Jan 19, 2018
Executives
Patrick J. Ottensmeyer - President and CEO Jeffrey M.
Songer - EVP and COO Brian Hancock - EVP and CMO Michael W. Upchurch - EVP and CFO
Analysts
Brian Ossenbeck - J.P. Morgan Ravi Shanker - Morgan Stanley Allison Landry - Credit Suisse Matthew Russell - Goldman Sachs Chris Wetherbee - Citi Investment Research Tom Wadewitz - UBS Unidentified Analyst - Barclays Capital Justin Long - Stephens, Inc Ken Hoexter - Bank of America Merrill Lynch Bascome Majors - Susquehanna Financial Group Scott Group - Wolfe Research
Operator
Greetings and welcome to the Kansas City Southern Fourth Quarter and Full Year 2017 Earnings Call. At this time, all participants are in a listen-only mode.
A brief question-and-answer session will follow the formal presentation. [Operator Instructions].
As a reminder, this conference is being recorded. This presentation includes statements concerning potential future events involving the Company which could materially differ from events that actually occur.
The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the Company’s Form 10-K for the year ended December 31, 2016, filed with the SEC. The Company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments.
All reconciliations to GAAP could be found on the KCS website, www.kcsouthern.com. It is now my pleasure to introduce your host, Pat Ottensmeyer, President and Chief Executive Officer for Kansas City Southern.
Mr. Ottensmeyer, you may now begin.
Patrick J. Ottensmeyer
Okay, thank you and good morning everyone. Welcome to the Kansas City Southern fourth quarter and full year earnings conference call.
Slide 4 again same cast of characters we have had for several quarters so I won't spend a lot of time here. I am delighted that everyone is here.
According to one source Missouri is the epicenter of the flu epidemic and several of us on the call have suffered from that over the last couple of weeks. But everyone is here today and ready to participate so I will turn to slide 5 just very briefly to cover the results for the quarter.
Revenue increased 10%, volume 5% particularly strong in chemical and petroleum, automotive and energy. Brian will get into much more detail in a few minutes.
Operating ratio of 64.0 and fourth quarter earnings per share up significantly as you will see on the next slide. While I would love to talk about a 340% EPS growth for the fourth quarter and 107% EPS for the full year as Mike Upchurch will cover in great detail the impact of U.S.
tax reform had a very large impact on our results particularly earnings per share, so I'll focus more on the still impressive 23% increase for the quarter and 17% for the full year. So, flipping over to slide 6 you can see for the full year revenue increase of 11% on 5% volume growth and importantly for the full year we saw revenue growth in all of our six major business units and again Brian will cover that in a few minutes.
Operating ratio of 64.3, a 60 basis point improvement from last year and earnings per share of 5.25 adjusted, a 17% increase compared to 2016. So with that I will turn the presentation over to Jeff Songer.
Jeffrey M. Songer
Thank you Pat and good morning. Reviewing the key operating metrics for the quarter on slide 8, velocity of 27.3 miles per hour was down approximately 2% versus prior year, a low of 23.6 hours improved 4% versus the same period last year.
Lingering Harvey impacts, Mexico flooding issues mentioned last quarter as well as typical holiday seasonal impacts drove the increases in Dwell versus Q3. Looking at the full year operating performance several other key metrics showed improvement.
Resource productivity initiatives delivered total volume growth of 5% supported by 3% headcount increase and GTM growth of 9% with a 5% increase in active locomotors. We also saw improvements in On Time Originations and On Time Arrivals of 8% and 9% respectively, fuel efficiency improvements of 2%.
On page 9 our capital outlook for 2018 shows a reduction of approximately 4% 560 million to between 530 million and 550 million. Reductions in the Sasol Investment which is now complete and other reductions in PTC and Sanchez Yard have somewhat been offset by investments in new projects and continued growth opportunities.
A couple of projects we're discussing are the rehabilitation of our F-Line in Mexico which is the segment between Monterey and our border crossing at Matamoros. Driven by the long-term outlook for refined product exports to Mexico the F-Line is another viable gateway for refined products and other cross border shipments.
We have elected to start a multi-year rehabilitation of this line to ensure safe and efficient movement across the segments. The Celaya Bypass is another project we have talked about recently.
Celaya is the connection point of our main north-south route in the Ferromex, east-west route between Guadalajara in Mexico City. This project will provide benefit to both railroads and improve the overall fluidity and interchange between our networks and we now project to start work in 2018.
One other notable investment which will start in 2018 is our participation in track construction to support the BMW facility for its planned 2019 opening. The current 2018 plan will mark the fourth year in a row of declining capital spend both on an absolute basis and as a percent of revenue.
Heading into 2018 we will maintain a close eye on resources. PTC will create some additional demand on resources as we work to complete implementation across our network.
However, our current crew base is in a good position and we will continue to work on crew efficiencies while ensuring adequate resources to manage volumes. Regarding locomotives while we have not included any purchases in our 2018 capital plan we will continue to monitor volume and particularly the refined products segment and timing of these opportunities.
We believe there are ample options to short-term leases or purchases that would allow us to add additional resources if necessary. Overall I'm very pleased with our operating performance this year.
Our operating team overcame major challenges with Mother Nature and improved operations while delivering solid volume growth. I will now turn the presentation over to our Chief Marketing Officer, Brian Hancock.
Brian Hancock
Thank you Jeff and good morning everyone. I'll start my comments on page 11 where you can see fourth quarter year-over-year revenue was up 10% and volumes were up 5%.
And as we'll see on the next slide full year revenue and volume growth are at 11% and 5% respectively. The chemical and petroleum business unit revenue growth of 24% was primarily driven by solid performance and our longer length of haul Southbound refined products and LPG business as well as our heavy fuel oil.
The industrial and consumer segment also showed improvement in the fourth quarter with revenue growth of 8% and an increase of volume of 10%. This growth was a result of the continued strength we saw during the quarter in our military and paper shipments.
The paper segment was impacted by increased brown paper demand seen during the quarter paired with easy comps during the fourth quarter mill outages of 2016. This quarter our energy line of business growth was due to crude oil and frac sand improvement driving a year-over-year revenue increase of 15% on a volume increase of 3%.
The crude volume increase was primarily driven by the increased production in Canada with decreased pipeline capacity paired with increasing [indiscernible] WCS spreads. The automotive business was up 15% over 2016 driven primarily by growth in manufacturing capacity as new model launches continued driving year-over-year growth.
In addition fourth quarter volumes benefited from inventory carry over caused by the hurricane impacts of Q3. Intermodal revenue and volume increases have improved to 5% partly driven by the new business and the New Cross Border Services with the slight drop in RPU due to mix and shorter length of haul.
Our investments in service improvements and security have positioned us well against the continued stiff competition from low trucking rates and ocean shipping consolidation. The agricultural and minerals lines of business revenue was down slightly year-over-year on a 9% volume decline driven by grain and food products.
Grain volume declines were driven by the new plant stockpiling during fourth quarter of 2016 in Monterey. Food products experienced a shift in sourcing trends and volume declines were offset by favorable pricing and a longer length of haul.
Turning to the next slide you can see in 2017 annual revenue was up 11% and volumes were up 5% in spite of the hurricane impacts experienced in the third quarter. Overall very solid performance with revenue growth in all of the business units including double-digit growth in energy, automotive, and chemical and petroleum.
Overall RPU for the year came in at 5.8% driven primarily by changes in the portfolio mix. On slide 13 we provide an outlook for 2018 for each of the business segments.
As you can see we expect good growth from the majority of the businesses led by the chemical and petroleum group. Mexico energy reform will be a significant focus for 2018 including the continued ramp up of volume driven by more storage projected to come online later in the year.
We also expect solid growth in intermodal with continued focus on conversion of the cross border freight currently moving by truck and solid growth out of our Lazaro Cardenas port facility. We'll continue to see growth in the automotive segment in the mid single-digits which is in line with most third party industry estimates for the Mexico auto production.
We should also see positive growth in the grain and food products volumes after 2017 which included the impact of the 2016 inventory build at the new soybean facility in Monterrey. We expect economic activity in 2018 to be positive which should drive our industrial and consumer businesses in both steel and paper.
Year-over-year comps in military shipments could be difficult given the strong performance we had in 2017. The only unfavorable business unit would currently be our energy segment that will be impacted by the closing of a coal fired power generation facility in Texas, however, we do expect both crude and frac sand to be solid in 2018.
Overall we expect mid single-digit carload growth for the full year of 2018, however, revenue per unit will be impacted by mix as we expect growth in our relatively low RPU intermodal business. Additionally we will see some RPU mix pressure from a reduction in the long haul utility core volume due to that plant closure.
Finally on page 14 I want to provide an update on Mexico energy reform. After our third quarter report we received several questions regarding what investors should look for to determine the rate and pace of this important initiative in Mexico.
We would like to suggest the following important drivers of growth during the next few years. First, the emergence of alternative retail outlets, this will signal that consumption and demand are being serviced by multiple retail brands expanding the number of shippers into the country.
Second, the emergence of storage capacity. Millions of barrels of storage are required over the next seven years to meet the government's objectives.
This will be a critical signal as to how the market is developing in certain regions of the country. Third, pipeline construction, the rate and pace of these projects will be a good indicator of how quickly they will influence the market.
Current estimates are that any major project is at least five to seven years away from completion. Fourth we would focus on terminals that are on the KCS line.
In 2017 we announced volumes moving to the Howard Terminal in San Jose Iturbide, our joint venture facilities in San Luis Potosi and Monterrey as well as several other projects [indiscernible] and Mexico City. We continue to believe high density terminals with a very fast unloading capability are critical to the long-term success of rail shipments.
We will continue to update you as this important market change evolves in the coming months and years. And with that I'll turn the call over to our Chief Financial Officer, Mike Upchurch.
Michael W. Upchurch
Thanks Brian and before I review the slides I have to tell you it's a bit strange this morning looking around the table and missing two extremely valuable team members Bill Galligan our Former Vice President of Investor Relations and Mary Stadler our Senior Vice President and Chief Accounting Officer both who retired two weeks ago. So, Bill and Mary whatever beach you might be on today know you made KCS a much better place and I thank you again for all your tremendous contributions over the years.
So let's start with the numbers on slide 16. A summary of overview of our fourth quarter 2017 results, revenues of 660 million were up 10% driven by 5% carload growth and 4% plus revenue per unit growth.
Operating ratio improved to 64% and 80 basis point improvement despite an 18% increase in fuel prices. Reported earnings per share for the quarter was $5.33, a 340% increase over fourth quarter 2016 representing strong core earnings growth and the benefit of tax reform.
On an adjusted basis earnings per share was a $1.38, a 23% increase over 4Q 2016. Our reported effective tax rate was negative 186% due mainly to the benefits of tax reform and on an adjusted basis our effective tax rate was 32.8% slightly below the 34% guidance.
And on slide 33 in the appendix we've included a reported to adjusted effective tax rate reconciliation. Moving to slide 17 on a full year basis we delivered a terrific year with 5% carload growth, 11% revenue growth, a 60 basis point improvement in OR to 64.3 and 17% improvement in adjusted earnings per share to $5.25 evidence that delivering top line growth while improving OR can lead to significant EPS growth.
We delivered these results despite experiencing negative financial impacts from hurricane Harvey in the third quarter and incurring much higher fuel prices throughout the year which increased more than 50 million year-over-year. On a reported basis we were $9.16 per share for the full year which is inclusive of tax reform benefits and I'll spend a few more minutes on tax reform on the next slide.
But for a more complete condensed income statement and foreign currency tax and hedge impacts please refer to the appendix. On the next slide I'm going to spend a few minutes trying to highlight the key impacts of tax reform to KCS.
While tax reform has a net positive impact to KCS they certainly didn't simplify the tax code particularly for multinational companies. I'll try to summarize to the best I can the overall benefits we expect to see from lower tax rates and from immediate expensing of capital expenditures which are offset by the negative impacts of a onetime repatriation tax and other foreign income inclusion provisions.
So first, the U.S. statutory rate is declining from 35% to 21% which requires us to revalue the net deferred tax liabilities on the balance sheet.
Accordingly we are reducing our net deferred tax balance by $488 million as a result of the reduced 21% rate we now expect to pay on previously recorded tax liabilities. Second, we expect to incur a onetime repatriation tax of 177 million which represents approximately 1.5 billion as cumulative foreign earnings of our international subsidiaries.
New and existing tax credits reduce that liability to 45 million now payable over an eight year period. So you might think of this one time repatriation tax as a 3% incremental tax on our historical foreign earnings.
Third, we expect our historical adjusted effective tax rate of 34% to be reduced to 29% to 30% over the foreseeable future. Included in this effective tax rate guidance is an approximately 1% rate increase due to the provisions of the guilty tax that are intended to tax intangibles moved to offshore to take advantage of low tax rates in foreign jurisdictions.
Not only does KCS not have intangibles but we do not operate in a low tax country as all of our earnings in Mexico are already taxed at 30%. Fourth, we do not expect any negative impacts from the beat tax, the base erosion anti-abuse tax.
Fifth, as a result of the U.S. tax reform we expect our projected cash taxes over the next three years to decline by approximately $90 million.
However, we are moving into a period where KCSM will begin incurring more substantial cash taxes and accordingly we expect our consolidated cash tax rate to be in the range of 20% to 25% over the next few years. And finally the move to a more of a territorial tax system or cash can be moved more freely to the U.S.
from foreign countries without incurring new taxes should substantially benefit KCS. Moving to slide 19, operating expenses increased 9% driven primarily by higher fuel prices that contributed in a $11 million increase in expense.
And on the topic of fuel we also saw $5 million lower Mexican fuel excise tax credit as a result of the excise tax declining during the fourth quarter. We also saw increases in wage inflation, higher expenses from foreign currency impacts, and higher casualty expenses.
I will cover more details on comp and fuel in the next two slides but maybe just a quick comment on materials and other, while we experienced a $9 million increase year-over-year $3 million of that was related to a gain for insurance recoveries we booked in the fourth quarter of 2016 and barely causes a difficult comp. We did see a challenging quarter for derailments and other casualty expenses that increased 2 million and our insourcing of various maintenance agreements adds another approximately million in M&O.
And to give you a little bit of visibility for 2018 on expense tailwinds and headwinds we continue to believe we will keep headcount growth below carload volumes, we expect PTC operating expenses of approximately 32 million that's split 18 million in depreciation expense and 14 million in labor costs. So for the full year 2018 we expect depreciation expense to be approximately $360 million.
Moving to slide 20, comp and benefits expense increased 6% primarily on wage inflation and higher headcount. As you can see in the graphs, excluding another insourcing effort to reduce our overall costs headcount went up 2% well below our carload volume growth of 5% and demonstrates the nice productivity we achieved in our operating team.
On slide 21 fuel expenses increased $14 million or 21% primarily due to the $11 million in higher fuel prices in both the U.S. and Mexico increasing our cost per gallon from $2.01 to $2.37 per gallon.
Higher fuel consumption added 2 million of expense, FX and other 2 million in increases and efficiency contributed a $1 million decline to fuel expense. We also experienced the $5 million lower Mexican fuel excise tax credit during the fourth quarter.
The good news and as we expected the excise tax credit for railroads on fuel purchases will continue in 2018 which we currently expect to be about $35 million. And finally on slide 23 our capital allocation priorities will continue to be focused on investing back into our business to drive industry leading growth.
As Jeff mentioned earlier our CAPEX spending of 560 million was right in line with our guidance and for 2018 we expect our CAPEX to slightly decline to 530 million to 550 million, the fourth consecutive year of declining CAPEX spend and declining CAPEX to revenue ratios. During 2017 we also made 20 million in investments in liquid terminals in Mexico to stimulate more line haul traffic for our petroleum segment.
And you should expect we will continue to look for investment opportunities to grow our business as a result of energy reform in Mexico. As for shareholder returns we will continue to be thoughtful about balancing our investment needs to grow the business with the desire to return a reasonable amount of capital to our shareholders in the form of both dividends and stock buybacks.
Since the Board of Directors authorized a new $800 million share repurchase program in August 2017 we have repurchased another 2.4 million shares at an average price of $105.48. And while we continue to find opportunistic situations to repurchase or convert leased equipment into owned assets we are gradually nearing the end of that opportunity.
We now own 70% of our rolling stock in locomotives and have a leverage ratio of 2.1 times, both levels we are quite comfortable with. And with that I'll turn the call back to Pat.
Patrick J. Ottensmeyer
Okay, thanks Mike. I will wrap up here with slide 24 just, we certainly didn't feel right about not talking about NAFTA on our call today given that round six begins next week and by all external reports that could be an exciting week.
We have no new news per se but I think this round is expected to really focus because so many of the minor issues and minor chapters of NAFTA have been resolved by a lot of reports. The big issues are probably going to come to the table and rise to the surface this next week.
So the five year sunset, the country rules of origin, government procurement rules, and ISDS are expected to be the central focus of the negotiations next week in Montréal. The -- we get a lot of questions about what would happen if there's a collapse of NAFTA or a withdrawal, what would happen to our business levels and trust as we've done a lot of sensitivities as we look at our planning not just related to outcomes of the NAFTA negotiation process but general economic conditions, etcetera.
So we we've done a lot of that work. We think we could scale very quickly and very appropriately to preserve profitability and cash flow under a wide range of scenario and potential downturn outcomes.
But we're not going to talk specifically or give guidance about what part of our business we think we would lose or what would happen to our volumes and revenues because there are just too many unknowns to really know how we would be effective. If there would be a collapse or withdrawal of NAFTA the immediate safety net would be WTO rules and tariffs would apply to those commodities and products that are covered by NAFTA, those are not horrible.
Oddly enough they are more punitive to U.S. exports to Mexico particularly grain than they are to imports from Mexico to the U.S.
Furthermore approximately 60% of trade between the U.S. and Mexico today doesn't have a specific connection to NAFTA so we would assume the biggest commodity group in that category would be energy.
So we would assume that that portion of the trade between the U.S. and Mexico would not be affected.
As you know about 30% of our revenue and volume comes from cross border franchise moves. So it is a significant part of our portfolio but not the majority.
And then the final thing is just the sheer magnitude of investments in plants and supply chains between the U.S., Mexico, and Canada. That investment is not going to go idle and we would expect that that is going to support a continuation of most of the trade values that take place between U.S.
and Mexico if there were a bad outcome of NAFTA. But we need to be prepared and certainly aware of the fact that next week could be a headline week for Kansas City Southern depending on the sentiment and the news that comes out of the negotiations in Montreal.
Really glad Mike picked up on recognizing the retirement of Bill Galligan and Mary Stadler but I certainly want to assure all of you and point out that we've got very talented people moving into those roles and around the table today we have Ashley Thorne and Suzie Grafton who is our new Chief Accounting Officer. They have both been here for a long time and very capable and as much as we will miss Bill and Mary we won't we won't miss a beat so to speak because of talented people in the form of Ashley and Suzie that are taking those positions.
So in the past few quarters I've given you some guidance as to what the headline from our perspective is. I suppose we'll see something like modest beat for the quarter so credit to the Wall Street crowd, you have kind of got it right in terms of the outlook and the expectations for the quarter.
But I hope people notice that this is really at least four very solid, very consistent at some level fourth quarter in a row that we've had the word record in our press release, in our results. Had it not been for the Hurricane Harvey disruption in the third quarter I think that would have been a more solid quarter but four very solid consistent quarters and an outlook going back to the slide that Brian showed, an outlook for 2018 based on assumptions that we have made about the economy and a lot of other factors that I think are very solid grounded in reality based on the best information that we have today.
90% of our business and commodity portfolio looks like it's going to be positive for 2018 with the only exception being energy where we've had a major plant closing that is just going to be hard for us to overcome. So with that I will conclude our official comments here and open the line up for questions.
Operator
[Operator Instructions]. Today's first question comes from the line of Brian Ossenbeck with J.P.
Morgan. Please proceed with your questions.
Brian Ossenbeck
Hey, good morning, thanks for taking my question.
Patrick J. Ottensmeyer
Good morning Brian.
Brian Ossenbeck
So, we are kind of past the one year mark on energy markets regulation in Mexico, clearly there has been a lot of change in that time and the government even lifted the fuel caps month early last year. So it doesn't seem like the prices have risen as much as you might have thought.
It seems like that's related to the IX tax, we've also seen open season kind of moving ahead and fits and starts with PEMEX so, Brian if you can just -- and you gave us lot of detail there on that one slide but is this really second half inflection as we get past some of the political uncertainty with the presidential election and I guess more importantly getting some of these tanks up at the few sites that you mentioned?
Brian Hancock
Yeah Brian thanks for the question. Obviously we continue to be excited about the Mexico energy reform.
Certainly the big impact for us is going to be once the tanks and the storage facility start to come online. It is certainly -- in 2017 the story kind of two halves.
There was a lot of uncertainty at the beginning of the year when people weren’t sure how that was going or how the price was going to impact. They did use the IX tax to manage that a little bit from a consumer perspective.
We have seen and we're working with a number of folks who now have retail outlets on the ground, major companies obviously multinational companies that now have a retail location in Mexico. And so we're starting to see kind of what we talked about in the first quarter of last year, going into 2018 we feel very, very comfortable that it's just going to continue to grow all of the ports, all of the barrels that we thought would be coming into particular areas are doing that.
And so we continue to be very, very positive on what's going to happen. Jeff talked a little bit about the investments we're making in capacity and safety and security, all of that is focused on as these tanks come on.
We do have the tank in San Jose it has been up but in 2018 you're going to see a lot more storage capabilities, a lot more foreign retail owned, and with the election I believe the government will continue to manage that price a little bit with the IX tax but once that's complete and the storage is in I think you're going to see some pretty positive things from an overall Mexico energy market perspective. So good question and we think we're positioned very well for it.
Brian Ossenbeck
Okay, thanks and then just a quick follow-up on the labor market trends, you've been able to keep -- headcount last year and expecting do so this next year, in general it is a tighter labor market for just about everything including real team employees. So I guess specifically in Mexico how does that shape, maybe a question for Jeff because in the past you've run into some issues there where volumes really got ahead of the staffing levels and you had to kind of do a hard reset and reconfigure some of the actual management team and go back into labor negotiations, so how does that stand?
And I guess are you seeing any benefits from that deal that you negotiate I guess that was maybe 18 months or so?
Jeffrey M. Songer
Yeah, you are right, as stated I am feeling very comfortable where we're at on the headcount. I'm hoping we can gain -- start gain more efficiencies and I think we will through the year.
The lessons learned from a couple years ago really what that ended up doing is ensuring we have an adequate force. And so maybe we run that a little bit heavy from time to time but that ensures we've got that -- if you recall we talked a lot about just the longevity of hiring and training in the process.
So believe we've got that under our belt so I feel very comfortable where we're at and we're certainly looking forward at the volume growth. Certainly it was an impact for us this year on the volume growth and I think we're positioned well if that's not going to be an issue going into 2018.
Brian Ossenbeck
Thank you.
Operator
Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your questions.
Ravi Shanker
Thanks everyone. Can you just give us an update on pricing in the quarter but sequentially and year-on-year and also your expectations are for pricing in 2018?
Brian Hancock
Sure and this is Brian. Our pricing kind of came in where we had seen most of the year come in right around that 3% range.
We're very comfortable with where we're at right now from a pricing perspective. Obviously there are a number of factors impacting the intermodal space that you are seeing with some of the trucking companies and others.
But for our particular set we still -- we continue to see the pressure on our intermodal pricing down in Mexico. So we continue to hold where we're at there.
But overall we're very positive on where we're at and we believe we will continue to see that into the future.
Ravi Shanker
Right, is there a pricing numbering you can share with us that was sequentially a higher or lower versus last quarter?
Brian Hancock
It's pretty much the same.
Ravi Shanker
Got it and lastly on NAFTA I'm just trying to look at the -- obviously there is a lot of uncertainty there, I am trying to figure out what the bull and the bear case here is. If there is a bull case outcome and there's basically no change and the way NAFTA is structured do you feel like there's a bunch of pending business that people are kind of holding off announcing right now that will kind of flood into the market and so you could see a surge and kind of longer-term volumes if that happens?
At the same time if there is a bear case outcome on NAFTA do you expect any change in either the concession or any regulatory credits if you will to help you guys kind of defray the impact?
Brian Hancock
On the bull case not that we're aware of so you know we don't -- I don't have the feeling that there's a big pent up demand or sort of announcements about new plants or new investments. On the downside case we would expect and I've heard from Mexican government officials of very high level that if there is a collapse of NAFTA, for example just picking up on the ISDS, the investor protection that if there is a withdraw all or if there is a collapse and ISDS is no longer part of NAFTA that the Mexican government may incorporate some of those investment protection features into their own law.
So I wouldn't be surprised and I would kind of expect based on what I've heard that maybe Mexico would do some things from a legal perspective that would give that type of assurance to foreign investors that currently exists under NAFTA that might be removed.
Operator
The next question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.
Patrick J. Ottensmeyer
Good morning Allison.
Allison Landry
Good morning, thank you. So I just want to ask a little bit about refined products, the storage facilities seem like maybe they're coming on toward the back half of the year.
So, as we think about the cadence of the volume growth would you expect the first quarter and second quarter to moderate a bit from the growth that we've seen so far and then went back up in the second half of the year, is that right way to think about it?
Patrick J. Ottensmeyer
Yeah Allison, the way I would have you look at it is when you think about what we're doing now so we're moving refined products to all three of those facilities. We weren't doing that in 2017 throughout the whole yield.
In the fourth quarter we kind of got all three of those facilities up and running. So you'll continue to see volumes move north if you will on that front in all three of those facilities.
You will also start to see some of the volumes moving off of the ports that will probably be in our numbers here in the next few quarters. When we talk about the tankage, the important part of that is mostly tanks are being built are somewhere in the range of about 150,000 barrels, that allows us to not have to have storage inside a rail car.
We can use the storage tanks for that storage purpose and so we can turn those cars much faster. So that's the reason that that's important.
When you have three locations you can land trains at significantly better situation than where we're at now, where we have to land the train and then we do that transloading directly into trucks. So, I think that's the way you'll see it and as that storage comes on you will obviously see us be able to turn those trains much faster.
Allison Landry
Okay great. And then sort of just a follow up question as you think about Sasol, you mentioned that you have -- to get the investment there, I think the timing as of the last call was sometime in the second half, just curious to know if there's any update there when you think you might be able to move some volumes and if you have received any clarity on Sasol as to what they're thinking about in terms some destinations and specifically how much you think that you'll be able to move out of Lazaro?
Patrick J. Ottensmeyer
Yeah, I would tell you Allison that we are in weekly contact with Sasol and I would refer you to their plans. They've obviously already announced that second half of 2018 is when they will be starting up.
We're working with them on those plans. We feel very comfortable that there will be a percentage somewhere in that 5% to 10% that will go into Mexico.
Now whether it's the transload, export, whatever it will be but obviously we're going to touch every single one of those cars whether it's going North America, Europe. And so we feel very comfortable with the plan that they have put in place and I'll just refer you to them on when that startup happens.
But we're in constant contact and we have a pretty good idea of what we need to do and the impact it will have on our business. So we're good there at Sasol.
Michael W. Upchurch
Allison this is Mike, just a reminder that we do generate lease revenues here in the first half of the year before they officially open up their plant. So there will be a little bit of a lift in the revenue line item.
Operator
Thank you. Our next question is from the line Matt Russell with Goldman Sachs.
Please proceed with your questions.
Matthew Russell
Thanks for taking my question. Quickly on intermodal, can you talk about how the tight trucking market in the U.S.
is impacting your business and is it helping accelerate the market share gains from highway to rail, can you maybe talk about the opportunity there and whether you are seeing an acceleration in that trend?
Patrick J. Ottensmeyer
Sure Matt, obviously intermodal is a key factor in U.S. as you see the drivers short especially that you saw in the fourth quarter.
We play a part of that from a domestic perspective across our Meridian Speedway in the Dallas area and some other places from Dallas into Mississippi. But what I would tell you is the biggest impact for us is obviously the cross border piece which is still being impacted by the very cheap trucking down in Mexico.
So we don't see nearly the benefit that you would see on some of the other railroads that have much longer haul in their intermodal space but we are seeing much more of our customer base looking to build towards intermodal because once things do get into the U.S. you don't have a driver to move them.
And so we are seeing an impact but we're also very, very tied into the Lazaro Cardenas port and we have a very heavy business there in domestic Mexico. So we're a little bit more diversified in our intermodal space but that cross bidder business will continue to grow as we saw this year and we'll continue to support our domestic partners as well.
Matthew Russell
Great, and just a follow up, I know there's some large customer bids out in the intermodal business in the first quarter, can you just talk about how those negotiations are going and the pricing there?
Patrick J. Ottensmeyer
Yeah I think we're in a very good place right now. In our intermodal bids people are more receptive to intermodal because of the tight labor market, because of the tight driver shortage.
So they're more receptive to our solutions, we're giving them much more complex solutions that they have for their supply chains. So we feel very comfortable that we're going to have a good year and that we have a great product out there in the marketplace.
Operator
Our next question comes from the line of Chris Wetherbee with Citi Group. Please proceed with your question.
Patrick J. Ottensmeyer
Good morning Chris.
Chris Wetherbee
Hey good morning guys. Wanted to ask a little bit about some thoughts on the operating ratio for 2018, I know you don't give specific guidance but you've been able to sort of continue to move that number lower for a record again.
I want to get a sense sort of if you could help walk us through some of the puts and takes, it looks like the fuel excise taxes credit is coming down but cash would grow lower than volumes. So I think there's the potential for some operating leverage here but if you could just sort of help us put some color around that that would be great?
Michael W. Upchurch
Sure Chris, this is Mike. I think as you look at some of our costs, labor productivity I think is something you should expect out of us.
I might have Jeff comment a little bit on that but our investments we made in fuel technologies for the locomotive should continue to produce some fuel expense benefits, we've talked a lot this year about contract renegotiations and in sourcing. We benefited about $11 million in 2017.
When I think about at least half of that being some incremental savings going into 2018. And then I think we've begun to make some real progress around equipment cycle times that should continue to improve.
But let me let Jeff comment a little bit about labor.
Jeffrey M. Songer
Yeah, on labor front again we're continuing to push headcount lower than volume. I see us continuing to do that certainly for this coming year but also gearing up with service design efforts.
And got a little new staffing and learning technology helping with that really looking at reducing overall train starts, looking at new train link initiatives. So -- and as Mike mentioned the asset utilization overall and cycle time.
Seeing some improvement coming out of the year and going into next year. Fuel and fuel efficiencies I touched on and we saw some improvement this year.
We really haven't gained as much of the benefit for the Mexico fuel efficiency technology. That hasn't been in play for much of 2017 so we should start to see a full benefit of that.
And use of different and other and newer technologies as well. So hitting on your major fronts locomotors I have talked about as well.
Again I think we're in a good spot on that and continuing to do the same from our active locomotive fleet that will come in short of the volume increases. So feel very good for continued efforts around all those three major areas.
Chris Wetherbee
Okay, so it sounds like maybe the fuel upside is maybe the one of the sort of headwinds that you are calling out but it doesn’t sound like there is much else you have going on from headwind perspective?
Michael W. Upchurch
I would say just rising fuel prices is a headwind so forget about the -- well fear about the excise tax that even if we have 100% coverage of our fuel surcharge program, when you add incremental rising fuel costs and the offset is rising fuel surcharge revenue that is essentially 100% operating ratio impact on our overall performance. So rising fuel prices are going to be a headwind.
We overcame that in the quarter and for the year but it's going to be a headwind for overall operating ratio performance.
Patrick J. Ottensmeyer
And Chris just a reminder, in my comments on the operating expense slide, I did indicate depreciation would be about 360 million next year so that's certainly a headwind and that our PTC expenses would be approximately 32 million that was split 18 million depreciation and 14 million labor. So that's up substantially from 2017 as PTC gets in serviced.
Operator
Our next question comes from the line of Tom Wadewitz with UBS. Please proceed with your question.
Tom Wadewitz
Yeah, good morning. Let's see so just I guess following up on the prior question, does that equation lead you to meaningful operating ratio improvement it sounds like you have puts and takes in the cost side but obviously a very healthy volume outlook, so I mean is it reasonable to say 100 to 200 basis points of our improvement or how do you kind of without being specific on guidance give a directional comment on OR?
Michael W. Upchurch
Well nice try Tom but we won't go to guidance. We do expect improvement in our operating ratio next year.
We do think we have enough opportunities here to reduce costs and cover some of the incremental headwinds. We do have a very favorable outlook as Brian indicated on volumes and volume is a big driver in our business to continue to do improve our overall earnings.
You just have to look at full year and fourth quarter 2017 results and see that delivering top line delivered some pretty solid earnings per share growth of 23% in the fourth quarter and 17% for the full year.
Tom Wadewitz
Okay, great. So that -- for the -- my other question I appreciate the framework you gave us in the comments Pat on NAFTA, it's helpful to hear your perspective and I know you're really close to the pulse of what's happening there.
I wanted to ask about I guess the secondary effect, so if maybe trade flows don't change a lot but the Peso has a significant step down if the U.S. withdraws from NAFTA I know this is all kind of hypothetical but how would you think about a significant step down in the Peso, I guess two different aspects, how it affects your competitive situation in Mexico versus truck?
And also from the financials when you think about kind of locally generated income and you translate that in the Peso is weaker then that's the headwind but can you offer some thoughts on competitive impact, the weaker Peso, and then kind of financial impact as well?
Patrick J. Ottensmeyer
Let me take a stab at answering that and then I'll ask Mike to talk about the financial impact. But as you know we've got kind of a natural hedge in terms of revenue and cost basically echoing each other and offsetting each other.
So when the Peso declines we see a hit to revenue but we see also a reduction on the cost side that in the past has largely sort of offset each other. It's interesting if there's a withdrawal in NAFTA you could probably expect that the Peso is going to take a hit.
As I mentioned if WTO tariffs apply they're actually higher for most of the export categories than they are for the import categories. But let's say there's an increase in tariffs on some of the NAFTA protected commodities.
It wouldn't be surprising, I shouldn't say I would expect because my projections aren't worth that much but one would expect that maybe the reduction in the in the currency values would offset largely or maybe even more than offset the increase in tariffs. Don't forget when we were talking about a 20% border adjustment tax this time last year the Peso devalued by 25% so it was still cheaper to buy things in Mexico even if you assume that there was going to be a border adjustment tax.
So capital markets and currencies have a lot of impact on what's going to happen with -- in the absence of a trade agreement or changes in the tariff structure.
Michael W. Upchurch
Tom on the P&L impact, on slide 30 in our appendix we showed you the impacts of that. We do have a pretty natural hedge in the P&L.
We benefited $2.4 million in the quarter on operating income, on reported operating income of 237.8 million. So it has a pretty negligible effect whether it's positive or negative in any quarter.
I do find it interesting that as we look at our competitive situation in Mexico we did grow intermodal volumes in Mexico in the fourth quarter and our competitor did not. So I think we're doing a pretty good job holding our own.
The other thing that I'll mention is not really covered on the slide that I talked about that another factor and probably maybe even the biggest factor is if there's a collapse in NAFTA, if there is a withdrawal the administration, the U.S. administration has said back from the very beginning that what they don't like multilateral agreements, they prefer bilateral agreements.
So one would expect again that if there's a collapse or withdraw that the U.S. then begins to engage in or is open to bilateral agreements with Mexico.
So the biggest kind of wild card and unknown here is how quickly is the U.S. and Mexico, are they able to get into a bilateral agreement that replaces NAFTA and what did the terms of that agreement look like, how does it differ than NAFTA.
So we would expect that there will be some agreement between the U.S. and Mexico if NAFTA doesn’t survive and the timing and the outcome and the impact of that agreement is obviously a bigger unknown than some of the other factors.
Operator
Our next question comes from the line to Brandon Oglenski with Barclays. Please proceed with your question.
Unidentified Analyst
Good morning, it is Dan Kegel [ph] on for Brandon, thanks for taking my question. I just wanted to ask again about energy reform, it looks like after the significant development in 2Q last year to about 14 million a quarter run rate, how should we think about that going forward and be on the ramp of some of the storage in retail locations you talked about, could you talk about what markets in Mexico and open and closed today and if additional markets open there or when additional markets open, could we see another step function change in revenue in volume like we did last year?
Brian Hancock
Sure Brandon, this is Brian. All of the markets in Mexico are open, all of the taxes have been taken off, all of the monopolistic type things that PEMEX had have been taken off.
So, we are fully engaged in Mexico energy reform. So we are currently shipping to Mexico City to get [indiscernible] which is north of Mexico City.
There's no market that we're not engaged in and trying to understand what the supply demand equation will look like.
Unidentified Analyst
Appreciate that and then just as a quick follow-up, Mike could you clarify the comment on CAPEX side regarding locomotive purchases not being included in 2018? Are there leases there?
Michael W. Upchurch
We don't currently plan on purchasing any locomotives in 2018. If we do that will be a great story because we'll have exceeded our forecasted carload growth.
Unidentified Analyst
Understood, thank you very much.
Operator
Our next question is from the line of Justin Long with Stephens. Please proceed with your questions.
Justin Long
Thanks and good morning. I wanted to start with following up on the mix commentary earlier in the call, given the headwinds your expecting from intermodal and coal, is the message that consolidated mix will likely be negative in 2018 and RPU probably increases in that low single-digit range versus the mid single-digit range that we saw last year?
Patrick J. Ottensmeyer
Justin I would say that the mix difference, I mean a significant piece of that will be the loss of that coal customer obviously. But when you think about intermodal, intermodal is going to impact us because we have more of a cross border freight.
Now that has a lower RPU but we love that business. So it's a great business for us.
So when you think about mix overall it potentially could have an impact on our RPU to the negative but it would be because the intermodal business is growing which would be a positive. So I don't want to -- I'm not sure exactly what your question was but we see very positive business mix, all of the markets growing except for that facility that we lost in Texas, that's all we are saying.
Michael W. Upchurch
Justin, this is Mike. Just because we're going to lose the coal volume on that one customer and have some headline revenue per unit mix issues does not mean that's going to negatively impact our profitability.
In fact the incremental margins on intermodal despite the much lower revenue per unit are quite good.
Justin Long
Okay, and maybe as my follow-up I can ask about incremental margins as well because I think historically you've talked about that number averaging somewhere in the mid 50's over time, is that still a good ballpark to be thinking about for 2018 or given the step up in PTC costs that you mentioned and depreciation and I guess a little bit lower number on the excise tax credit, could we be somewhat below that incremental margin framework?
Michael W. Upchurch
No, our expectation are we will be above 50% on incremental margins. If you look at 2017 whether it's full year or the fourth quarter, I mean rising fuel prices have had a negative impact on the peer calculation of your incremental margin.
If you look at it without fuel prices then we were well above 50%, I think 60% in the fourth quarter here. It's just you have 100% OR business when fuel prices grow that hurt your calculated operating ratio but our expectation is incremental margins above 50%.
Operator
Thank you, the next question today comes from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.
Ken Hoexter
Great, good morning. Mike or Pat, I guess you talked about CAPEX declines accelerating free cash flow given the earnings growth, you've got the buy back in place, I think Pat you mentioned you like where the leverage is now.
What are the next steps for KSU as you start to generate incremental cash and is this a signal that maybe you expect slower growth if you're pulling back the CAPEX to down below four years in a row now or is there other steps that you can do with that incremental free cash?
Patrick J. Ottensmeyer
Hey, I will chime in here because they can't help myself. No, the reduction in CAPEX does not reflect that we see lower growth.
It's a function of completing some really major discrete capital projects and in the absence of new projects that come along that it certainly does not reflect that we feel different about the growth outlook or that the growth outlook is going to be weaker.
Michael W. Upchurch
Ken remember we had $58 million spend related to Sasol in 2017 so if you pull that out you can actually conclude we've got a little bit of growth in our capital which is largely equipment to carry the incremental volumes that we think are going to be there in 2018
Ken Hoexter
And just to wrap up then on that same thing Mike, thoughts on what do you do with that cash, right you've got the buyback but -- and you mentioned leverage was good, is it all then focused on the buyback or where do you see the use of that cash?
Michael W. Upchurch
Yeah, I think we fully intend to continue to execute our buyback program that the board approved in August. It was an $800 million program.
We'll continue to execute that, we will continue to take a look at our dividend and see how the year plays out. I think it's -- in the 10 years I've been here absolute the best position that we've been and the most flexibility that we have.
We have talked about potentially making some more investments in Mexico energy reform assets that would allow us to drive more revenue there. But we have a tremendous amount of flexibility.
Patrick J. Ottensmeyer
And I would say that we are more aggressive and more looking at different investments that could help drive growth on the railroad. The key ingredient I think is going to be things like these terminal projects in Mexico.
Possibly transloads to support the plastics and petrochemicals business. We were looking at a lot of other alternatives including technology that could help drive growth of volume and revenues on the railroad.
So we haven't included that in the CAPEX budget but I would say I would be disappointed over the course of the year if we don't have some things to talk about with you guys in terms of additional uses of capital that will help drive growth even further.
Operator
The next question is from the line of Bascome Majors from Susquehanna. Please proceed with your questions.
Bascome Majors
Mike you talked about tax reform saving giving you an incremental 90 million in cash taxes over the next three years, but you also said that your cash tax rate was going to be 20% to 25% over that time frame and I think you've enjoyed something closer to the mid single-digits on a cash tax rate recently. Could you help us reconcile the absolute dollar savings with the rising cash tax rate and just maybe back up a little bit, give us a little better color on how your cash tax position changes over the next three years versus the last three?
Michael W. Upchurch
Sure, yeah, great question and you're right we've had a nice low cash tax rate. We are paying cash taxes in Mexico.
We have for the last couple years and we expect to pay higher cash taxes in Mexico. So that's the driver of the 20% to 25% range.
As one of our Board Members has reminded me paying cash taxes is not necessarily a bad thing because it's a sign that we're making money. And you're going to just see a little bit of a step up in cash taxes paid in Mexico and that will be offset from a planning standpoint with a $90 million improvement over the next three years in the U.S.
So net, net this is better for Kansas City Southern and we expect to pay lower cash taxes for the next three years.
Bascome Majors
Thank you.
Operator
Our next question is from the line of Scott Group with Wolfe Research. Please proceed with your question.
Scott Group
Hey, thanks, good morning guys. So I don't know if anyone asked about COFECE can you just give an update on timing there if you still expect something in January and any expectation there and then just one more NAFTA question, can you just clarify that the total cross border exposure if you include business just moving on one side to the border?
Patrick J. Ottensmeyer
COFECE we now expect a final resolution in April. Apparently there were some delays in the process and now expect a decision in April instead of January.
We don't have any new information or insight to share with you so not much of an update other than the deadline has been extended. I am not sure I understand your question about cross border.
Scott Group
So, you guys talk about 30% of the businesses is cross border that only includes stuff where you're on both sides of the border. I'm just -- if you move something --?
Patrick J. Ottensmeyer
I mean it could be 40% if you include the Union Pacific Interchange.
Scott Group
Okay, perfect and then do you think -- do you view the COFECE delay as a good thing meaning it's taking longer, is it more likely than they're going to change their view?
Patrick J. Ottensmeyer
No idea. We really -- it's just a process extension so we don't have any information from COFECE that would give us insight as to whether there -- the signal is any positive or negative sentiment.
So, we really just don't have any new information other than the time line has been extended.
Scott Group
Okay, makes sense and then Mike I want to just go back to the margin on --
Michael W. Upchurch
Go ahead and then we'll cut it off.
Scott Group
Thank you, so you've talked about I think between depreciation in the fuel tax credit that's like 180 basis point headwind to margins and then fuel price is rising that had something, so call like a 2.0 plus margin headwind to overcome I'm struggling a little bit to get to margin improvement but you sound very confident that you get. So maybe what are some of the discrete tailwinds to overcome like that the 2.0 plus headwind?
Patrick J. Ottensmeyer
Well, I'll repeat what I said earlier which was labor productivity, fuel expenses, continued benefits from contracts that we've in sourced and renegotiated, equipment cycle times that have shown nice improvement over the year and then don't forget the fact that incremental margins on our carload growth will deliver nice improvement in operating ratio. Okay, I think operator does that conclude our questions.
Operator
Yes, please go ahead Mr. Ottensmeyer.
Patrick J. Ottensmeyer
Okay, well thanks again for your attention and your questions. I will just recap some of the highlights, 23% earnings per share growth for the quarter, very solid performance across all four quarters of 2018 and I think most importantly we see 90% of our portfolio of commodities, of major business units seeing positive trends and results for 2018.
So we are really very optimistic about the outlook for growth going forward. And I think on the operating ratio and performance side as well we're doing things.
Jeff and the team are doing things that are very focused on producing productivity gains in an environment where we see volume growth, good pricing environment, and a very strong focus on productivity gains. There is absolutely no reason to expect that we won't see further improvement in operating ratio and good growth in earnings per share as well.
So we're very positive on the outlook for 2018. Lot of factors obviously that we don't control that could be things that we have to deal with during the year.
But as far as the core business and the position of the company right now we feel very good about where we're at and the outlook for the future. So thank you all for your participation and we'll see you in 90 days.
Operator
Thank you. This will conclude today's teleconference.
You may disconnect your lines at this time. Thank you for your participation.