plant shutdown schedules, our automated – our Automotive business will be facing tough year-over-year comps, but we’re still expecting strong growth for the total year. The challenge of the end of year plant schedules may be mitigated to some extent due to the heavy demand for replacement cars and trucks in the area impacted by hurricanes and earthquakes. Crude oil and frac sand shipments will remain strong in the fourth quarter, but year-over-year volumes in the utility coal market will create a difficult comp when compared to the second-half of 2016. Moving to Slide 13, as I mentioned before, we announced the planned investment in refined products terminal in Salinas Victoria just north of Monterrey Mexico. This joint venture with Bulkmatic will continue to demonstrate our commitment to creating quality facilities in critical markets that allow us to provide rail service and growing refined products markets in Mexico. This slide provides an update on our shipments in this important segment. Adjusted for the hurricane impact, we saw a 17% increase in volumes and refined fluids as well as LPG. LPGs continue to make up more than half the carload shift year-to-date. It’s important to remember that growth in this business will come in stair steps. The first portion coming after all the facilities are open, and the second, a larger step will come after construction of the storage tanks is complete in the second-half of 2018. On Slide 14, we have included a diagram that provides a visual of the KCS network, the important new terminals on our line and the existing pipeline systems for both refined products as well as LPG. As you can see, our investments are strategically located in to serve major population centers and growth areas that are not close to existing pipeline. The diagram also shows that almost the entire pipeline system is already running near capacity levels. Given the difficulty of acquiring land as well as topographical and security challenges of building new pipelines, we believe the strategic investments give us a significant foothold in this new and developing infrastructure. With that, I’ll now turn the call over to our CFO, Mike Upchurch.

[Michael Upchurch:]

Thanks, Brian, and good morning, everyone. I’m going to start my comments on Slide 16. Despite the Hurricane, third quarter volumes increased 3% and reported revenues increased 9%. Operating ratio improved from 66.9% to 64.4%, despite the loss of significant operating income due to the hurricane. However, helping year-over-year comparisons was lower incentive compensation expense of $6 million, or about 90 basis points. Operating income improved $34 million, or 17%, and our incremental margin was approximately 65%, reflecting good expense management and productivity. Reported EPS was $1.23, a 10% increase over third quarter 2016, while adjusted EPS was $1.35, a 21% increase over 3Q 2016. And our reconciliation from reported to adjusted EPS can be found on Slide 27 in the appendix. So overall, we were quite pleased with the third quarter results, which were achieved despite experiencing significant negative impact on the quarter from Hurricane Harvey. Moving to Slide 17, let me briefly cover the estimated impacts from Hurricane Harvey. First, we believe the loss margin from traffic that is either permanently lost to customer production outages, or that moved under alternative modes of transportation is in the range of $19 million to $23 million. As you saw in the slide that Pat reviewed, our traffic prior to the hurricane was increasing at approximately 6% over the prior year. And after getting our network and equipment back to normal operating levels, we are now growing carloads again at the same pre-hurricane level. In addition to lost operating income from business interruption, we also incurred incremental operating expenses related to detour costs, property damage and other operational disruptions that totaled approximately $7 million. We will be filing a claim under our property insurance policy and accordingly are permitted under GAAP to record an offsetting receivable for those incremental expenses in the third quarter P&L. While our third quarter estimated impact from Hurricane Harvey is a negative 140 to 160 basis points to operating ratio, or $0.12 to $0.14 per share, GAAP does preclude us from recording additional estimated insurance recoveries, which are in essence contingent gains until we have final resolution of the claim. And we would expect that to occur sometime in the back-half of 2018. Accordingly, we don’t expect the net impact of the hurricane to be about $0.05 or less, once the claim is finalized. Turning to Slide 18, operating expenses increased $18 million, or 4% over a year ago to $423 million, demonstrating good cost control. Key drivers of expense variances were fuel prices in Mexico in the U.S., which increased $6 million and $3 million, respectively, volume-related fuel increases of $3 million, reduced fuel excise tax credits of $5 million, depreciation increases of $5 million, wage inflation of $4 million and then reduced incentive compensation of $6 million. I’ll cover the key expense variances in the next few slides, but do want to point out several expense saving initiatives, such as favorable equipment expenses on a year-over-year basis, which were partly the result of reduced cycle times in Mexico and the mechanical in-sourcing and contract restructuring, which also saved $2 million in the quarter. Turning to Slide 19, compensation and benefits expense increased $1 million, or approximately 1%, largely due to the year-over-year decline in incentive comp, the benefit of our year-over-year OR by about 90 basis points. Excluding the incentive comp benefit, expense would have increased approximately 5%; wage inflation added $4 million of expense; increased headcount, excluding the mechanical in-sourcing added $ million in expense; and mechanical in-sourcing also contributed $2 million in compensation expense. And importantly, our overall headcount including the in-sourcing, excluding the in-sourcing of a mechanical vendor facility increased 2% below our volume growth, increased compensation expense of $6 million due to wage inflation and increased headcount was essentially offset by the $6 million year-over-year benefit in incentive compensation. Turning to Slide 20, fuel expense increased $12 million, or 18%. Increasing fuel prices in both the U.S. and Mexico contributed $9 million to that increase. Higher consumption also increased fuel expense as we experienced a 3% carload increase and a 6% GTM increase. Our guidance for fuel tax credits in Mexico is being reduced from the $45 million to $50 million range to $42 million to $45 million as rising fuel prices have caused the Mexican government to reduce the fuel excise tax rate. We do believe the fuel excise tax will continue to 2018 and beyond, and that that railroads in Mexico will continue to benefit as a wholesale user of fuel by being exempt from those excise taxes similar to the U.S. fuel excise tax system. Turning to Slide 21, purchase service expenses declined mainly from savings we achieved from the mechanical in-sourcing and contract restructuring, which decreases expense by $10 million. And materials and other increased $5 million, primarily due to materials and supplies required for the mechanical in-sourcing. Finally, as I discussed earlier, we recorded a $7 million receivable from our insurance carriers that offset $7 million in incremental expense due to property damage, detour costs and other operational disruptions. And finally, on Slide 22, turning to our capital allocation priorities, we continue to be focused on growing our business faster than our competitors, something we have consistently achieved since 2007, growing our overall carload volumes by 22%, while the rest of the Class 1 railroads have declined by 3%. As Jeff indicated earlier, our CapEx guidance continues to be in the $550 million to $560 million range for 2017, which will be the third year in a row of declining capital spend. In addition to the capital expenditures, we’re projecting to invest approximately $37 million in 2017 and $24 million in 2018 by partnering with others to invest in rail served, refined liquid terminals in Mexico to capture the Mexican Energy Reform opportunity that Brian discussed. And these will be accounted for as equity method investments, not as capital expenditures. Our management team and Board of Directors are committed to continuing our practice of returning capital to shareholders through dividends and share repurchases. Accordingly, our Board approved an $800 million share repurchase program on August 15 at a 9% increase in our common stock dividend. During the third quarter, we purchased 1.75 million shares of our common stock under an accelerated purchase program with two financial institutions at an average price of $105.70. And the remaining 150,000 shares under this program were settled in early October, thus completing the $200 million accelerated repurchase program. And finally, from a capital structure, we’re very comfortable with our credit profile and debt levels, having secured the lowest weighted average interest rate in the Class 1 space at 3.9%. And with a leverage ratio of 2.2, our credit metrics are as good as or better than most of our peers rated BBB+. And with that, I’ll turn the call back to Pat.

[Patrick Ottensmeyer:]

Okay. Thanks. I’ll just make a couple of quick comments before we open it up. I want to go back to Slide 17 that Mike covered and just want to make sure and sort of reiterate what Mike emphasized on this slide. This slide only shows the impact of the hurricane. Obviously, there are other factors positive and negative that took place during the quarter. So it would not be correct for you to extrapolate that our operating ratio would have been 140 or 160 basis points or better in the quarter without the hurricane. Again, there were other factors that were not reflected in these numbers on Slide 17. And just really again, the past few quarters, I’ve given you suggestions for the headline to your research updates, very strong quarter, amazing resilience and just outstanding performance. I couldn’t be more pleased and proud of the operating team in the way we got support from the other railroads during Hurricane Harvey. Harvey was the headline obviously and the biggest impact that both Jeff and Brian mentioned flooding in Northern Mexico that didn’t get so much coverage in the press that occurred after Harvey that really did slow us down in terms of recovering and getting back in business, particularly for cross-border traffic. And some of that will impact our operating metrics on into the first week or so of the fourth quarter. So in spite of – as I said at the beginning, in spite of Mother Nature throwing us almost everything she had, we just overcame that and had a very strong quarter, record operating income, record operating ratio for the third quarter. I also know that NAFTA has been in the headlines this week, and I’m sure there are a lot of questions about that. We still just don’t have answers as to how this is all going to wrap up and conclude. There has been a delay in the process in the pace of the negotiations. We actually think that’s a – not a bad thing. And as I – I was in Washington for three days this week during – when the negotiations were taking place. And the explanation that I heard about the reason for the delay was not attributable to the negotiations deteriorating or collapsing, it was really this round included much more specific detailed proposals. And it’s just going to take longer for all sides to analyze and asses what the impact of those proposals are. And they felt that it was appropriate to delay the next – the timing of the next round, so that all parties could make those assessments and before they get together again. So we don’t have solid answers, but obviously, the process is continuing and all parties are still at the table, which is good. And we just don’t know yet what the impact is going to be. So with that, I will open the call up to Q&A.

[Operator:]

Thank you. We will be now conducting a question-and-answer session [Operator Instructions] Due to the number of participants on this morning’s call, management will limit your question to one primary question and one follow-up question. Our first question comes from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.

[Ken Hoexter:]

Great. Good morning. Congrats on working around the hurricane and the performance.

[Patrick Ottensmeyer:]

Yes.

[Ken Hoexter:]

Brian, you mentioned some low truck rates in your opening – in your prepared remarks. I presume that you were talking about Mexico intermodal given the decline of peso. So maybe you can kind of just fill us in on how business is trending given the decline of the peso on intermodal side and compare and contrast that with the strength you might be seeing in the U.S. given the tight truck market?

[Brian Hancock:]

Yes, absolutely, Ken, thanks for the question. Definitely, I was talking about Mexico. The truck rates in Mexico continue to stay low, continued relatively cheap equipment and fuel, very competitive specifically into the Mexico City market, but we’re positioned well. We’re seeing great volumes off of the Lázaro terminal, also inter-Mexico, like I said, the cross-border is working very, very well. As you mentioned, we are seeing significant price increases in the domestic space, which allows – there’s a lot of things that happen there specifically for our market basically between Dallas and Atlanta, that’s a fairly competitive market. And so as those truck rates go up and as intermodal rates go up, obviously it’s positive for us, because we’re able to get more freight on the railroad. So we think intermodal is positioned well. We think it’s maybe coming out of that pricing funk that it’s been in for the last few years. And so we continue to believe, intermodal is going to be a great benefit going forward.

[Ken Hoexter:]

Great. And then if I could have my highlight, Jose, if you’re still on the line just to get his thoughts on the COFECE timing and the sustainability of the tax benefit on the Mexican side?

[Patrick Ottensmeyer:]

Jose, are you there?

[Michael Upchurch:]

No.

[Ken Hoexter:]

Okay.

[Patrick Ottensmeyer:]

Sorry, Jose is not there. No change on the COFECE process. There’s really been no change. We’re still expecting a conclusion in January. And there really hasn’t been any dialogue or indication privately or publicly as to an update, so we just don’t have anything to say there. And I think, Mike covered the – are you talking about the excise tax? We just don’t see any evidence or any reason to think that that’s not going to be a permanent benefit.

[Michael Upchurch:]

Yes, Ken, this is Mike. I mean, at the end of the year, we’ll know for sure about our ability to get the credit. But this excise tax has been in place for 30 years in Mexico. It’s no different than the U.S., where we pay excise taxes on fuel, it’s just the realization of that benefit, is slightly different in the U.S. We buy wholesale and don’t have to incur it at the time of purchase. In Mexico, we do have to pay it and then get a credit through our withholding taxes or income taxes. But net-net, the systems really aren’t any different in Mexico than they are in the U.S.

[Operator:]

Thank you. Our next question comes from the line of Jason Seidl with Cowen and Company. Please proceed with your question.

[Jason Seidl:]

Thank you, operator. Good morning, guys. I also want to say how heartening it was to hear about the two railroads really working together when times get tough, so that’s a nice note. I wanted to focus a little bit on some of the revenue per carload numbers. I thought automotive was up a little bit more than we’ve been modeling. Was that just a mix issue in the quarter, or did some business reprice?

[Brian Hancock:]

No, I would say, it’s a mix issue exactly, Jason. There’s no repricing happened in the quarter.

[Jason Seidl:]

Okay. And going forward, if we exclude Mexican intermodal, because obviously, the truck rates down there are different than what’s going on in the U.S. Overall, you guys – would you say the pricing environment is improving for the roads as you look out?

[Brian Hancock:]

Jason, I would say that the pricing environment right now is relatively positive and strong. We continue to believe it will be inflation plus on both sides of the border. There’s really no change in that. We are seeing some change in some of the markets in the U.S. I would tell you, I think that the pricing in the refined products market has kind of stabilized. And I think everybody kind of is seeing how that’s going to play out. So we feel very comfortable that it’s a good solid pricing environment and we’ll continue to expect inflation plus.

[Jason Seidl:]

All right. Those are my two. Thank you so much for the time.

[Brian Hancock:]

Thanks.

[Patrick Ottensmeyer:]

Thanks, Jason.

[Operator:]

Thank you. Our next question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.

[Allison Landry:]

Hi, good morning. So it sounds like the Intermodal partnership with BN has seen some good early success. I was wondering if you could help us size the volume opportunity here longer-term, if you’re seeing any developments with IMC partners to build out density in the broader – cross-border franchise? And then lastly, how quickly do you think you can move the needle in terms of rail market share versus truck at the border?

[Brian Hancock:]

Thanks, Allison. Again, this is Brian. That’s a great question. And what I would tell you is, from a market share perspective, we still have very little market share there as the number of containers coming across the border is around 3% to 4%. And so you think about upside, there’s significant upside in converting that freight from the road to the rail. What I would tell you is, we are extremely pleased with the business. We just had a review this week with our partners BNSF and both groups are very pleased with what’s happened. We feel very comfortable that it’s going to grow. There’s a lot of interest. We also see the exact same thing with the UP, our partner in the automotive business and some of our other intermodal. So the IMCs are focused. They understand the opportunity. It doesn’t take much to understand it, just go stand at the border and look at the 16,000 trucks trying to cross every day, it’s a great opportunity for us. And I think, as Jeff mentioned, he mentioned the kind of quietly in his comments, he mentioned the joint facility between Mexican and U.S. customs. If we’re able to get that time at the bridge down like he’s really working hard on, that’s going to be a great benefit to the intermodal as well as the carload customer. So we think it’s going to be a good space.

[Allison Landry:]

Okay. And then just as my follow-up question on Sasol. So, the terminal close to completion, how should we be thinking about the ramp in carloads in 2018? And do you have any incremental visibility into how much you could move single haul for exports through Lázaro? And then if you just had any other initial thoughts on the petrochemical volume opportunity in general as we look forward, that would be helpful? Thanks.

[Patrick Ottensmeyer:]

Sure. What I would tell you is, Jeff and his team, as he mentioned, are going to complete the Sasol yard here in the fourth quarter. It’s a beautiful yard as the picture showed. What I would tell you is, I think Sasol has already announced that they will begin operations in the second-half of 2018, and we concur with them. We’re working daily with them to make sure that they have proper support, how that will ramp up and how that will turn into carloads, you probably have to talk to Sasol about that, because obviously the facility is theirs. What I would tell you is, we’re very excited about the continued growth of the crackers on the Gulf Coast, not only for volume within the U.S., but volume through Lázaro. We don’t really have projected volumes for those yet into 2018. But they’re certainly going to ramp up next year and then it’ll continue to grow as that – as those facilities get built out and the capacity comes online. So it’s going to be a gradual ramp up, but we’re focused on it and all of our partners are focused on it, it’s a big opportunity.

[Operator:]

Thank you. Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

[Diane.Huang:]

Hi, this is Diane on Ravi’s team. Thanks for taking my question. My first question is, you estimated about $0.12 to $0.14 of EPS impact from lost revenue due to the hurricane this quarter and the third quarter. Can you estimate how much of the $0.12 to $0.14, do you think you can recover in the fourth quarter, or was the majority of that announced permanent in nature? Thanks.

[Michael Upchurch:]

This is Mike Upchurch. No, we can’t do that. We haven’t filed a claim with the insurance companies yet to establish the total loss. That will take probably another 30 days or so. You have to appreciate the amount of detail that we have to go through in terms invoices and customer carload lost. We do think we’re going to get a recovery here that will be booked at a later date, but it’s not going to be in the fourth quarter. I indicated that would be in the back-half of 2018, and just appreciate how many claims the insurance companies are dealing with right now, given the two major hurricanes and other issues around the world like the earthquake in Mexico. So it’s going to take some time to work through that.

[Diane.Huang:]

Got it. That’s helpful. And my follow-up is, in the call you guys said, there were other factors that were not reflected in Slide 17. And so can you talk about the other tailwinds or headwinds that you guys found in the quarter? And if any of these trends will continue going forward?

[Michael Upchurch:]

On Slide 17 related to the hurricane?

[Diane.Huang:]

Yes. You guys said there were also other factors?

[Michael Upchurch:]

Well, we had things like detour costs that we had to incur. Pat mentioned that we were detouring a lot of trains over Union Pacific and still getting those into Mexico. There were car hire expenses that were incurred, because the equipment is sitting idle.

[Patrick Ottensmeyer:]

I think, what I was referring to in my kind of summary comments was things unrelated to the hurricane. So this slide only reflects the impact of the hurricane. It doesn’t include other things like incentive comp and other things that occurred during the quarter. So my statement was that it would be incorrect to assume that, our operating ratio would have been 140 to 160 basis points better absent the hurricane.

[Operator:]

Thank you. Our next question comes from the line of Brian Ossenbeck with JPMorgan. Please proceed with your question.

[Brian Ossenbeck:]

Hey, thanks. Good morning. So you mentioned earlier time on the bridge is going to go down with some of the cross-border initiatives that you’re working on. To help the speed, but what about balancing out the network flow going north and south? And maybe you could just comment on the addition of APM terminal and BNSF service, if that’s really affected it? And is there something you might have to add your own equipment or containers down the line to help rebalance and perhaps solve that challenge?

[Jeffrey Songer:]

This is Jeff, Let me start, and then I’ll probably turn it to Brian for APM comments. So the new cargo processing center is currently only working on northbound flow. The desire is that we pilot this for a period of time and then we do this same action on the southbound flow. And I think customs is very supportive of what we’re trying to do here and certainly we’re showing. I think Laredo was the only border in the country on the south border that truck rail airlines have this kind of unified cargo processing application. So again, I would look for hopefully early into next year that we’re able to execute the same activity on the southbound. So that being said, I don’t view that this is a bad thing or a thing that’s going to create some kind of an imbalance. I look at the overall time spent on the bridge and every minute we can shave on off the train would allow you to maybe shift the time. We currently work under a window structure at the bridge. So maybe if the northbound is flowing more fluidly, you shorten the time for those windows and you expand the time for the southbound. So again, it’s a positive, no matter how you look at it, and I think, we’ll continue to see some benefit on southbound trains early in – into next year.

[Patrick Ottensmeyer:]

This has – I’ll chime in here as well. This has been one of the important elements of our discussion with lawmakers and policymakers on both sides of the border as a possible update modernization of NAFTA. If we’re going to take advantage of the opportunities that we see in the next three, five-plus-years, specifically refined products and plastics for export growth from the U.S. to Mexico, we really need to change the process that the trains have to go through to cross the border. That’s a lot better, easier, cheaper solution than building another bridge, which is probably $1 billion plus project in five to more years. So if we can change the process in this cargo inspection facility is one of the key elements of that. We feel that we can significantly improve and increase the capacity at the bridge from what’s currently possible.

[Michael Upchurch:]

Brian, I don’t know if you want me to say anything more about the balance. Obviously, Maersk, all of our IMCs, all of the container operators, I mean we’re all very focused on making sure we stay balanced. There is a lot of freight moving south, a lot of export volume and refined products and plastics come in. But there are many teams working on this across the transportation network. And so we’re very focused on as well as Jeff. So nothing more to say on that.

[Brian Ossenbeck:]

Okay understood. Just a quick one for you, Brian, the follow-up on that LGP opportunity, you’ve heard a lot about refined products and the lack of storage, a couple of days storage on hand in terms of demand in Mexico. But I haven’t heard too much about LPGs, you can just give us an overview on maybe the relative market opportunity there, that’s bigger in terms of your current volume base, is that expected to stay that way? Do you have to make more investments in other terminals to help that continue?

[Brian Hancock:]

Yes, great question, Brian. What I would say is the LPGs have been surprising to us how quickly it picked up. And bringing those LPGs into Mexico obviously it’s used in almost every home in Mexico. And so the storage facilities are being created in most of the major population centers. But what I would tell you is, we’re going to continue to see that business grow as well. I think refined products will probably grow a little bit faster now, because LPG has really got a quick start out of the gate. But it’s going to continue to grow significantly as again that’s one where they do not have enough from a national supply perspective and you’re seeing already facility is being constructed in the San Luis Potosí area, obviously in Salinas, Monterey. So it’s going to continue to grow as well.

[Operator:]

Thank you. Our next question comes from the line of Chris Wetherbee with Citigroup. Please proceed with the question.

[Chris Wetherbee:]

Hey, great. Thanks. Good morning. Wanted to stick on the refined products for a minute. So you’ve had, I guess a couple of quarters under your belt of sort of improvement and growth there. I just wanted to get a sense if you sort of look into 2018, you have sort of better sense of maybe what the opportunity could be like for next year? I think you highlighted a couple of individual investment opportunities for you, as well as other folks down in Mexico on the storage side and we kind of have the timing of that beginning to take shape. I was wondering if you could kind of help us put some numbers and thoughts around what the opportunity could look like for you either in 2018 or 2019?

[Brian Hancock:]

Yes, Chris, I think that’s the million-dollar question obviously is how fast is this going to ramp up? I think the keys for is we watch are going to be primarily a couple of things. First off, the instance of new retailers into the market, how quickly that happens, how quickly the infrastructure from a retail perspective occurs. Second is going to be the distributors that are currently in place, how do they play from a storage perspective, as well as distribution into these new retailers. And then third, what is the infrastructure off of the ports, off of other facilities coming out of Texas, right now it appears that the big Texas facilities are going to be around Beaumont area, around Corpus Christi and then into the center of the country across a number of different items. So we expect it to ramp up significantly from a retail perspective. Starting in 2018, a number of firms have already announced their plans and how big that will be. How quickly that actually plays itself out? I don’t know. If you look at the expectations from a storage perspective, you have about 10 years for the country to gain that that significant storage capacity they were looking at of adding 10, 15 days of supply. But we think here in 2018, you’re going to see some pretty significant volumes, not only in off of the ports, but also out of the rail line. Again, I think the pipelines are pretty full, they’re almost at capacity. So I don’t think they’ll be significant movement on that space. So we’re very positive about how it will impact this in 2018 forward, but the ramp up is going to be really tied to the retail – the new retailers.

[Chris Wetherbee:]

Okay, that’s helpful. And then maybe sticking on this topic and sort of bringing NAFTA into the discussion, I think, it’s probably one of the more interesting sort of dynamics within the whole NAFTA sort of headline risk relative to investments are actually occurring for some of this cross-border opportunities. So when you’re talking to your partners and other people who are getting involved in this trade, even in just the last couple of weeks, I don’t know, Pat, if you have some perspective on this? How is sort of this NAFTA sort of risk playing into the discussion? Is it slowing anything down? Is that something that people are talking about? I just want to get some perspective – some real-word perspective on that?

[Patrick Ottensmeyer:]

It’s really not slowing anything down. In terms of business, I think, I said this in the past, we don’t know what we don’t know. So, are there projects and investments that have been thought about by industrial companies that have been delayed, things that haven’t been announced. My sense is, yes, waiting to see kind of what the outcome is. But as far as refined products and other opportunities, even steel, we had a great meeting a few weeks ago, a couple of weeks ago with one of our large steel companies that forging ahead and building out a presence in Mexico based on what they see in terms of automotive growth. So, we have to continue to build out the capacity and make the investments that we’re making to support our customers. As you know, these types of investments take a long time to build and with permitting and land acquisition and just the size and scale of the types of projects we invest in. So we’re forging ahead to be ready for the growth and to serve our customers based on the best information that we have as to what’s going to happen. So – and we’re spending a lot of time. I mentioned, I was in Washington for three days this week, talking about and trying to make sure as many people as we can touch, understand that there’s a huge opportunity right in front of us for export growth in the form of refined products and plastics in addition to ag and other commodities that we move that I think will be very helpful and significant in reducing the trade deficit, which is what the negotiating team seems to be primarily focused on.

[Operator:]

Thank you. Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your questions.

[Brandon Oglenski:]

Hey, good morning, everyone, and thanks for taking my question, and likely congrats on operating through a pretty difficult period.

[Patrick Ottensmeyer:]

Thank you.

[Brandon Oglenski:]

So, Pat, I mean, I want to come back to the question from Diane earlier, and you called attention to it as well in your closing remarks here. Are you inferring that there were some positive or negative offsets in the quarter in your comments about how it’s not just the hurricane impact you need to look at for what our OR could have been?

[Michael Upchurch:]

Hey, Brandon, this is Mike Upchurch. Imagine, once you get the script, you’ll be able to see my comments. But I think a couple of times I referenced that we had a 90 basis point year-over-year benefit as a result of lower incentive compensation. So I think you would have to net that against 140 to 160 basis point impact of the hurricane. So net-net, you’re probably looking at 50 to 70 basis points that our OR could have been better in the third quarter, had we not have this hurricane event, hopefully that helps.

[Brandon Oglenski:]

Yes, I’m sorry, we’re probably just at a slow speed here in Friday. So I want to ask – I know we’ve talked a lot about coal over the years. But we’ve gotten the indications that you’re going to see another coal shutdown in your network or potentially. Can you guys talk through what that impact could conceptually be? And do you think that it’s actually going to shutdown this time, or what’s the outlook there?

[Patrick Ottensmeyer:]

I’ll take that one. The answer is, no. We’re – we’ve obviously done internal sensitivities and sort of scenarios looking at the possible – the range of possible outcomes. But we’re not going to get into detail on those, because we don’t want to get ahead of the process. This isn’t the first time that we’ve seen this. And until we know what ERCOT – what the outcome of the current process is, we really don’t feel it’s appropriate to comment and quantify what the impact could be. We don’t think it’s material. And you’ll see when we file our financial statements in 10-Qs later on the disclosure in the 10-Q. We don’t think, it’s material. And until we know what the facts are, we’re just not going to spend a lot of time talking about the volume, revenue or earnings impact. It’s not out of the question, and I don’t want to sound naive and foolish here. But it’s not out of the question that ERCOT will step in and say, this is critical infrastructure and we will support you and that could actually be positive to volumes. So until we know what the outcome is going to be, we’re just going to let the process work. And when we know what the facts are, we’ll deal with it.

[Operator:]

Thank you. Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.

[Scott Group:]

Hey, thanks. Good morning, guys.

[Patrick Ottensmeyer:]

Good morning, Scott.

[Scott Group:]

So, Mike, I just wanted to go back to some of the math on the hurricane. So the $19 million to $23 million of operating margin impact, what’s the revenue loss and then what’s the assumed margin on that? And then are you trying to suggest that, if we take – add back the $0.13 and call it a core earnings maybe at $1.48, that that’s sort of the starting point to use for, I guess fourth quarter, because fourth quarter is usually pretty similar with third. Is that sort of what we’re trying to say here?

[Michael Upchurch:]

Well, on the first question that you have related to the revenues, I indicated, we – we’re still going through a lot of quantification and contacts with our customers what was permanently lost. We’re not going to provide any additional color on it other than to say a lot of it was cross-border traffic. We were embargoed at the border for what just 10 days or thereabouts.

[Jeffrey Songer:]

Well, and beyond that as we went into recovery.

[Michael Upchurch:]

Yes.

[Jeffrey Songer:]

So multiple weeks of it.

[Michael Upchurch:]

So there’s little better revenue per unit associated with that cross-border traffic there. And Scott, I don’t recall your second question that was on operating ratio?

[Scott Group:]

No, it’s not about operating ratio. Just so, I guess, you’re calling up $0.13 from the hurricane. So if we say, hey, then the quarter could have been $1.48, is that sort of how you would think about fourth quarter, which is typically pretty similar with third? Is that a good starting point, obviously, that’s well above where the street is. I just wanted to understand if that’s sort of the message here?

[Michael Upchurch:]

No, we’re not providing that guidance. All we’re saying is, third quarter was off to a great start. We were really looking at a blowout quarter prior to the hurricane and had some negative impacts on that. So we’re not necessarily guiding to fourth quarter.

[Scott Group:]

No, I understand. But is that a reasonable way to think about this a starting point?

[Michael Upchurch:]

We’re not guiding to the fourth quarter.

[Scott Group:]

Fair enough. Okay. And then just for you, Brian, on auto. So flat volumes in the fourth quarter, is that a timing issue or in any way a change in how you guys think about the auto growth opportunity right now? And then do you have any view, if there is a change in NAFTA that requires more U.S. parts? What the – I’m guessing that’s a positive opportunity for your item of moving more parts down, but any thoughts there?

[Brian Hancock:]

Yes, Scott, I would tell you that, we don’t have really any idea where it will end up. We know that what the proposals have been from a part and content perspective, deal content. What I would tell you is, there are – there is a little bit of a change in the downtime scheduling around Christmas that impacts us and 2017 and that might be some of the changes, just a calendaring space and how the calendar work for those particular plants. But overall, we’re very positive in our automotive business. And we continue to believe that no matter what happens. Mexico is going to be a great place to build vehicles for the world, and that’s going to have content from all over the world and we’re going to be a part of it. So we’re – we continue to be very positive on our automotive business.

[Operator:]

Thank you. Our next question comes from the line of Justin Long with Stephens, Inc. Please proceed with your question.

[Justin Long:]

Thanks, and good morning. So I’m sorry if I missed it, but could you talk about what core pricing was in the quarter? And as we think about this tightening truckload market that we’ve seen since, call it June, how long does it typically take for a pickup like this to start driving in acceleration of pricing on your rail network?

[Brian Hancock:]

Yes, Justin, this is Brian. Our core pricing was 3% that’s both in renewals and in the what’s….

[Michael Upchurch:]

Same-store?

[Brian Hancock:]

The same-store, I’m sorry, I was thinking about the second part of your question. When you think about the intermodal space, obviously those bids go out for the large customers, they go out sometime in the first quarter. And so it takes a while to see that. What you’re talking about is the spot market of intermodal that impacts both truck pricing and intermodal pricing in probably that spot market, let’s say, the top 20% or that piece that’s flexible during the search periods of the year. That’s not going to impact us as much as it would our intermodal carriers. And so, we’re primarily into that bid season in the fourth quarter, first part of first quarter, and then that’s when we would see the pricing improvements. But obviously, it’s going to be a benefit to us as truck pricing continues to go up and gives us some pricing power, as well as intermodal becomes a better option for some of those people who had products on the road. So it usually takes a full cycle of bids from an intermodal perspective on that.

[Justin Long:]

Okay great. That’s really helpful. And maybe secondly, I was curious if you could comment on crude by rail. It seems like, there’s a little bit more optimism in Canada recently. So I was wondering, if you’re seeing any increased activity around moving Western Canadian crude down to the Gulf. And just from a capacity standpoint, could you talk about your ability to handle a pickup in this market if it materializes?

[Brian Hancock:]

Yes. First off, we are seeing a little bit more movement. As I mentioned, we saw over 100% increase, but that’s from a pretty low number, basically hardly anything in the third quarter last year. Our capacity to move the Canadian crude or crew coming from anywhere is, we have plenty of capacity. There’s plenty of equipment, and Jeff is ready to move it when people are ready to move it. Obviously, the spreads create an environment where the market can change overnight. But we’re seeing some positive signs in crude by rail and we’re going to continue to take advantage of it when possible. And but we’re not going to say, boy, this is going to come on like gangbusters, but if it does, nobody would be happier than Jeff Songer, because he’s ready to move with when they bring it to him.

[Operator:]

Thank you. Our next question comes from the line of Tom Wadewitz with UBS. Please proceed with your question.

[Tom Wadewitz:]

Yes, good morning. I was wondering if Pat or Brain, you could offer some thoughts on, you’ve got, it seems like quite a few headwind, or excuse me, tailwinds when you look at volume growth over the next couple of quarters maybe into 2018. I guess there’s some potential headwinds in terms of coal, maybe some other things. But do you think there’s good chance that we see, or a better chance that we see acceleration volumes looking over the next couple of quarters when you consider some of those tailwinds, or would you say it, it’s kind of more likely that we stay kind of stabilization as we think of single-digit volume growth? Just looking for some kind of broader perspective on that?

[Brian Hancock:]

Yes, Tom, I – I’ll take. This is Brian. Here’s what I would tell you, we are very, very focused on doing this in a rational, competent way in building out infrastructure and building out the Sasol Yard, the Sanchez Yard, these two terminals, that’s all infrastructure which allows us to take advantage of markets that are coming that we can see. That volume is going to come on in a ramp environment. We’re going to continue to see it grow again as retail markets change, as NAFTA is renegotiated, that will have a big impact on steel. We are focused on creating fluidity and capacity in Mexico across the border and in the U.S., both in intermodal terminals, track, everything else. And so we’re going out in a very rational way in a way that allows us to take advantage of markets. We’re not making big jumps into anything that might be a swing in the marketplace. But we do – we see great growth in Mexico, great growth in Southeast Texas and along the Gulf Coast with the crackers and others. So it’s going to take time. It’s going to ramp up in a way that we think we can take advantage of it. But we are spending our infrastructure dollars to make sure we’re fluid and we have the capacity to get it when it comes.

[Tom Wadewitz:]

Do you want to offer a thought on that Pat, whether it accelerates or?

[Patrick Ottensmeyer:]

Well, I think, I’ll just say at this time. I think we are extremely well positioned for good growth for years ahead, whether it accelerates from current levels, again go back to what we said earlier, prior to Hurricane Harvey hitting, we were up about 6% during the quarter and we’ve kind of gotten back to that level since we’ve reopened. But if you just look at our network and you look at the investment, you look at the opportunities in refined products and we kind of stop talking about the other aspects of Mexican Energy Reform in terms of exploration production. The Eagle Ford, South of the Rio Grande, we still think that’s an opportunity that hasn’t occurred yet because of pricing and other factors. But automotive, intermodal, plastics, those plants are $165 billion or $170 billion of capacity and more to come, all taking place in the U.S. Gulf Coast. And every one of those plants even those that we don’t touch physically, we’ll have opportunities either with intermodal or other ways to serve those plants. And we’re just extremely well positioned for growth for years to come. The infrastructure is in great condition. And I feel like – and they’re obviously factors outside of our control that are going to be things we have to deal with and adjust, but we’re very optimistic about the outlook for growth for years to come.

[Tom Wadewitz:]

Yes, that’s great. I appreciate it. And just a follow on. It sounds like you’ve made a lot of investments to handle the growth you expect to be coming from a, I guess, the train schedule perspective if I consider BN, it would seem like you’re running probably pretty substantially shorter train, and you could see operating leverage on those. Just kind of broadly speaking, would you expect to see strong operating leverage on the areas where you expect growth in 2018 and beyond?

[Jeffrey Songer:]

Yes, this is Jeff. From a train length capacity, certainly, that’s something we have opportunities on. I know Brian speaks a lot about the cross-border intermodal service or certainly opportunities there. Refined products where as it forms certainly more unit trains, which I know Brian is driving towards. There’s opportunities there. So, yes, I think it’s a fair assessment to say, we have opportunities in existing capacity just from a train length perspective. I think the capacities at Sanchez, the other just physical infrastructure capacities certainly in place. We spent – we’ve invested a lot in the Lázaro corridor to boost that traffic, which we feel good about right now. Certainly, the cross-border we talk a lot about and we feel very good on the U.S. side from a capacity standpoint.

[Patrick Ottensmeyer:]

So I’ll chime in here a little bit as well. A couple of questions came up on the call about intermodal. I really think our intermodal position and the strategy that we have and the relationships we’ve developed puts us in terrific position to grow that business. We literally have a solution now with every container company, every railroad, every market that you can think of. So we’re focused on improving the consistency and reliability of service, density and volume, I believe will occur. The intermodal thesis for cross-border traffic is very solid, and we’re just in a great position to take advantage of that.

[Operator:]

Thank you. Ladies and gentlemen, we have come to the end of our time for questions. I’ll now turn the floor back to Mr. Ottensmeyer for final remarks.

[Patrick Ottensmeyer:]

Okay. So as you’re thinking about your headlines, very strong quarter, amazing resilience, things like that, so come to mind. I mean we really feel that this was an extremely strong quarter, could have been better and dealing with the elements of nature in about the best possible way. So – and the growth outlook is really strong. There clearly are things out there that we’re paying close attention to and trying to influence not just reading about them in the paper like NAFTA. And I think all we can say about NAFTA is that, all three parties are still at the table, negotiations will continue. We are still hopeful and confident that NAFTA will be modernized. And even if things don’t turn out the way we would hope, North American trade will continue and we will continue to play a role in those supply chains. So thank you for your time and attention, and we will tee this up again in about three months. Thank you very much.

[Operator:]

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.