Kansas City Southern Earnings Call Insights: Fourth Quarter Incrementals and Mid-Single Digit Volume Expectations

Kansas City Southern, Inc. (NYSE:KSU) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Fourth Quarter Incrementals

William Greene – Morgan Stanley: Dave, I know you mentioned that you don’t want to give too many specifics around the 2013 operating ratio. You had some very good incrementals though in the fourth quarter despite the slowdown in traffic growth. So, I was hoping maybe you could add a little bit of color maybe (harkening) back to some of the comments you made in the past about kind of 1 to 1.50 in terms of improvement in the operating ratio. As you get better, I don’t know when we should think about this topping out the productivity stories that have been going on a long time. So, can you add any color here about the incrementals about the margin sort of over the next few years just where it can actually get to?

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David L. Starling – President and CEO: William, as we’ve stated in the past, we still have opportunities. We have a contract will expire actually in the first quarter that we are going to probably go from contracting out to bringing it in-house. We’ve got one other major contract we’re looking at in Mexico on maintenance. So, we still have opportunities. We’re still able to do creative things on (deepening) locomotives in Mexico which we had not been able to do in the past. We’re now running those locomotives through. So, we’ve still got a lot of opportunities. No doubt with the 12 point reduction we’ve had over the last few years you would think we’ve taken out all the low-hanging fruits, but there’s still opportunities there. With the team we have in place we will continue to lower the operating ratio. Our main goal is to remain fluid, to spend enough capital that we’re onboarding all of this volume and revenue without any service deterioration. But we will continue to improve and it will be a combination of cost control and revenue growth. But at this point, I think we are better just to tell you we are going to continue to improve rather than set an arbitrary target out there.

William Greene – Morgan Stanley: Then maybe you can offer some comments and Mike feel free to weight in, just in terms of the CapEx number, where should we think about this normalizing and when sort of would it normalize? It sort of feels like the revenue story is very good, but does require a pretty heavy CapEx budget, maybe just some comments there.

David L. Starling – President and CEO: Well, we are at $515 million for 2013. To us, that’s not a big number. Again, we are a growth railroad and the worst thing that this team wants to be accused of is having some service deterioration because we didn’t have the foresight to spend the money require to onboard the business. The automotive business is very service sensitive. Some of that business actually carries penalties when you have failures. So, we are going to make sure our system is fluid and when you are looking at a franchise that’s been around 125 years and you are making capacity investments, I don’t know when those become bad investments. I mean, we are going to be around for a long time. If you look at the growth projected by the AAR and others, railroad volume is going to grow up tremendously over the next 30 years. So, I don’t know when capacity becomes a bad investment.

Michael W. Upchurch – EVP and CFO: Phil, this is Mike. I mean, just two comments and Dave Ebbrecht provided a little bit of guidance on where we are spending money in 2013, but remember, our intermodal growth and our automotive growth, we are not going to lose that opportunity to continue to capture well above market growth and it does require some investments in our intermodal facilities and certainly on the equipment side in some Automaxs and we are going to make the right investments to make sure we get that growth.

David L. Starling – President and CEO: I might add one other thing. We talked in the past about 80% lease and 20% ownership. We are trying to change that model over time. We certainly see some OR improvement and more ownership and less leasing. So, just like the locomotives that we purchased this year in 2012. In the past we would have leased those locomotives. This time we paid cash on. It requires capital, but we think that’s the right decision to make.

Mid-Single Digit Volume Expectations

Allison Landry – Credit Suisse: Wanted to ask you guys a little bit about the guidance for 2013, and do you think you are being on the conservative side with regards to your mid-single digit volume expectations? You know it seems that with the new opportunities coming online specifically towards the back half of the year that you might see some things towards the higher single digit range and maybe that would push revenues to the low double digit. So, I was wondering if you could comment on which businesses you might be hearing on this side of caution.

David L. Starling – President and CEO: Well, I’ll take. This is Dave. I’ll take quick shot at it and then turn it over to the expect here, but, if you can tell me what the weather is going to be in Iowa up in the corn belt which had the worst drought that this railroad can remember and you can tell me what’s going to happen with coal, then I will give you a better answer. Are we being a little conservative? There are some unknowns out there. Are we nervous about the economy and what’s going to happen with the fiscal cliff? Of course we are. So, far it’s not reflecting in our numbers, as the negative customers still feel good about 2013, but are there some opportunities for higher growth rate, absolutely.

David R. Ebbrecht – EVP and COO: I would just pick up. It wouldn’t take much to move that across the double-digit line, but just again some of the things that Dave mentioned, the uncertainty, the difficulty we’ve had in forecasting coal and grain in particular, we felt that we would maybe mute those projections a little bit in those businesses.

Allison Landry – Credit Suisse: Then just a follow-up question on the crude opportunity. There’s obviously a lot of pipeline capacity coming online in the Bakken and the Gulf Coast. So, I was wondering if you could talk about your growth expectations for the crude by rail business, maybe within the context of changing supply flows and growing demands in the Gulf for heavy Canadian crude.

Patrick J. Ottensmeyer – EVP, Sales & Marketing: I don’t – I guess, I’d start by saying don’t expect 780% growth that we reported (indiscernible). That was remarkable, but it’s a small base. But what we’re seeing is, and what we feel good about long-term is our position in Port Arthur, Texas. Port Arthur is one of the largest refining markets in the world, some of the largest refineries in the world are located there. It imports over 1 million barrels a day. The customers there like the heavy and the sweet. So, we are moving Canadian and Bakken and West Texas. There’s just a lot of activity and really getting back to your first question Allison, this is one of the areas that’s very difficult for us to forecast because the business is coming at us from places that we are not even looking for it to be honest with you. So, we think crude by rail in spite of what happens with the pipelines, crude by rail we believe is going to be around for a long time, because the customers seem to like it. It gives them flexibility. It doesn’t require the kind of long-term rock solid take or pay commitments that the pipelines require to be built and financed. So, we think this is a business that’s going to grow fast for the foreseeable future and around for a while.