Executives with Kansas City Southern (NYSE:KSU) are cautiously optimistic about rail volumes in 2021, with optimism for an economic recovery tempered by uncertainties related to the coronavirus pandemic.

“The recovery has been remarkable, if a bit uneven,” said Kansas City Southern (KCS) Chief Marketing Officer Mike Naatz during the company’s third-quarter 2020 earnings call Friday. Although certain businesses remain under pressure and COVID-19 is still a risk, KCS has good reason to be optimistic about an economic recovery, Naatz said. He based his observations on customers’ feedback as well as on market conditions such as a tightening truck market.

Cross-border traffic between the U.S. and Mexico could drive volumes in 2021 amid improving markets for intermodal, motor vehicles and parts, grain and industrial products. But an outlook for refined products is unclear and dependent on the economy and on whether many people will continue to work remotely. 

KCS declined to provide specifics on metrics such as operating ratio in 2021, train lengths and plans for how it expects to encourage truck-to-rail conversions, saying that some of those discussions will occur when the company reveals its fourth-quarter results in January.

Instead, KCS executives stressed a bullish outlook on cross-border intermodal and viewed the railroad as an option for customers that want cross-border movement and connections to the other Class I railroads but don’t want to commit to intermodal marketing companies or other railroads.

“We believe that we have a nice opportunity to convert cross-border truckload over to rail,” including converting truckload volumes moving through Laredo, Texas, Naatz said. 

Despite waiting until January to offer guidance, KCS said it expects its capital expenditures to equal roughly 17% of revenue. The railroad plans to keep this level of capital investment so that it can expand its network capacity by improving fluidity through yard and siding expansions. The railroad is considering 17 siding expansions and is planning to finalize that list and determine the pace of deployment by the end of this year. The sidings will help KCS’ network accommodate longer trains.

The company will also be watching how anticipated higher volumes will impact operational costs in the fourth quarter. Back-to-back hurricanes in the third quarter resulted in outages across several segments in the network and led to a backlog, especially for cross-border traffic. KCS also experienced rapid volume growth between the second and third quarters.

“Once we weed out the hurdles we went through in Q3 … that is going to translate hopefully into higher revenue without increasing the cost,” said Sameh Fahmy, executive vice president of precision scheduled railroading (PSR). 

Third-quarter 2020 results

KCS achieved an operating ratio (OR) of 58.8% in the third quarter, which was an “all-time best” for the company. Operating ratio is a tool used to gauge the financial health of a company, with a lower percentage implying improving health.

The record low OR is a “solid validation” of the improvements made in the way KCS runs its network as a result of PSR, said KCS President and CEO Pat Ottensmeyer. 

KCS’ challenge in the third quarter was to balance between bringing back resources, introducing service and meeting customers while also “being very thoughtful” with how to maintain operational and cost efficiency, Ottensmeyer said. 

By the end of the third quarter, KCS’ volumes were running 60% above the trough of April and May on a daily basis, he said. 

“It’s a really remarkable story and a remarkable roller coaster,” Ottensmeyer said. 

KCS’ third-quarter net profit rose 5.3% as a 16.7% decrease in operating expenses helped to offset a 12% decline in revenue.

Net income in the third quarter of 2020 was $189.7 million, or $2.01 per diluted share, compared with $180.1 million, or $1.81 per diluted share, in the third quarter of 2019.

Third-quarter revenue fell 12% to $659.6 million as a result of lower volumes, which in turn were driven by a decline in demand due to COVID-19. Carload volumes slipped 4% in the quarter. Lower commodity prices, a lower fuel surcharge and unfavorable foreign currency impacts also affected quarterly revenue, KCS said.

But operating expenses were $388.1 million in the third quarter of 2020, compared with $465.7 million a year ago. Lower fuel charges drove the decline, and compensation and benefits expenses were also down year-over-year.

Kansas City Southern 2020 Value 2019 Value Y/Y Gross Change Y/Y % Change
Freight revenue (in millions) $659.6 $747.7 ($88.1) -11.8%
Carloads (000s) (exclues automotive) 52 65 -13 -20.4%
Revenue per carload (excludes automotive) $909 $1,005 -$96 -9.6%
Intermodal shipments 265 260 5 1.7%
Intermodal revenue per carload $337 $386 -$49 -12.7%
Gross ton miles (in millions) 23,963.0 26,414.0 -2,451 -9.3%
Train velocity (mph) 14.5 13.9 1 4.3%
Dwell time (hours) 22.9 20.3 3 12.8%
OR% 67.10% 70.90% -3.8% -5.4%
Adjusted OR% 58.8% 60.7% -1.9% -3.1%
Diluted EPS $2.01 $1.81 $0.20 11.0%

For more on KCS’ third-quarter financial results, go here.

Click here for more FreightWaves articles by Joanna Marsh.

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