Kansas City Southern is refraining from adjusting its earnings guidance for the year amid uncertainties over the global chip shortage and teacher protests and supply chain disruptions for refined fuel products in Mexico.
“We’re the first to admit that the visibility on the commercial side is limited,” KCS (NYSE: KSU) President and CEO Pat Ottensmeyer told investors during the company’s third-quarter 2021 earnings call Tuesday morning.
KCS had said in January that it was anticipating double-digit revenue growth in 2021, as well as an operating ratio of around 57.5% in 2021 and between 55% and 56% in 2022 and an earnings per share of $9 or better in 2021 and between $10.50 and $11 in 2022.
The global chip shortage has curtained North American automotive production, resulting in a 17% drop year-over-year in KCS’ automotive revenue to $40.1 million amid a 30% drop in automotive units.
But there are two other factors that affected KCS’ financial performance in the quarter, executives said. Teachers’ protests blocking access to the port at Lázaro Cárdenas in Mexico have significantly curtailed KCS’ ability to serve the port for more than 75 consecutive days, according to KCS CFO Mike Upchurch, who noted the railway was “essentially operating trains only in the month of July, with no traffic in August or September.”
The teacher strike “is a chronic issue in this part of the country,” Ottensmeyer said.
As a result, while KCS’ third-quarter cross-border volumes rose 3% year-over-year and cross-border revenue rose 13%, Lázaro Cárdenas intermodal volumes tumbled 67% and intermodal revenue fell 62%. There were also negative impacts on heavy fuel oil moves for Mexican petroleum company Pemex and on metals volumes, Upchurch said.
In addition to the teacher strikes, Mexico altered how it regulated refined fuel products shipments into Mexico, and that change slowed down rail shipments temporarily, according to KCS executives.
“We noticed that the government was cracking down on some of the permits and inspections and that caused kind of a double whammy,” Ottenmeyer said. “Not only did it slow down our own supply chain and the flow of that product, but it caused some unusual congestion in our yards that rippled into added cost and service disruptions across our entire portfolio. That piece of it, the congestion and service disruption from a broader perspective, I … feel like we’ve really resolved during the quarter.”
The heightened permit and inspection rules for refined products could “dampen” some growth opportunities, although demand for these products will continue to be strong and “hopefully get back into a more normal predictable cycle of how we can move this without the kind of interruptions that we’ve seen,” Ottensmeyer said.
Meanwhile, KCS said it’s “making progress” with its merger with Canadian Pacific (NYSE: CP), with shareholder meetings for both companies expected to occur by the end of this year. KCS also anticipates federal approval of the merger sometime in the second half of 2022.
Ottensmeyer noted the absence of Sameh Fahmy, KCS executive vice president of precision scheduled railroading, on the third-quarter earnings call. KCS announced last week that Fahmy, whose tenure at KCS began in January 2019, would be leaving the company by the end of the year.
KCS “really cannot say enough about what Sameh brought to the company over the last almost three years, his enthusiasm, his focus, his passion,” Ottensmeyer said.
Third-quarter 2021 financial results
Despite the third-quarter headwinds, revenue rose 13% to $744 million in the quarter year-over-year on higher fuel surcharges, a favorable products mix and the strengthening of the Mexican peso against the U.S. dollar. Overall carloads slipped 3% from the third quarter of 2020.
Operating expenses rose nearly 27% to $492.1 million, which included $36.5 in merger costs. Operating income fell 7% to $251.9 million.
Reported operating ratio was 66.1%, which takes into account the merger costs and expenses related to service challenges from earlier this year, according to Upchurch. Excluding the merger costs, the OR would be 61.2%. Both figures are higher than an OR of 58.8% in the third quarter of 2020. Investors sometimes use OR to gauge the financial health of a company, with a lower OR implying improved health.
Third-quarter net profit was $156.1 million, or $1.71 per diluted share, which is nearly 18% lower than net profit of $189.7 million, or $2.01 per diluted share, in the third quarter of 2020.
“We are encouraged that despite several commercial headwinds, our network is performing extremely well and we are delivering near record velocity and dwell,” Ottensmeyer said in a release. “Underlying industrial demand is strong, and KCS has maintained resources to prioritize customer service as volumes return to the network. As certain supply chain disruptions are resolved and our revenue environment improves, our network will be well positioned to handle incremental volume while continuing to provide premium service to our customers.”