Kansas City Southern Railway appears confident the Mexican government won’t require it to open up its track to competitors as legislation had threatened last fall.
The Mexican Senate in September will send modified rail reform legislation to favorably counter a bill passed by the House that would strip the railroad of its concession agreement and allow third parties to use its network, Kansas City Southern de Mexico President Jose Zozaya said yesterday during a first-quarter earnings call. Such an outcome would have undermined the rapid growth KCS has achieved in cross-border intermodal.
Following conversations with legislators, other government officials and shippers about how much KCS has invested in its Mexican network, there has been a “dramatic shift in the attitude toward the railroad,” KCS President and CEO David Starling said during a call in which the railroad reported a 38 percent year-over-year increase in intermodal cross-border traffic.
One of Mexico’s largest carload shippers is against striking the concession agreement, suggesting that at least one business heavy hitter is pressuring the Mexican Congress to water down the reform proposals. The shipper, which agreed to talk to JOC on the condition it wasn’t identified, supports more regulation of the railroads, however.
If Mexico chooses to end the concession agreement, which lasts for another 14 years, Starling said there are “other courses” that could be taken. The railroad has previously said striking the concession agreement could violate the North American Free Trade Agreement.
“But right now, we’re feeling pretty good about it,” he said. “They support our position. They understand the importance of the railroad, so we think the worst of this is behind us.”
Under the House proposal, Grupo Mexico, operator of the Ferromex and Ferrosur railroads, would also lose its concession agreements. The government granted KCS and Grupo Mexico 50-year concessions to run their businesses, but the railroads’ rights to be sole operators of their respective lines last for only 30 years.
The concession agreements have become more valuable as more manufacturers choose to produce products for U.S. and Canadian buyers in Mexico, which has led to rapid growth in cross-border intermodal volumes.
Rising China labor costs, increasing transportation costs and shippers’ drive to respond to demand faster are expected to further strengthen Mexico’s manufacturing competitiveness. Via KCS, the only U.S.-Mexico cross-border rail network, shippers can access Mexico and the rest of North America through connections with the other six Class I railroads. Weather-related delays and a lack of equipment at those other Class I railroads, however, pulled down cross-border growth in the first three months of the year. KCS expects even higher cross-border intermodal growth rates for the rest of the year.
The intermodal growth last quarter helped KCS mitigate lease termination rates, unfavorable foreign exchange and debt retirement costs. The company’s profit in the first quarter fell 9.8 percent to $104.2 million, even though it achieved record revenue of $607 million, a 10 percent increase from the same period a year ago. Although total intermodal traffic inched up only 3 percent, total revenue from intermodal rose 10 percent to $88 million, suggesting that KCS enjoys strong pricing power.
The growth in intermodal is possible because of the hundreds of millions of dollars KCS has spent in recent years on its cross-border network. Kansas City Southern de Mexico and Grupo Mexico invested roughly $2 billion between 2007 and 2012, according to the Organization for Economic Co-operation and Development. The railroads have trumpeted these investments while also warning that striking the existing concession agreements would raise red flags to investors as Mexico seeks more foreign direct investment.
The Mexican Senate could seek a middle ground between radical reform proposals and doing nothing by creating a railroad regulatory agency like the U.S. Surface Transportation Board. A research analyst during the earnings call raised the idea of creating such an agency, but KCS declined to disclose elements of the bill being negotiated. Mexico City’s recent reform fever, along with shippers’ limited ability to challenge rates, is driving the aggressive proposal to shake up the rail industry.
Dramatic changes in rail regulation would also endanger KCS’s prospects of gaining more intermodal business from the port of Lazaro Cardenas. Traffic growth connected to the port has slowed, as the container gateway fights for market share with the port of Manzanillo. But KCS expects consistent double-digit intermodal growth from Lazaro Cardenas after APM Terminals opens a $300 million terminal in the second half of 2015. The project by the Maersk Group subsidiary is the first phase of a more than $900 million planned investment at one of the fastest-growing North American container ports.