Kansas City Southern's CEO Discusses Q2 2012 Results - Earnings Call Transcript

Kansas City Southern (KSU)

Q2 2012 Earnings Call

July 17, 2012 8:45 am ET

Executives

David Starling – President, Chief Executive Officer

Michael Upchurch – Executive Vice President, Chief Financial Officer

David Ebbrecht – Executive Vice President, Operations

Patrick Ottensmeyer – Executive Vice President, Sales and Marketing

José Zozaya – President, Executive Representative – KCM Mexico

Analysts

Bill Greene – Morgan Stanley

Chris Wetherbee – Citigroup

Ken Hoexter – Bank of America Merrill Lynch

Jeff Kauffman – Sterne Agee

John Barnes – RBC Capital Markets

Anthony Gallo – Wells Fargo

Tom Wadewitz – JP Morgan

Scott Group – Wolfe Trahan & Co.

Tyler Brown – Raymond James

Allison Landry – Credit Suisse

Matt Troy – Susquehanna Financial Advisors

Brad Delco – Stephens Inc.

Presentation

Operator

Greetings and welcome to the Kansas City Southern Second Quarter 2012 Earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded.

This presentation includes statements concerning potential future events involving the Company which could materially differ from the events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the Company’s Form 10-K for the year ended December 31, 2011 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, David Starling, President and Chief Executive Officer for Kansas City Southern. Mr. Starling, you may begin.

David Starling

Thank you. Good morning and thank you for joining us for Kansas City Southern’s second quarter earnings presentation. Joining me today will be Dave Ebbrecht, EVP of Operations; Pat Ottensmeyer, EVP of Sales and Marketing; and Mike Upchurch, EVP and Chief Financial Officer. Also joining us by phone this morning is José Zozaya, President and Executive Representative of KCM from Mexico.

If you go to Page 5 on the overview, I’m going to keep my opening remarks brief and let Dave and Pat and Mike get into the specifics of the second quarter. However, I would like to say our profit in the face of the lower than anticipated utility coal carloads, some foreign exchange headwinds, and an uncertain economy, KCS had a good quarter and in certain areas a very good quarter. That we set second quarter records for revenues, carloads and operating incomes speaks to the overall strength of the KCS Rail franchise and underlines the fact that our growth story is very much intact, and that our key growth areas gained significant momentum.

For example, look at our cross-border intermodal business. In 2011, cross-border intermodal carloads increased by 56%. We were very impressed by that until the first quarter of 2012 when carloads increased by 78%. Again, we were impressed with this growth until the second quarter when the year-over-year volume growth hit 106%. It’s very exciting to see the percentage growth nearly double from 56 to 106% as the base actually gets larger.

This growth is extremely important for us for a number of reasons. First, it validates what we have said for a while now – there’s a huge market for a premium intermodal product between the U.S. and Mexico, and that market will continue to grow. KCS is in the enviable position of being the only railroad that had single-line service on both sides of the border and controlled the primary gateway between the U.S. and Mexico. We’ve invested in our network to ensure we can provide the service necessary to successfully convert a large percentage of the business from truck to rail. Now that the infrastructure is in place and our truck and rail partners are fully engaged, we’re seeing the results. And what is especially exciting, we’re still at the very beginning of what promises to be many years of expansion growth.

The second aspect that makes cross-border intermodal important to us is that it represents some of the longest haul traffic on our network, which along with the high incremental margins we’re enjoying in this business segment makes this line of business quite profitable.

I don’t want to steal all of Pat’s thunder, but by no means was cross-border intermodal the only bright, shiny object in the second quarter. Traffic on Lazaro Cardeñas remains strong and automotive continues to grow rapidly. We’re also experiencing the ripple effect of automotive growth on our other commodity areas. And as Dave Ebbrecht will illustrate in a few minutes, KCS’ operational performance continues to excel and our safety statistics just get better and better. The two really go hand-in-hand. As you have heard me say in the past, a safe railroad is inevitably a well-run railroad, and that KCS is both is having a very definite, positive impact on our profitability.

While there are certain mixed signals regarding the direction of the economy, we do feel that some of the bright spots in the economy are having positive impacts on our business. Most notably the surge in automotive sales is certainly being felt in a number of our commodity groups. More over, the very solid manufacturing numbers we’re seeing related to Mexico are being reflected in our KCS volumes. I don’t by any means want to suggest that KCS is immune from the mood of uncertainty which is prevalent regarding the direction of the global economy. We are certainly impacted by it, but there are enough positives in the economy for KCS to maintain strong volume growth in the present business environment.

We are also very satisfied with the outcome of the Mexican presidential election. José Zozaya has a good working relationship with President-Elect Peña Nieto. We believe his administration will be pro-business and we’re confident that the relationship between our company and the Mexican government will remain solid and positive.


If you’ll turn to the next page, second quarter results, I’m going to let Pat and Mike get into the nuts and bolts; but I would like to say we are certainly enjoying reporting the 62.6 second quarter operating ratio, but we understand the comparative adjusted second quarter operating ratio of 70.5, representing a 1.2 point improvement over last year, is the important number. Our second quarter adjusted diluted EPS was $0.85 compared to last year’s adjusted diluted EPS of $0.71.

If you turn to Page 7, finally despite some of the volumes and foreign exchange challenges in the quarter, KCS remains mostly on target in terms of its 2012 guidance. Year-to-date volume growth of 6% is solidly within the mid-single digit range we laid out in January. Pricing also continues to be mid-single digit. Our year-to-date revenue increase of 7% is tracking somewhat below our low double-digit projection. I will point out, however, that the combined effect of lower than anticipated coal volumes and a weaker peso amounted to a 4% negative impact on our first half revenues.

Finally, our year-to-date adjusted operating ratio is 1.9 points improved over the adjusted operating ratio for the first half of 2011, which among other things speaks to the Company’s ever-improving operating efficiencies and the overall profitability of its commodity areas. I’ll come back at the end of the meeting with a few comments on how we see the remainder of 2012 playing out and how that could transcend into 2013 and beyond; but now, let me turn it over to Dave Ebbrecht.

David Ebbrecht

Thanks, Dave. Turning to Slide 9, I want to start out by emphasizing the importance of our safety efforts at KCS and the value it has provided for the Company. We’re very proud of the recognition of our best-in-class safety award of May. Not having injuries, not having accidents and not having derailments is not only great for our employees and the public, but it also adds value to the bottom line. Our injury claims are down 43%, total liabilities down nearly 60%, and our total casualty expense is down 60% compared with the same period in 2008 when we had higher headcounts and higher train activity. Recognizing that the cost of failure in our business can be expensive, we continue to improve our standards in the future and ensure safety is at the forefront of every decision.

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