Kansas City Southern: new U.S.-Mexico trade deal is mostly what we hoped for

 KCS executive vice president Brian Hancock 

KCS executive vice president Brian Hancock 

 

Talk about timing. Brian Hancock was just in Mexico this week when a new trade agreement was announced with the U.S. 

The news came as Hancock, an executive vice president of Kansas City Southern, was meeting with the board of the rail’s Mexican subsidiary and business and political leaders in the northern industrial city of Monterrey and Mexico City. 

Much of the new agreement focused on how the two countries would rejigger the $84 billion trade in vehicles. That trade is close to Kansas City Southern of Mexico (KCSM). At the end of August, motor vehicles and equipment took up space on 2,158 KCSM railcars, accounting for  under half of the weekly total carried on Mexico’s rails, according to the Association of American Railroads.

Hancock, who also worked at Family Dollar, Schneider National and Whirlpool, says the new trade deal appears to be mostly a win for U.S.-Mexico trade in general and KCSM specifically. But details such as pay requirements for auto plant workers are still unclear. 

Mexico’s recent presidential election may also mean another overhaul of the country’s energy sector, which has been an area of growth for the railroad. But Hancock says KCSM can still play a role in any further such efforts. One of the rail’s biggest challenges, though, is the country’s weak currency, which pits KCSM’s intermodal service against the local drayage industry. Hancock spokes to Freightwaves about these issues:

What is your initial take on the new U.S.-Mexico trade agreement?               

I am cautiously optimistic on it. You cannot take anything for granted at this point as the deal is not done is until it’s signed. But our company’s CEO has been leading the way saying that having Canada as a part of this deal is very important. We’re positive on the U.S. and Mexico delegations coming to an agreement, but we do get a lot of freight from Canada too. I would say the agreement is about 70% to 80% of what we had hoped it would be.

 

What are the uncertainties for KCSM in this agreement?

There’s the content rules for automobile parts going from 62.5% to 75% being sourced in either the U.S. or Mexico. And there’s the labor rules that 40% of automobile workers receive a minimum wage of $16 per hour. 

The content rules could mean more parts would flow down to Mexico. But there’s not enough understanding around the wage requirement and how that’s going to be calculated, whether that will apply to floor workers or also white collar jobs as well. In Mexico, you are talking about $20 per day environment for many workers. That might create a wage bubble, which could drive changes in the supply chain no one understands yet. 

Even if the requirements can’t be met, a 2.5% tariff on automobiles coming from Mexico on a $20,000 car would be between $500 and $750. That’s not a killer for most people. It’s not going to shut down trade. Also the steel requirements of Nafta and the fact that steel from Russia and China is subject to tariffs is good for domestic steel makers, which are our customers. So we’re cautiously optimistic.

Since you were just in the country, how was the deal received in Mexico?

So our entire board met with the board of KCSM and then we had one meeting in Mexico City and in Monterrey. We met with 20 CEOs and everyone was very positive on the  agreement. Some had investments that they had been wanting to make or increase capacity that had been slowed. This agreement is helping facilitate that. Overall, we came away with the sense that people are excited to continue Nafta.

Mexico elected a new president that has signaled interest in making the country more self sufficient in terms of energy. Refined products imports are big part of the KCSM business. Do you see any impact from those reforms?

Mexico depends on imports for up to 75% of their domestic consumption, primarily gasoline and diesel. The majority of that comes in through vessels and the pipeline at the Port of Vera Cruz. Rail is the next best option, especially for the northern part and the middle of the country. In our second quarter, we saw revenue related to Mexico’s energy reforms (which allowed non-state owned companies to import refined products) grow 57% from a year ago to $22 million. 

The new president (Andres Manuel Lopez Obrador) has spoken about building two new refineries to supply Mexico. If you were to build a new refinery, it could take seven to 10 years and cost up to $15 billion. This is a very slow process. 

We have actually encouraged that Mexico bring in more of the light, sweet crude coming from the U.S. and blend it with the heavy, high-sulphur crude they produce to make their plants more efficient and produce more refined product. 

Some of the fears around the country’s energy reform efforts may be overblown. They are very concerned about their dependence on imports, but pulling back on energy reform is not going to their lives any better. If they are going to move forward with their energy needs, we are going to support them.

How has the company’s intermodal business out of the Port of Lazaro Cardenas?

In our last earnings call, we mentioned that Lazaro Cardenas is seeing an uncertain volume environment. The truckers there bill in pesos while we bill in dollars. We have thus far not reduced our prices. I assume the truckers haven’t, but the devaluation of the peso has made it effectively 30% cheaper to use them  But we are looking at ways to grow back the volume there.