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3 Things Kansas City Southern's Management Wants Investors to Know

By Asit Sharma – Apr 18, 2019 at 3:15PM

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Executives discussed travails and rewards in its Mexican network, as well as initial results from its new efficiency initiative.

Kansas City Southern's (KSU) first-quarter 2019 earnings report, released on Wednesday, evidenced strong revenue growth, as the company's top line improved 6% year over year for record first-quarter revenue of $675 million. The company also achieved record first-quarter operating profit after adjusting for productivity-related charges and the tax impact of a Mexican excise fuel credit. Below, let's review three comments made by management during the railroad's earnings conference call, which put KCS's recent performance -- and 31% year-to-date stock appreciation -- into perspective.

1. Mexico-related business is flourishing despite challenges

I'm happy to say this was a record first quarter for KCS, despite the headwinds from the teacher protests in the State of Michoacan. [P]lease note that the service interruptions caused by those teacher protests impacted [us] across several business units including our intermodal, automotive, and industrial consumer segments.
-- Michael Naatz, chief marketing officer

Early in the quarter, it appeared that unplanned shutdowns in the automotive and paper industries in Mexico, as well as the teacher protests that disrupted rail traffic in Michoacan state, might sink the company's overall quarterly results. Indeed, teacher protest blockages hit intermodal traffic between Lazaro Cardenas and Mexico City, causing intermodal segment revenue to drop by 12% and pushing the company's total volume into a 1% decline year over year.

Yet KCS's U.S./Mexico cross-border volumes improved by 13%, and associated revenue jumped 18% against the prior year. The company is seeing increased volume in refined products and cross-border intermodal business. Mexican energy reform has pushed up volumes in petroleum shipments, and the company's efforts at precision scheduled railroading, or PSR, have freed up capacity for additional cross-border traffic. Thus Naatz projected a robust potential for Mexico-related revenue over the next few quarters.

A freight train with petroleum tankers seen at dusk.

Image source: Getty Images.

2. Financial performance will benefit from a comprehensive focus on service metrics

Numerous factors are contributing to the overall service improvement, [including] PSR initiatives, reduced inventories, execution at our key terminals and improved asset utilization are all having positive impacts. Specific areas of improvement include our border terminals: Monterrey, Sanchez and Laredo all showing marked improvement both sequentially and year-over-year.
-- Jeff Songer, chief operating officer

In the quote above, Chief Operating Officer Jeff Songer refers to an effort to reduce assets in use while improving the efficiency of train operations through implementation of PSR principles.

Songer referred to KCS's Monterrey, Mexico, border terminal to demonstrate utilization improvement, noting that the gateway is currently operating with an inventory of about 1,500 cars, which is down roughly 40% from last year's peak congestion.

Songer also advised investors that KCS will be focusing more closely on gauging its service success through PSR-oriented metrics, which will ultimately improve financial performance. For example, KCS will pay close attention to train length, a vital metric in PSR implementations. Longer train lengths indicate reduced train starts (which itself connotes higher efficiency). KCS intends to increase train length by 3% in 2019, resulting in a projected average train length of 6,000 feet. The railroad will also home in on another important PSR metric, car miles per day, which can illuminate delays and repair needs, and help set baselines for train performance.

3. A successful PSR implementation depends on balancing two objectives

When people think of PSR, they typically think of train consolidations [and] scheduling...In other words, service design. But there is also an execution aspect and a discipline that comes with PSR, which is the intensity of watching the assets, checking every train delay and understanding what's going on at least a couple of times every day, and [that process should both precede and follow] any service design changes.
-- Sameh Fahmy, executive vice president of precision scheduled railroading

As I discussed in a recent analysis of Kansas City Southern's plan to jump-start efficiency via precision scheduled railroading, the company's PSR approach leans heavily on improving network fluidity. This relates to service design, the practice of reducing avoidable congestion while increasing overall network speed. KCS recently hired veteran rail executive Sameh Fahmy to lead its PSR charge, and in his first conference call since joining the executive team, Fahmy was quick to point out the less glamorous side of PSR. As he mentions above, service design must be balanced with network observance.

Fahmy gave several examples of specific instances over the last quarter in which network delays were addressed in rapid fashion, through a sort of high-touch intervention method that often involved members of the management team. Essentially, Fahmy conveyed that PSR is an ongoing process that requires frequent monitoring, as rail traffic bears an inherent tendency to congest due to innumerable moving parts and pieces.

The efforts have already yielded fruit. Fahmy relayed that reducing assets and congestion around the Houston area has resulted in 100 fewer crew starts per week, equivalent to 100 fewer locomotives and 1,000 fewer cars in service. Less congestion and improved network fluidity in this area have in turn generated a 4% gain in fuel efficiency. While it's still quite early in Kansas City Southern's PSR journey, the dual approach of service design and intense monitoring of network flow appears likely to generate higher profits in the coming quarters.

Asit Sharma has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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