Kansas City Southern Earnings Call Nuggets: Investment Grade Potential, Growth Pace

On Friday, Kansas City Southern, Inc. (NYSE:KSU) reported its third quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Investment Grade Potential

Chris Wetherbee – Citigroup: May be I could just pick up on where you left off Dave and maybe for Mike just when you think about the potential for getting upgraded to investment grade. Can you give us some of a sense of may be what the opportunity would be for you as far as refinancing some of the maturities you have out there I mean what really is possible as far as getting the rate down and what may be could be the incremental savings from that?

David L. Starling – President and CEO: Sure. Go ahead, Mike.

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Michael W. Upchurch – EVP and CFO: Yeah, Chris great question. Obviously in today’s environment with historical rates the opportunity we think is pretty substantial. If we’re investment grade today, we could probably refinance some of the stated 3.5% on a 10-year note. We clearly have substantial cash balances where we could chose to go ahead and retire with cash the 12.5% notes I mean that issue alone would be $12.5 million of interest savings given that we have $100 million outstanding. Then really if you look at our issues down in Mexico, most of those could be refinanced the average rate there outside of the 12.5% is a little over 6% and reducing that to potentially 3.5%. The only thing that could present a little bit higher interest expense and offset some of those savings will be if pushed the maturities out to 30-years where there is still an overall savings, but probably keep on closer to 5% on a 30-year note. So, depending on the strategy it could be a bit challenging to give you a point estimate there but, I think it’s pretty material off of the $100 million 2012 exit rate that we have.

Chris Wetherbee – Citigroup: Just on the operational side for Dave Ebbrecht I guess, when you think about the headcount leverage that you still have in Mexico, in particular, how should we think about that? I know you kind of have given us some guidance for keeping headcount flat. You’ve done a very good job with that but, as you see this continuing growth, particularly in 2013, do you feel like you’re reaching a point where there’s a set function move up, or are you still able to get some pretty good leverage out of that?

David R. Ebbrecht – EVP Operations: We are still able to get good leverage. We are hiring but most of our hiring is in the (indiscernible) and we will hire in the areas where we have growth, but overall when you look at the total network, we’re able to scale relatively flat as we still have a lot of latent capacity with (indiscernible).

Chris Wetherbee – Citigroup: (Indiscernible) plant closures on your lines, I realize some of this stuff may not be finalized. We may not know, but any color you can offer there in terms of how to think about guideposts for ’13?

David L. Starling – President and CEO: It’s been all over the map. When we talked to our customers, the range of forecast that we have gotten this year, as I mentioned, we don’t yet have our nominations for next year, is really very broad. So, it’s been difficult for us to forecast with any degree of accuracy. I mean, we only have nine plants on our network and we ought to be able to do a better job of forecasting that there are just so many factors that have changed the landscape. Texas is going to be power. I don’t think Texas can really operate with plant closures on a long-term basis. That in any given quarter with natural gas prices being where they are, we could see shutdowns like we did in the spring of this year, where we saw significant shutdowns of capacity. So, it’s just a real hard thing for us to get visibility on as I said, our crystal ball is very cloudy. There are a couple of big events that are going to happen here in the next few weeks that we’ll hopefully get a better clarity, including our customers giving us the nomination for 2013 around December 1.

Chris Wetherbee – Citigroup: If we look at 2013 and we think about the broader portfolio, can you give any sense for what percent of your business is locked in already so you have a view on pricing and you’ve had very good pricing, arguably among the best in the industry. Can that continue or do you sort of converge toward a norm?

David R. Ebbrecht – EVP Operations: I think it can continue. Remember half of our business is in Mexico and if you just think about pricing being a function of inflation and CPI inflation in Mexico has consistently been a point or so higher than in the U.S., so that’s one of the reasons that we have a little bit better pricing than the rest of the rails. A lot of our business in Mexico prices on an annual basis. So, we have less locked in than you’re hearing from the other Class Is, probably 50% locked in next year versus I think the others have reported higher numbers but again it’s inflation in Mexico. The other factor and Dave Starling touched on this is we’ve really got a superior product, service, security, other things in Mexico and that has allowed us to be a little higher in terms of the value that we’re offering and coming through in rate negotiations on contract renewals.

Growth Pace

Thomas Wadewitz – JPMorgan: Good morning and congratulations on the good results again. I wanted to ask Dave Starling I think you made some comments I believe it was the second quarter where you said 2012 is kind of a slower growth year (indiscernible) broader trend in (indiscernible) and given some of the projects and market initiatives and so forth (indiscernible) you might see a step up in the growth pace in 2013 (indiscernible) and 2014. I want to ask you if you still think that’s the case and as you look to 2013 what the markets or areas where you would expect to see a significant step up?

David L. Starling – President and CEO: Well, Tom I think in the context of the 2012 comment I think we referred to it as a bridge year that it really was going to be a slower year, but with the five auto plants coming on in the next two to three years we think we’ll see the volume grow in 2013. It should accelerate even more in 2014 and then with all five plants fully operational. We should hit some kind of peak around 2015. In the meantime, you’re going to see the Intermodal growth continue. You’re going to Lazaro grow – Lazaro Cardenas continue and possibly accelerate even beyond where it is when the APM facility opens in 2014 or 2015. You’re still going to see crude and frac sand grow. So, we don’t see a downturn of any kind, but you may see, we could very easily slip back into double-digit in the out years. Did that answer your question?

Thomas Wadewitz – JPMorgan: Yeah it does. I recall you said bridge year necessarily solar year but, when we think about auto, is there a timing where the impact of the plans coming on would be more material. Is that kind of second half of 2013, where you might see that step up? Then in terms of drilling down on the crude oil, that’s accelerated, but how do you think about factors that would cause a step up there? There are some refinery investments in receiving facilities or are there other factors and kind of timing of when they would give you potentially a step up in 2013 on crude oil.

David L. Starling – President and CEO: I’ll let Pat talk to you about the automotive side, but I think one thing we don’t want to lose sight of is we are still the largest supplier of grain for Mexico and we’ve just come out of a drought year. So, we certainly expect the back half of 2013 to be a very good year for grain and given the contract, the deal that was done with one of our customers, who is a major user in Mexico, we don’t expect the first half of the year to be that weak. They’ve got orders to fill down there and they’re going to fill those orders. In fact, they bought out into the future to secure this corn. So, they have got a contract, they have got to fulfill for the full year 2013. So, we’re certainly going to help them do that, but the grain has been a significant hit for us this year. It’s something that we generally – it’s good margins, gives us a nice long haul. So we should have that grain back next year and with the two new elevators we should have even growth in grain or whatever we’ve ever had in the past.

David R. Ebbrecht – EVP Operations: On the auto and crude oil, Tom, the auto plants, they are under construction (Mazda), Nissan, those will begin producing finished vehicles in the first quarter of 2014. So, we won’t see much from those plants, but you look at, we keep saying that this is a bridge here for automotive and adjusting for currency we’re up 30% plus. So, we like that bridge, we’ll take that bridge. We’re gaining market share and so we’ll see the big pop from the new plants beginning in 2014. Crude oil is just really hard for us to predict. I mean we’re literally getting – our team is working hard. They are doing a great job, but we’re getting new request. We’re getting new movements and new business literally coming in almost every week. We’re looking at a number of options to invest and use our footprint in Port Arthur, Texas to maximize our opportunities in that business. We are very well positioned at the receiving end. Obviously, like our whole business we don’t originate any crude oil. The thing that gives us a seat at the table is our footprint and our position in Port Arthur, which is one of the biggest refining markets in the world. So, we’re looking at making some investments. I don’t think there is anything huge or there is no real kind of step function capital that has to take place it’s just a big market it imports a lot of crude oil and it wants to draw crude oil from Canada and from Bakken and we through our rail connections we can deliver both. It’s probably not that fine answer, but it’s just very hard for us to forecast the future there, because literally we’re getting new business almost every week.

David L. Starling – President and CEO: I want to leave you with the 2012 with the statement that I had made is that we were not excited about 2012 we were going to be excited about 2013. We’re extremely excited about 2012 we think it’s been a great year and at a time when we’ve had a grain draught or draught affecting our grain and also the coal being down. So, we’re very pleased with the growth of those other five major commodities we don’t see that slowing down we see grain coming back.