RAILROAD TRAFFIC GOING VIRAL ON US/MEXICO BORDER

KANSAS CITY SOUTHERN RAILWAY LEADS THE WAY IN NORTH AND SOUTHBOUND RAILROAD TRAFFIC ON THE MEXICAN BORDER
Written by
ALEX KOWALSKI
Bloomberg News

 

 

Kansas City Southern railcars are rumbling over the Rio Grande as record trade between Mexico and the U.S. buffers the railroad from a slowing global economy.

Escalating shipping and labor costs in world manufacturing centers such as Asia have encouraged companies including Nissan Motor Co. and DuPont Co. to shift capital spending to Mexico. Many of the goods produced by their investments will head to the U.S., the destination for about 80 percent of Mexico’s exports.

Cross-border merchandise trade totaled $341 billion by the end of September, about 18 percent higher than it was at the same point in 2010, according to the most recent data from the Bureau of Transportation Statistics in Washington. The increase will help Kansas City Southern, the only U.S. railroad with a wholly owned Mexican subsidiary, weather the effects of a possible European recession as the 125-year-old company seeks to take business away from trucks traversing the border.

“This is the best organic growth story in the U.S. rail network,” said Matt Troy, an analyst at Susquehanna Financial Group in New York. He estimates Kansas City Southern revenue will rise two to three times faster than similar regional railroads for “several years.” “The combination of bringing manufacturing capacity back from Asia and the potential for highway share conversion creates a very strong one-two punch.”

Gunfighter generation

Traffic at the company founded in 1887, the same year American gunfighter Doc Holliday died, increased 9.2 percent in 2011 through mid-December, Troy said, citing data from the Association of American Railroads. That’s about two to three times the growth at other North American railroads, he said, adding that car loadings at Kansas City Southern have exceeded their pre-recession peak in 2006, unlike the rest of the industry.

Risks for Kansas City Southern include a possible recession in the U.S. or new federal regulations. A reduction in volume on its rails due to any prolonged weakness in the economy would leave the company vulnerable because a unionized workforce makes cost-cutting difficult, Troy said

Also, “there’s increasing sensitivity toward pricing power,” Troy said. “The risk would be if Washington were to take a more proactive role in examining how rails price their business.” Drug-related violence in Mexico hasn’t affected Kansas City Southern’s operations, Chief Financial Officer Michael Upchurch said at a Sept. 13 conference in Chicago.

The company’s shares have gained 18 percent since June 30, while the Standard & Poor’s Railroads Index has fallen 1.6 percent in the same period. Troy, who has a “positive” rating on Kansas City Southern, said “you can check the box for every type of investor.”

As its plans in Mexico progress, the carrier has more room to grow, can increase profitability and will probably soon offer a dividend, he said.

Mexico accounted for about 45 percent of Kansas City Southern’s $1.57 billion in revenue in the first nine months of 2011, according to company filings. The company’s Mexican carloads increased 15 percent to mid-December from the beginning of 2011, Troy’s data show.

The fifth-largest U.S. railroad by revenue can cross the border without having to hook up to a new engine, as is the case with trucks, because of its counterpart, Kansas City Southern de Mexico.

It also owns the rail bridge at Laredo, Texas, where the largest share of goods flow across the border between the two countries. The railroad provides the only service at the Port of Lazaro Cardenas on the west coast of Mexico, which is scheduled to be expanded to compete with California.

Union Pacific

Union Pacific Corp., the largest U.S. railroad by revenue, also carries goods to and from Mexico, using Ferrocarril Mexicano SA de CV, of which it owns a portion. It relies on Kansas City Southern, which moves almost half of Union Pacific’s Mexican shipments, according to company reports.

Traffic should continue to pick up as America’s southern neighbor boosts factory output, according to Neal Deaton, an analyst at BB&T Capital Markets in Charlotte, North Carolina, who has a “buy” rating on Kansas City Southern. Almost 80 percent of shipments cross the border by land, the transportation bureau’s data.

 

“There’s been a strong manufacturing renaissance in Mexico over the last four to five years, and it’s only getting stronger,” Deaton said in a phone interview.

Producers are seeking to move supply chains closer to end markets as transportation costs rise and because they’ve seen how much disasters like Japan’s tsunami can set back business, he said. Cheap manufacturing and a growing number of engineers also support the renewed pickup, according to Mexican Economy Minister Bruno Ferrari in an Aug. 19 interview.

Wage differences

While China’s wages are still below those of some other developing nations, they’ve been increasing at a faster rate. Chinese manufacturing labor compensation rose 106 percent from 2004 to 2008 on a U.S. dollar basis, data from the U.S. Labor Department show.

Mexican factory wages rose 23 percent in the five years through 2008, and were lower than that year-end peak in 2010. The Labor Department says the figures for China “are not directly comparable with estimates for other countries” because the country’s published statistics on wages often don’t follow international standards.

“Mexico is eclipsing China as a very attractive source of imports into the U.S. and what we’re seeing is that labor costs between Mexico and China are converging,” Kansas City Southern treasurer Michael Cline said at a Dec. 2 finance conference in Orlando, Florida.

Mexico attracted more than $400 million in investment each from automakers Yokohama-based Nissan, Germany’s Volkswagen AG, Japan’s Mazda Motor Corp. and Detroit-based General Motors Co. in 2011. Honda Motor Co. in August announced plans to build an $800 million factory in the central Mexican city of Celaya.

DuPont, the world’s biggest maker of titanium-dioxide pigment, said last year that it will spend $500 million to boost production of the ingredient used in paints. The Wilmington, Delaware-based company said some of the increase will come from an expansion in Altamira, Mexico, around 2014.

As more goods originate in Mexico, Kansas City Southern is trying to poach a bigger share of the $260 billion worth of goods that crossed the border by truck in 2010. Auto parts are second only to grain as the biggest commodity it moves across the border, and Kansas City Southern expects to get business through greater shipments of vehicles and shipping containers, Patrick Ottensmeyer, executive vice president of sales and marketing, said in a phone interview.

Between 2.5 million and 3 million trucks cross the border into markets that Kansas City Southern could serve in the eastern half of the U.S., Ottensmeyer said. The company currently handles about 1 to 2 percent of that market, he said.

The railroad is rehabilitating the Victoria-Rosenberg line, a 90-mile stretch of track in Texas that offers a more direct route from across the border. And it has invested in the Meridian Speedway, which connects the eponymous town in Mississippi with Dallas, along with a logistics center near Houston.

“We have invested to build a franchise,” Ottensmeyer said. “We’re having very good conversations with almost every railroad, and they all want to participate in the growth that’s happening in Mexico. They really have to use us to do that.”

 

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