Michael W. Upchurch, the CFO and Executive VP at Kansas City Southern de Mexico, very much had NAFTA on his mind when he addressed the Bank of America Merrill Lynch 2018 Global Industrials Conference in London Wednesday. His remarks were available via webex.
Upchurch spoke about the future of KCS, while extensively discussing the challenges faced by the U.S. railroad industry with regard to NAFTA and its prospects in the Mexican cross-border trade set against the country's presidential election this year.
Over the last few years, Mexico has been seeing a surge in manufacturing activity, particularly in the automobile sector with OEM majors like Chrysler, GM, Ford, Volkswagen, BMW, and Mercedes setting up their production plants in the country. Two-thirds of all the produced units end up being exported into the U.S., and often move via railroads. KCS benefits from this activity, as it controls the Laredo International Gateway with goods destined toward the Midwest, Northeast, and Southeast moving through this gateway.
“Another area that we are pretty excited about is the 3.8 million truckloads that cross the border at Laredo on an annual basis, and we are through a 4% market share. There is a great opportunity to grow that over the long run,” said Upchurch.
The conundrum of NAFTA negotiations
In the NAFTA debate, KCS finds itself in the eye of the storm. Before the presidential elections of 2016, the railway company was often called the NAFTA railroad due to its dependence on cross-border trade which accounts for 30% of its total traffic. But all this changed after Donald Trump was elected, with the company's market cap slumping by 10% on a single day over concerns of the U.S. pulling out of the NAFTA agreement.
Ideally, Upchurch said, the NAFTA agreement will be revised rather than scrapped, which Upchurch argued would not impact the fortunes of KCS. IN the unlikely situation of the U.S. pulling out of the agreement, trade between the two countries would possibly revert to pre-NAFTA WTO tariffs. That would mean an average tariff of 3-4% for goods coming into the U.S. from Mexico, not substantial enough to create economic tremors.
Upchurch pointed out that KCS moves more carloads from the U.S. into Mexico than vice versa, predominantly due to corn exports from the U.S. The tariffs in effect prior to NAFTA would mean that roughly a 12% tariff would be imposed on grain going into Mexico. But Upchurch insisted that KCS is insulated against a significant decline, as for farm interests the alternative to shipments to Mexico would be to trade with South America. As the supply chain leading to South America is extremely complex and riddled with inconsistencies, he trusts businesses would continue to rely on Mexico for trade.
“We strongly believe that we will continue to see the grain move. We charge in U.S. dollars, and if you are buying in Mexico, the peso has depreciated 50% over the last five years, and that has not slowed down our movement of corn into Mexico at all,” he said. “So I think...ultimately we will see very minimal impact even if we pull out of NAFTA.”
Seven rounds of NAFTA talks have generally been viewed as not particularly productive. The timeline of the talks is important, because the Mexican elections loom in July. A failure in the talks is viewed as having the potential to impact the Mexican election, particularly as it related to leftist candidate Andrés Manuel López Obrador.
Railroad contribution in the Mexican energy sector
In 2013, the Mexican government in a historic move edited their Constitution to allow the possibility of foreign involvement in their energy sector, opening up immense possibilities for foreign companies in offshore drilling, frac-sand drilling, or to move crude oil into the country.
Companies like ExxonMobil, BP, and Valero moved to Mexico to set up service stations, bringing their fuel in rather than using Pemex fuel. The product can be run through railroads, and KCS reported revenue from energy-related movement into Mexico last year of $15 million.
“Honestly, that [revenue] could be a lot higher, [but] the challenge is getting infrastructure built in Mexico - rail unloading facilities, storage facilities, to be able to bring a train of product in, unload it on an efficient basis and move that train back into the U.S. to load it up back again,” Upchurch said. “Just a week ago, we received a permit to build tanks on that side. So that process will commence, and this is going to create a good opportunity for us to increase revenues.”
The “manufacturing jobs are moving out of the U.S.” crisis
Many OEMs have set up base in Mexico and Upchurch contended that in the next 5-10 years, there would be a lot more manufacturing activity commencing in Mexico. Referring to the conviction of the current U.S. administration, he says that job losses in the U.S. should not be tied up with increased industrial growth in Mexico.
“It is automation that has really reduced the number of jobs in the auto sector. If you have a chance to tour an auto facility, the first thing you are going to know when you walk in, is how few are the people they actually have in those plants. And if you compare that to videos from 20-25 years ago, it is staggering how few are the people employed in these facilities now,” he said.
Upchurch concluded by talking about the ELD mandate and how the decreasing capacity in the trucking industry is helping the railroads channel more business towards itself. “We are seeing a rebound in volumes and are beginning to see a better price environment there. Honestly, prices around the intermodal business have been pretty flat,” he said. “I think all the regulation that is being enforced against the trucking industry, is going to take some capacity out of the marketplace and will help not just our intermodal business but also the other rails.”
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