Kansas City Southern seeks to maintain PSR-related cost cuts

Although the COVID-19 pandemic led to a 23% drop in revenue in the second quarter for Kansas City Southern (NYSE: KSU), the operational changes the company made to cut costs are serving as the silver lining.

Many of those changes will become permanent even as volumes grow beyond February’s pre-pandemic levels, Kansas City Southern (KCS) officials said during the company’s second-quarter earnings call on Friday.

“This is a permanent structural savings in our cost structure that we think will carry forward in the incremental margins as volumes return,” said KCS CFO Mike Upchurch.

These changes include fewer train starts and crew starts but longer trains with increased velocity and longer dwells times, executives said.

Although second-quarter carloads were down 21% compared with the same period in 2019, current volume is now only 6% below February’s pre-pandemic levels, according to Sameh Fahmy, KCS’ executive vice president for precision scheduled railroading (PSR).

Yet despite volumes “equalizing” to February’s levels, KCS is still experiencing 20% fewer train starts and crew starts, and it is utilizing 20% fewer locomotives than in February. Meanwhile, train lengths have grown by 20%, while fuel efficiency has improved by 9%, Fahmy said.

To achieve these metrics, KCS employed a variety of strategies, including “mixing” trains more so that trains are carrying intermodal, automotive, grain and other types of volumes on one train. Northbound trains are consolidated at smaller rail yards in Mexico and then are “split” into various trains bound for various U.S. destinations, while southbound trains are consolidated at Shreveport, Louisiana, before being split in Mexico.

“A lot of these consolidations that are happening in Mexico, in small yards, like Vanegas, San Luis Potosí, Escobedo, which are not large yards, have been done with great precision,” Fahmy said. “What we did is that we build tight windows for trains to arrive within that window, make the connection fast so that we don’t affect the dwell time and then get out of the yard before the next trains come in.”

He continued, “And that has been executed with a lot of discipline, and that’s precision scheduling. I mean, that’s PSR and it has been very successful.”

To continue these operational changes, KCS expects to deploy measures such as extending siding to 12,000 feet to accommodate longer trains. The organizational changes announced earlier this month are also part of KCS’ activities related to these PSR-related changes.

Should North America experience a second wave of the COVID-19 pandemic, KCS executives said they would use the lessons they learned in April and May while continuing the operational changes they made in the second quarter.

“Our biggest concern sitting here right now is the volume environment, and what if any negative impact as a result of the second wave of infections could cause plants to shut down,” Upchurch said. “But what we do feel extremely confident in is the ability to continue to generate cost savings here. And I think we’re going to be even better positioned as a company than we were in the first quarter, where we delivered record results because of those cost actions that Sameh explained, and we do believe that those are permanent cost savings.”

Second-quarter financial results

Second-quarter net profit was $110.3 million, or $1.16 per diluted share, compared with $129.1 million, or $1.28 per diluted share, in the second quarter of 2019.

Revenue in the second quarter of 2020 totaled $547.9 million, down 23% from the same period in 2019 as demand slumped because of the coronavirus pandemic, the railroad said early Friday. Carloads were down 21% in the quarter.

Operating expenses were $367.5 million in the second quarter, compared with $506 million a year ago. Meanwhile, operating income was $180.4 million, compared with $208 million last year.

Operating ratio was 67.1% in the second quarter, compared with 70.9% for the same period in 2019. Operating ratio is a metric that can be used to gauge the financial health of a company. KCS calculates operating ratio by dividing operating expenses by revenue.

“I don’t think anyone on this call has ever seen a 90-day period where business levels dropped so quickly, stayed at a stable level for a relatively short period of time and then recovered and responded so quickly thereafter,” said KCS President and CEO Pat Ottensmeyer. “So, I really feel like our team was on their toes. And we responded extremely well on the downside and on the recovery side as well.”

Average train speed in the second quarter was 17.1 mph, up from 12.5 mph for the same period in 2019.

Average terminal dwell time was 20.3 hours, down from 21.2 hours in the second quarter of 2019 but up from 19.8 hours in the first quarter of 2020. KCS said the sequential increase was because the railroad was focused on lengthening trains.