Apr 20, 2018
Executives
Mike Upchurch - CFO Warren Erdman - EVP, Administration & Corporate Affairs Jeff Songer - EVP & COO Brian Hancock - CMO Jose Guillermo Zozaya Delano - KCSM President
Analysts
Ken Hoexter - Merrill Lynch Ravi Shanker - Morgan Stanley Allison Landry - Credit Suisse Tom Wadewitz - UBS Chris Wetherbee - Citigroup Matt Reustle - Goldman Sachs Justin Long - Stephens Bascome Majors - Susquehanna Scott Group - Wolfe Research Brian Ossenbeck - J.P. Morgan
Operator
Greetings and welcome to the Kansas City Southern First Quarter 2018 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, the conference is being recorded. This presentation includes statements concerning potential future events involving the Company which could materially differ from the 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, 2017, 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, Mike Upchurch, Chief Financial Officer for Kansas City Southern.
Mr. Upchurch, you may now begin.
Mike Upchurch
Thank you and good morning everyone. This is Mike Upchurch.
Now I would like to welcome everyone to our first quarter 2018 earnings call. Our CEO, Pat Ottensmeyer, is unfortunately out of town and will not be able to join us on the call today due to the passing of his mother yesterday afternoon.
All of our thoughts and prayers are with Pat and his family and I would hope you would agree with us that Pat has his focus in the right place today being with his family. With that said, this morning, Warren Erdman, our Executive Vice President of Administration & Corporate Affairs will join us in case you have specific questions about regulatory matters.
Let me begin our prepared remarks with some opening comments on Slide 5. For the quarter, revenue increased 5% on 1% volume growth.
Brian will discuss our revenue performance in more detail, but we delivered strong results in most of our commodity groups led by automotive, intermodal, and chemicals and petroleum which continues to benefit from growth related to Mexican energy reform. Offsetting those growth areas, we did experience weakness in our coal business driven primarily by our Texas utility that closed a plant in January.
The North American Rail network congestion did impact both revenues and operating expense during the quarter. Congestion affected primarily our cross-border business as cycle times slowed and we experienced some challenges positioning equipment in and out of Mexico.
Both Jeff and I will touch on this later. However, we believe weakness related to network congestion will gradually improve during the second quarter.
We are confirming our mid-single-digit volume outlook for fiscal year 2018. We expect volume growth to improve throughout the rest of the year, particularly in our chemicals and petroleum business, as destination terminals in Mexico continue to be built or expanded to carry more refined product.
Sasol and other plastics facilities will begin production in the back half of the year and we would expect intermodal to continue to grow. So far, in April, we have started to see some acceleration in our carload trends.
For the first quarter, operating ratio was 65.8%, an increase of 40 basis points versus prior year. Although we are somewhat disappointed with the year-over-year increase in our operating ratio in the first quarter, we continue to believe we will deliver OR improvement for the full-year 2018.
And finally, first quarter diluted earnings per share was $1.40, while adjusted diluted earnings per share of $1.30, represents an increase of 11% versus a year ago. Let me turn the call over to Jeff Songer now.
Jeff Songer
Thank you, Mike and good morning. Reviewing the key operating metrics for the quarter on Slide 7, velocity of 27.6 miles per hour was relatively consistent with prior year and prior quarter.
Overall Dwell versus prior year improved 1%, while there was some variation in performance of some major terminals. Solid operating improvements in Mexico terminals including Monterey, Sanchez, and Querataro, was partially offset by increased Dwell intermodal terminals in Laredo and Nuevo Laredo that experienced elevated Dwell related to South Texas congestion.
As outlined in our response to the STBs service outlook inquiry, the majority of our network is performing well. Resources are at sufficient levels with respect to both crews and locomotives.
Congestion in South Texas and Houston has had the most impact to operating performance during the quarter, but are starting to show signs of improvement. We do expect some lingering effects in the second quarter as fluidity in this region returns to normal.
Congestion in this region also caused some expense inefficiencies during the quarter driven primarily by elevated re-crews over time and car hire expense related to multilevel cycle time. As Brian will illustrate some volume impacts were also felt due to the congestion primarily related to cross-border movements of agriculture and automotive.
However shippable automotive ground count levels have been reduced by about 50% today versus peak first quarter levels, signaling better availability and flow of automotive equipment. Other notables for the quarter include our mechanical insourcing initiatives and contract restructuring which we've discussed in prior quarters.
These initiatives are achieving their projected benefits and we anticipate approximately $7 million of net expense reduction for the year. Lastly, I would like to provide a brief update on PTC.
In summary we are progressing on schedule and project to be fully equipped on our network by the 2018 deadline. Approximately 40% of our PTC route miles are in service -- revenue service demonstration including our most dense corridor between Kansas City and Shreveport.
Thus far, we are experiencing only minor impacts to our operations as we begin transition to PTC operation. I would like to acknowledge the efforts of all the individuals who are working tirelessly to ensure our PTC implementation as a success.
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 9 where you can see first quarter year-over-year revenue was up 5% and volumes were up 1% despite headwinds from the closure of a large utility customer facility in Texas and the impact of network congestion with a number of rail partners in the U.S.
As you can see most of the business units saw increases in both volume and revenue with revenue per unit benefiting from higher fuel surcharge and favorable foreign exchange impact. The fuel surcharge impact is noticeable year-over-year primarily due to higher fuel prices including FX and rebasing fuel for certain customers from a line haul rate perspective.
Given that FX and fuel surcharge drove the year-over-year growth in our Q1 revenue per unit; we wanted to spend a little more time on the year-over-year RPU reconciliation. As we indicated on the Q4 2017 earnings call, we expected our revenue per unit to be impacted by mix this year as our profitable but relatively low RPU intermodal business continued to grow throughout 2018.
Additionally, we signaled that the reduction in long haul utility coal volumes due to a plant closure would pressure the RPU and this was exacerbated in Q1 by 6% reduction in grain. However when we look at revenue per unit by business unit and strip out the FX and fuel for year-over-year, all business units with the exception of intermodal, still had a year-over-year increase in revenue per unit driven by mix and price which we believe is more reflective of the overall strength in our business.
Furthermore, we also see in our 2018 same-store sales being in line with previous guidance of 3% with our renewals trending ahead of that pace. The chemical and petroleum business unit revenue growth of 10% was primarily driven by solid performance in our longer length of haul, Southbound refined products, and LPG business as we continue to see growth from Mexico Energy Reform.
Petroleum revenue grew at 26% from the strength in Mexico Energy Reform partially offset by volume decline in our heavy fuel oils due to some maintenance issues and a temporary plant outage at a facility in Mexico as well as a teacher protest in Michoacan. The industrial and consumer segment also showed improvement in the first quarter with revenue growth of 4%.
This business segment has benefited from strong cement shipments driven by strong construction demand. Additionally, we saw strength in lumber products due to a tightening truck capacity market.
The agriculture and minerals line of business revenue was down year-over-year on a 5% volume decline driven by grain and food products. The decline in grain business was driven by the U.S.
network congestion and softer overall demand. Food products experienced a shift in sourcing trends primarily in soy meal and volumes declined were partially offset by favorable pricing and longer length of haul.
This quarter the energy line of business decline was driven by previously announced closure of a power generation facility in Texas. This decline was partially offset by higher volume and pricing in our crude oil business.
And the crude business saw a slight resurgence due to the increased production in Canada with decreased pipeline capacity compared with the increasing Brent and mine spreads. Intermodal revenue increased by 9% driven by new cross-border services as well as growth in U.S.
domestic lanes. The Lazaro business was negatively impacted during the quarter due to the teacher protests and the protests were halted at the end of February, but still they had an impact on overall quarterly volume.
Our automotive business was up 17% year-over-year with improvements in both volume and revenue per unit. The volumes increased due to an inventory carryover from Q4, increased plant production, and growth in the import volumes at Lazaro, partially offset by challenges that Jeff mentioned in equipment availability.
During the quarter, we provided several very unique solutions for our customers which help to keep vehicles moving in spite of the congestion experienced by some of our North American rail partners. On Slide 10, we provide an outlook for 2018 for each of the business segments.
Our full-year volume outlook remains in the mid-single-digit carload growth for full-year, however the outlook by business unit has been updated to reflect wagon performance year-to-date. Starting with the chemical and petroleum group, Mexico Energy Reform continues to be a significant focus for 2018.
Volume growth continues as storage comes online later in the year. Additionally, we expect plastics to grow in the second half of 2018 as new petrochemical capacity comes on line.
We also expect solid growth in intermodal with continued focus on conversion of cross-border and U.S. domestic freight currently moving by truck and solid growth out of Lazaro Cardenas.
We'll continue to see good performance in our automotive segment with growth in the mid-single-digits which is in line with most of the third-party industry estimates as well as some of the market share gains which we've seen with some of our biggest customers. We continue to expect positive economic activity in 2018 which would positively impact our industrial and consumer businesses in both steel and paper.
We'll continue to see positive impact of military but year-over-year comps could be difficult given the heavy shipments that we experienced at the end of 2017. We expect agricultural min volumes to be neutral to slightly down due to ships and sourcing trends in food products and lingering North America rail network congestion.
We're working with our customers to provide additional services into Mexico that should help us continue to grow this important segment. We're encouraged that the congestion that has impacted this segment in Q1 appears to be potentially improving which will improve overall grain flow.
We expect the strong remainder of 2018 in food products and grain but do not believe that we will be able to recover all the shipments that were delayed or lost in the first quarter. As previously noted, we expect our energy business to be down year-over-year as it will be impacted by the closing of the coal fired power generation facility in Texas.
However, we do expect continued growth in Canadian crude as we previously mentioned. On Page 11, we provide an update on Mexico Energy Reform.
As we mentioned this important change in energy policy in Mexico is having a significant impact on our volumes versus Q1 2017 our volumes were up 287% and our revenue is up 275%. Most of this has happened with only a single facility currently with storage tanks.
Included on this update is a diagram of all of the origins and destinations we're currently working with as well as an update on the destinations that we've previously announced. As you can see, tanks are now being constructed throughout the network as well as new projects being announced in the Gulf at both Altamira and Veracruz ports.
We continue to expect steady growth as this infrastructures build out in the coming months and years. And with that, I'll turn the call back over to our CFO, Mike Upchurch.
Mike Upchurch
Thanks Brian. Let's move to Slide 13, revenues increased 5% to $639 million the result of a 1% increase in volumes along with favorable impacts of fuel surcharge to cover rising fuel prices and an improving Mexican peso currency.
Our first quarter 2018 operating ratio was 65.8% compared to 65.4% a year ago. We did not see an improvement in OR during the first quarter due to lower than expected volume growth, $3 million of year-over-year incremental costs resulting from casualty expenses, and an approximately $2.5 million negative impact in operating income resulting from the North American rail service issues.
But we continue to believe we will see improvement in our OR for the full-year 2018 as volumes grow. While we were somewhat disappointed in lack of OR improvement, we continue to believe volume growth will improve throughout 2018, and along with the favorable pricing environment and disciplined expense management will lead to an improved OR in 2018 as we continue to target strong incremental margins.
First quarter 2018 reported earnings per share of $1.40 increased 1% over 2017 first quarter, while on an adjusted basis excluding the impacts of foreign currency, EPS was $1.30 or 11% higher than 2017. A reconciliation of reported to adjusted EPS can be found in our Appendix on Slide 24.
A more detailed income statement is available in the Appendix on page 23, but I wanted to touch on one item of note. During the first quarter, we did experience lower equity in earnings of affiliates that declined $3 million year-over-year, while other income declined $1.4 million year-over-year.
After-taxes these below operating income line items contributed negatively to EPS by $0.03. Moving to Slide 14, let me spend a minute discussing some key changes in our taxes in light of tax reform and this should be pretty consistent with what we communicated back in January on our fourth quarter call.
As you can see in our effective tax rate reconciliation, our U.S. statutory rate has declined from 35% to 21% providing substantial benefit to KCS.
Offsetting that U.S. statutory rate benefit is a higher tax rate in Mexico where we pay a 30% rate.
The negative impacts of the Guilty tax which adds three percentage points to our effective rate, state income taxes, and finally, the foreign exchange impacts. And as a reminder, our hedging program generally offsets any positive or negative impacts of foreign exchange risk in the income tax line item and for the year we expect the net to be positive about $1 million.
We continue to project a 30% to 31% adjusted effective tax rate for the full-year. One more note on taxes, we currently believe that KCS's guilty tax impacts are at least partially due to unintended consequences as Congress was intending to prevent transfers of intangibles to low tax offshore jurisdictions with the tax rate less than 13.125%.
We are actively pursuing regulatory and/or legislative remedies as KCS operates in a foreign jurisdiction with a relatively high tax rate at 30%. And the final tax law was not limited to intangibles rather based on income generated on all assets.
With that, let's turn to expenses on Slide 15. Operating expenses increased by 5% or $21 million.
A stronger peso resulted in a negative impact to expense of $8 million, while U.S. fuel prices contributed $5 million to the expense increase, and depreciation and increased headcount contributed $4 million and $3 million respectively.
I'll cover compensation, fuel, purchase services, and materials and other and a little more detail in the following slides. On Slide 16, compensation and benefits expense increased $5 million or 4% and is inclusive of some of the inefficiencies created by traffic congestion in Texas.
Foreign exchange contributed another $2 million to our overall comp and benefits expense increase. In the bar chart you can see our overall increase in headcount, excluding the insourcing of service contracts was 3%.
While this increase was above our carload volume growth, most of the increase related to Teenie personnel in Mexico to allow us to better handle growth for the remainder of the year, and we would expect our headcount trends to be flat to slightly up throughout the remainder of the year. Turning to page 17, net fuel expense increased 13% largely due to fuel price increases and foreign exchange impacts.
As you can see in the bar chart U.S. fuel prices were up 19%, while Mexico fuel prices were up 8%.
Rising fuel prices negatively impacted operating income by $3 million in the quarter due to the timing lag in collecting fuel surcharges. On Slide 18, purchase services declined mainly from the insourcing of a car repair facility.
Offsetting that decline was slightly higher comp and benefits expense from hiring those employees, along with a $1 million parts expense in the materials and other expense line items. We do expect to see a $7 million reduction in overall expenses in 2018 from these insourcing activities, and finally, we experienced increased casualty expense of $3 million.
Let me quickly cover our capital allocation priorities on Slide 20. Our commitment to continue investing in our business is as strong as ever given our growth opportunities across our network.
Our 2018 CapEx guidance of $530 million to $550 million remains unchanged. We expect 2018 will be the third year in a row that our CapEx and CapEx to revenue ratio has declined.
In addition to capital requirements we will continue to explore investment in ventures to enhance our core revenues, particularly around Mexican Energy Reform. Turning to shareholder returns of capital, during the first quarter we repurchased approximately 500,000 shares at an average price of $108 and to-date we've repurchased 2.9 million shares at an average price of $106 under our repurchase program authorized by our Board of Directors in August of 2017.
Finally, we're very comfortable with our balance sheet and credit metrics but we'll continue to evaluate the acquisition of leased assets that provide positive financial returns. So in closing, let me provide a few thoughts on the regulatory and political landscape as I know these subjects are on your mind.
First, we were pleased to announce during the quarter that the COFECE issued a final resolution that dismissed the preliminary report along with its finding of a lack of effective competition for interconnection services. This final resolution represents the end of the COFECE investigation.
Second, we are encouraged that NAFTA negotiations are progressing and appear to be moving towards resolution hopefully sooner than later. Although we cannot predict whether negotiators will reach a resolution prior to Mexico's Presidential Election in July, we are very pleased by recent progress and hopeful that these negotiations result in a modernized NAFTA agreement that will benefit all North American economies.
And with that, I'll turn the call back over to the operator for our Q&A.
Operator
Thank you. [Operator Instructions].
Our first question today is from Ken Hoexter with Merrill Lynch.
Mike Upchurch
Good Morning, Ken.
Ken Hoexter
Great good morning Mike, my condolences obviously over to Pat and his family. But it just -- maybe you can step back and quantify, you talked a lot about the impact of UPs, I'm sorry other rail network congestion and the impact on results you mentioned a couple million dollars but I'm interested in your comment that things seem to be improving maybe you can kind of address that and kind of walk us through you talked a little bit about that the specific cost categories but how quickly can they get back to normal, what needs to happen and kind of the all rank to KSU you as you move forward?
Mike Upchurch
Jeff?
Jeff Songer
Yes, Ken, I'll take that firstly we did not say UP, we said overall congestion in the region, the way I look at this where as we've spelled on I think the energy is doing a much better job today understanding that we are a system of very interconnected system. So for us the impacts were slowdown really from between Belmont and getting things back and forth across the border to Texas.
Impacts to us as I outlined higher re-crew rates. We probably could have had some crews furloughed if not or for the just extra effort and extra resources that during these types of issues similar as what we saw with the hurricanes, we just have to load up the resources a bit more to ensure we keep fluidity for the traffic and for the customers.
I think Mike outlined the financial impact of that from a net income perspective.
Mike Upchurch
Yes, $2.5 million of operating income impact.
Jeff Songer
So that's a rough guess on the elevated expense net of any potential revenue loss opportunity. Where we're at today things are feeling little better and how I measure that just the fluidity, I mentioned the auto ground counts for me that was a big item here we had over substantial amount of ground counts here during Q1.
Those will relatively quickly clean themselves up, we're still not where we want to be but you've seen a lot of movement in the auto here early into Q2, we're seeing that on the volume side, you're seeing that just from the ground counts that are winding down. So that equipment is flowing better.
We are gaining more reroutes around some of the congested area I think during Q1, you had a lot of Texas, a lot of the routes in Texas we're really seeing some congestion in this harder route any carriers traffic in and through, in and through the areas. So I think we're feeling better on that now.
We are receiving some reroutes and some detour routes for various commodities. So again I don't think we're out of this quite yet.
I think we understand and I think our resources are at good level. And as I mentioned that the need to retain excess either locomotives or crews to ensure that we don't further contribute or aren't able to help work our way out of this issue here, it's elevated the cost bid, so.
Ken Hoexter
That's helpful overview, I appreciate the insight there. If I could just get a follow-up for Brian, you’ve got a lot of contracts I guess just ramping up U.S.
fuel with grain seems to be coming back online, the tanks. Are there specific kind of months or dates where you kind of look and see that acceleration is it gradual?
I noticed you noted that auto plants not really picking up for full production till 2019, anything you can kind of detail in terms of timing of the ramp up in volumes?
Brian Hancock
Yes, I would tell you, Ken, I think the key for us is watching how the plastics -- the manufacturers start to come online obviously we feel pretty comfortable. We know what's going to happen in the automotive space that will be at the very end at least, the new facilities that come out at the very end of the year.
But right now we're actually picking up some market gains, so we feel comfortable there. As you see tanks come on even with the increase that you've seen you have to realize that's only a single facility that has tanks specifically on the line for refined products.
So I think we now have, I want to say six or seven facilities that are building tanks across the network and so that's going to continue to go probably you won't see many of those tanks get completed until the third quarter and then certainly some in the fourth quarter and then it will just continue from there. So we feel comfortable there but overall the intermodal -- the only thing I want to say intermodal as that continues to grow certainly that is at the surge type capacity environment, so you see it always each year between June and August, September that's when those big volumes come from an intermodal perspective to feed the typical retail environment.
So we feel pretty comfortable with our estimates right now and right now we're very focused on fluidity and making sure that the customers have a great way to get product in and out of the ports and out of Mexico as well.
Ken Hoexter
Really helpful.
Mike Upchurch
Ken, maybe just a couple other real quick thoughts intermodal -- much of our intermodal business is carried in Mexico and with the improving peso puts us in a little better position than we have been over the last two to three years to be in a soft service is obviously growing and we've got peak season which we expect to be good coming up. Auto just to give you a data point, our volumes have accelerated here in April to 16% growth so far in the quarter and then while we wouldn't want to rest laurels on easy comps in the third quarter, remember a year ago, we had a pretty major impact from a hurricane that set us back with the volumes.
Ken Hoexter
And did you say that teacher strike was over done or just off your network or is it still lingering?
Brian Hancock
No, the teacher strike that impacted us is now off, I mean it's over but I would say we continually watch that I think Jeff and his team do a great job of making sure that really if somebody does get on the line at that space that it's off the line, it doesn't really impact any service just the -- the things we saw in February did impact us and impact us there during the quarter from a volume perspective. But we feel pretty comfortable; we've got our arms around it as long as some major event doesn't occur there.
Operator
The next question is from the line of Ravi Shanker with Morgan Stanley.
Mike Upchurch
Good morning, Ravi.
Ravi Shanker
Good morning everyone, thanks. Just to follow-up on something you just said about the extra resources needed to fix the service issues of the railroads, just to make sure I understand are these temporary resources that you need tied over the current bottlenecks or not just you also the other rails or do you think this is more of a kind of long-term resource addition to get these service running smoother for the long-term?
Jeff Songer
Ravi, I think if you look at our headcount growth, we've talked about trying to certainly have headcount growth below that of volumes. So I think what you saw really in the quarter is volume as we've stated here didn't quite achieve what we saw due to the various reasons, I feel pretty good where we're at with headcount.
Continuing to look for opportunities to improve productivity, really the expense drivers with re-crews so the headcount base that we have they're more than fully utilized and the re-crew rates it takes multiple crews versus fewer crew to get across territories when you see this type of congestion. So it's just -- it creates demand with the re-crew rate with the total expense to get that train from Point A to Point B.
As we kind of confirm volume for the rest of the year, I think again that's why I think we're in pretty good shape when it comes to resources to be able to then handle the certainly last three quarters, last half of the year as we expect the volume to pick up a little bit.
Ravi Shanker
Great. Also you briefly touched upon in your previous response but in terms of where the peso is and the intermodal market, how would you characterize the current competitive environment right now on the trucking side?
Brian Hancock
Yes, Ravi, I would say we feel very comfortable, we put in place a new program for some of our international shippers which we feel has been accepted very, very well. We've had some great wins in the normal bid process that happened in February both domestic and international in Mexico but also that that Peso has a big impact from a trucking market perspective and as it comes back down that's only going to benefit us because we have not only a great program in place, but we have capacity to be able to utilize not only on the BNSF service but the UP service, all of our intermodal products both cross-border and into Mexico are impacted by that and as that Peso strengthens, it's just a real benefit to us against the truck market.
Ravi Shanker
Great. And I may just sneak quick one, then, Mike you said that the other income affiliate income declined in the quarter, if you can elaborate a little bit more on kind of how we see that through the rest of the year?
Mike Upchurch
Good question. We did see a decline in other income and equity and earnings, the other income decline was due to a land gain that we recorded a year ago, didn't have that again in the first quarter 2018 and then our equity and earnings declined $3 million year-over-year that's primarily comprised of PCRC, our Panama Canal Railway and FTVM which is the operator in Mexico City.
I think the PCRC business is challenged a little bit right now in terms of container volumes, Maersk has moved some of their traffic from Valbao to the PSA port and that’s had some impact there. But I wouldn't expect it to be a material drop in equity and earnings over the full course of the year maybe just a slight decline.
Ravi Shanker
Great, thanks very much and our thoughts are with Pat and his family as well.
Mike Upchurch
Thanks, Ravi.
Operator
Our next question is from the line of Allison Landry with Credit Suisse. Please state your question.
Mike Upchurch
Hi, Allison.
Allison Landry
Hi, good morning, thanks. Thinking about Lazaro going forward and I'm sure they're no way to really handicap on that Teacher's Union is going to protest but it's all risk that the Ocean carriers shippers that are calling on the port may divert traffic away from Lazaro because of the network disruptions and could this potentially be a risk as we think about the upcoming election?
Brian Hancock
Yes, Allison, this is Brian. I think that’s a good question but what I would tell you is both port facilities, the Hutch facility and the AT&T terminal are marketed.
They are now fully marketing their product out of Lazaro. As a result not only the ports and the railroad but also customers are now almost in constant contact with both the state government and the federal government to make sure that these protests don't impact commerce.
And so what I would tell you the importance of the capacity at Lazaro is not only important to the railroad, but it’s important to the steel industry, the auto industry and if you look at the -- when these things occur we'll have probably over 30 to 35 companies join together along with the government to make them go away. This particular item that caused the February delay, I would say is probably a little bit of a different type of an item but we believe that there's not really going to be an impact.
Now certainly if there were some type of major delay, it potentially could but right now we just don't see that this was a very specific issue and there's enough people focused on it, including over the last couple of times, the military has actually come in immediately and removed the teachers because of international commerce needs. So we feel pretty comfortable that everyone is focused on and it becomes more and more an important part of the infrastructure of Mexico we feel pretty comfortable that we're doing and have done everything we can to make sure it's a fluid piece of railroad.
Mike Upchurch
Allison, this is Mike. Just one other thought there remember only about half of our Lazaro revenues are intermodal.
We have a number of other products there that predominately have to move by rail. So we shouldn't see a whole lot of impact things like steel and autos that move in and out of that port.
Allison Landry
Right, okay. That makes sense.
Thanks. And then on the cross-border intermodal piece, so we’ve been seeing very strong growth there, is that the longest length of haul segment within overall intermodal and if so is it fair to say that as this piece of it grows over time should the overall profitability of the intermodal franchise improve as a result of that?
Mike Upchurch
Yes, Allison this is Mike. Remember we report those as two carloads one in Mexico, one in the U.S.
to the extent we carried on our own network and we do get a little bit better length of haul with the BNSF service that does help our profitability and will take as much of that traffic as we can because those trains still have a lot of capacity. We've been what Brian 13, 14 months into the --
Brian Hancock
Yes.
Mike Upchurch
Service with BNSF and it's still showing very nice growth. So it is definitely profitable business.
Brian Hancock
Absolutely.
Operator
Thank you. Our next question comes from the line of Tom Wadewitz with UBS.
Mike Upchurch
Hi, Tom.
Tom Wadewitz
Yes, good morning. Wanted to see if you could give us kind of an update comment on the connectivity that you have with the Port of Veracruz with respect to automotive, I think that's something you had in the past kind of paired with the idea that as BMW came on there was commitment to get that connectivity in place, so just wondered if you could offer thoughts on where that's at and when that might become a growth driver in automotive as well?
Brian Hancock
Yes, Tom, this is Brian. I would say that we actually had a meeting with BMW again this quarter.
We're both working very hard on that obviously the connectivity is going to continue to be focused on the end of this year into 2019. But all of those plans that we've had in place here for the last couple of years as that plant has been being built they are all continuing down and down that path and we've had significant meetings on planning for the volume, certainly the parts coming out of Europe all of those things.
So we feel very comfortable that our connectivity with Veracruz is going to occur just like we have planned and that we should continue to see growth there. Certainly I would say as well don’t forget the export piece of automotive going on through Veracruz into Europe and some of the -- like Brazil or Argentina down in South America, it's an important part that we're tying in and I think everybody's working very hard on that, it just taken little longer than we had hoped but we feel very comfortable it's going to be done in the next year.
Tom Wadewitz
So it's fair to think about that as significant auto volume growth driver in 2019 that's right way to think about it?
Brian Hancock
Yes, I think it's certainly going to be a great pathway for all of our products to come out of Veracruz and go into Veracruz. The global sourcing piece because Mexico is becoming such a manufacturer of choice, it's not just automotive, it's anybody who builds or sells anything in Mexico, Veracruz, Altamira, Tampico those are all great ports and each one of them is building out infrastructure over the next year or two years and so we feel comfortable in all those ports on the Atlantic side of the page if you will.
Tom Wadewitz
Okay, great. Appreciate that.
And then the second question just along the lines of how we think about crude by rail and framing the volume opportunity. Obviously that stepped up nicely it's still off of I guess a reasonably low base.
But you -- it seems like there is room for meaningful growth, how closely do you tie your growth to what we're hearing from CP and how they talk about things? I don’t know if you can comment about how much your crude by rail in connection with CP and kind of how directly we would link growth in Canadian crude by rail to your growth?
Brian Hancock
Yes. I think the way I would think about is we are certainly an attachment to many of our North America partners.
CP being one of them, but there is a number of the big rails that we attach to as we deliver into the Southeast U.S. and into some of the larger facilities in the Gulf.
And so we have to talk to each one of those railroads as they speak, but we are very confident in our ability to move the freight. Jeff has been working extremely hard to make sure that we have the right capacity and right fluidity to be able to handle this train link, we're working with all of the terminals with all of the companies that we work with down in the Gulf to make sure that they can receive the trains but we're very comfortable, we're going to continue to grow that, we've got lots of spreads, they move around on us a little bit and they've been moving quite a bit lately.
So we're watching those very closely but given the pipeline capacity, given the amount of crude that's available up in Canada and in some of the Northern facilities, we feel pretty comfortable it's going to continue to grow and as you listen to the other railroads, we’re certainly in support of all of our partners that are bringing crude towards the Gulf.
Operator
Thank you. Our next question is from the line of Chris Wetherbee with Citigroup.
Please proceed with your question.
Mike Upchurch
Good morning, Chris.
Chris Wetherbee
Hey good morning guys and certainly our thoughts with Pat and his family as well. I wanted to ask about the sort of the Energy Reform opportunity, so we thought about this for a while and it certainly has been part of the business now for the last year or so, first quarter stepped up nicely from the run rate kind of in 2017.
I think it was mentioned earlier in the call that this is business basically from one facility with storage as you think about the six or seven that kind of come online over the course of let's say the next year or so. Is there any way we can kind of translate the business you're doing today to what ultimately the opportunity set looks like for you, is it simple with sort of looking at this quarter and multiplying it by six or seven or there other kind of nuances can you help us sort of frame this up a little bit?
Brian Hancock
Yes, sure. I actually love the question because we get asked that question probably more than anything else.
What I would say here's a way we think about it is these facilities are being built to handle unit trains because that obviously keeps the price per barrel low and so unit train responsibility and being able to receive that that type of capacity is kind of our key focus. What we're looking at is making sure that the facilities that we are assisting and also the facilities that we’re trying to service are looking at capacity in the right way.
Overall, we believe that it's going to continue to grow at a rate that is pretty close to what the government has said how they want to change the number of days available in Mexico, I think it's going to be very difficult to say when is it going to ramp up but if you look at the number of companies here is what I would say to focus on. Focus on the retail outlets that are non-PEMEX and those will be announced by other people, other companies the companies that are setting up that retail environment because that's really the key on how much we'll move and how fast it will move.
Now if you were to ride the train or take a car ride through some of the major parts of our railroad, Monterey's, SLP North, Mexico City you will start to see non-PEMEX retail outlets as those come online, it's much easier to understand how fast you'll be able to move and how many barrels you'll be able to move. But most of these facilities want to be able to handle a train or maybe let’s say a train every other day at least and so that's kind of the way they're building out, that’s the way their plans are set up and so we’re trying to make sure that we have the capacity to handle that type of volume because that's when you think about a train, it's about 60,000 barrels and so it's that kind of turn that you have to watch.
But I would look at those metrics that come out from the other energy companies around number of retail outlets and serviceability from a distribution, their midstream segments and that's probably the best way to get it. But the government wants to move from two days to 10 days over the next seven years and you’re going to see pretty much a ramp up of storage and logistics capacity to handle that.
Mike Upchurch
Chris, I think it’s safe to say this is going to continue to stair step up for us with one of the facilities expanding their storage capacity and our own facility at SLP getting tanks in during the third quarter, I think we see a pretty material step up in 3Q and 4Q.
Chris Wetherbee
Okay, all right, that's helpful. Those are great parameters to work with, I appreciate it.
And as a follow-up when you think about sort of the OR improvement that you’re targeting for the full-year, you just sort of called out some costs during derailment, there is also service issues in the quarter you had the teacher strike. We think about sort of the progression, volumes are getting better, is it fair to say that year-over-year OR improvement starts as early as 2Q, I just want to get a sense of sort of how transitory these costs really are and sort of how we can think about the timing as the year progresses?
Mike Upchurch
That’s a good question obviously it’s challenging to grow incremental revenues at a high rate when you don't have a lot of volume growth that we showed in the first quarter here, also rising fuel prices and FX are essentially a 100% OR businesses. So when those are growing, it makes it a bit more challenging but we do believe that we're going to see volume step up in the second quarter, obviously 20 days or so and April doesn't make for a quarter but we're seeing some nice results so far.
So I would expect us to see sequentially some improvement in OR going into 2Q and then 3Q, 4Q for a lot of the reasons, Brian, and I mentioned earlier that's when your plastics begins ramping up Sasol opens up in the back half of the year, the refined products which we just discussed will begin to grow from current levels because of all the storage facilities being built, intermodals are going to see a nice ramp, the crude is we're optimistic about that. But as Brian said, the spreads maybe aren't quite as wide as they were a month ago, auto will continue to accelerate.
So I think we have a lot of conviction in those drivers and are excited about the rest of the year.
Operator
Thank you. Our next question comes from the line of Matt Reustle with Goldman Sachs.
Please proceed with your question.
Matt Reustle
Yes, thanks for taking my question and just wanted to follow-up on those dynamics around OR, obviously kind of toughest start for the year than expected, are there any underlying trends here that have actually been better than you expected whether it’s volume or pricing that drives that confidence or had you always kind of baked in that much improvement in the back half of the year that even with the weakness in the front end you'll still be able to meet the full-year improvement?
Brian Hancock
Yes, Matt, good question. We did build our plan with third and fourth quarters seeing much better volumes and profitability.
I think first quarter what was off to a little slower start; I mean we did have some obvious issues that we've talked about here with respect to teacher strikes, with respect to the congestion that we've seen in the North American rail network. We had some negative comparisons around Holy Week in Mexico being in first quarter versus second quarter.
Not that it was a big driver but the revenue accounting standard pushed couple of million dollars of revenue into future quarters from first quarter. So we -- I think the first quarter is performing maybe just slightly behind where we thought we would be but I think second, third, and fourth quarter for all the reasons we've talked about we'll see growth and improving profitability.
Matt Reustle
Understood, understood. And what also on pricing, I think I heard earlier that it was 3% underlying pricing in the quarter, can you touch on that I think that the past few quarters have also been 3%, are you seeing any momentum there acceleration on pricing front?
Brian Hancock
Yes, Matt. I would -- this is Brian.
I would tell you we feel very comfortable in the pricing environment we're in right now. First off service has improved, I think that people are feeling the effects of a capacity constrained truck environment which allows them to look at other options certainly in the intermodal space but also in some of the other places where you could use a rail car to move it a long distance and transload.
So we feel very comfortable and a lot of our industries are doing very well, the paper industry is having a great year from our perspective because we're on the box plants as Amazon grows, as FedEx and UPS shipments continue to go higher boxes there's more boxes out there. So that's good for us.
If you look at the steel now one of the things you hear a lot of political rhetoric obviously we're now fully into an election cycle down in Mexico and that election rhetoric in the steel industry along with some of the things that have happened from the U.S. perspective, there's a lot of bullishness that that industry is going to continue to grow.
So like Mike said, we have a lot of great signs going, our capacity is there, our fluidity is there, we just had a little congestion in the South -- the Southern part of our U.S. network and we feel like that's breaking up, we are working very hard with our partners and so there's a lot of good things happening out there, Energy Reform, automotive.
So we're bullish, we think it's going to be a good year.
Mike Upchurch
Now just one last thought, we have seen a little bit of an acceleration in pricing around contract renewals that we had in the first quarter and I think that's always an important data point to look at because that's going to be reflective of what you're going to see in the next four quarters. So Brian mentioned roughly 3% range what we've been seeing for the better part of the year but in the first quarter, our renewals did step up from that level.
Brian Hancock
Yes, it's higher than that.
Operator
Thank you. Our next question is from the line of Justin Long with Stephens.
Please proceed with your question.
Mike Upchurch
Hi, Justin.
Justin Long
Good morning. Wanted to follow-up on the volume outlook for this year, you're sticking to the mid-single-digit growth target for 2018, but could you help us understand the quarterly cadence of that target over the remainder of the year, I'm just curious if the right way to think about it is that you guys see mid-single-digit volume growth in the second quarter and then maybe a ramp to high-single-digits in the back half as Sasol and some of the refined product opportunities kick in, could you just help us understand how you’re thinking about that?
Brian Hancock
Yes, I would say Justin, this is Brian. I would say, we are going to continue to see a ramp up as the second quarter kind of comes in obviously Jeff mentioned automotive has started out strong as we kind of taken that ground count down.
So we feel very comfortable in that space, intermodal obviously ramps up in the third quarter because it means retail season certainly grain and food products is going to continue to get better as we get better fluidity and so yes we're going to see those ramps continue. The tankage you guys kind of know when those are coming on there in the third quarter and the fourth quarter.
So certainly that's going to have an impact on those quarters, so I would say certainly in that space. But overall most of the industries look better as they come in on the second half; we talked about plastics in the second half.
So Q2 is going to strengthen because we're going to have better fluidity, better capacity much better, less congestion, but then as those tanks as the intermodal season hits as automotive continues to strengthen we're going to see that in the back half. So yes I would say you’re thinking about it correctly.
Mike Upchurch
And again 20 days in April doesn't make a quarter but we're running roughly 4% increase so far in the quarter. So I think you're going to see a little bit of a step-up in 2Q don't forget in 3Q we had a pretty substantial negative impact a year ago in the hurricane and then we would expect the fourth quarter to continue to show some growth.
Justin Long
Okay, that's very helpful and maybe asking a question earlier a little bit differently, Mike, I know you've always talked about 50% plus incremental margins in the business. There were some challenges in the first quarter that you’ve talked a lot about, do you think getting back to 50% incremental margins in the second quarter is achievable or is that something it's more likely to occur in the back half?
Mike Upchurch
We'll certainly with volume growth looking better than the first quarter, I think it's more achievable than it was for us in the first quarter that's always been our target to target 50% you have a lot of issues quarter in and quarter out but for the full-year, that continues to be our target we will see where we end up with that. But I think growth is a key contributor to that incremental margin target of 50%.
Operator
Thank you. Our next question is coming from the line of Bascome Majors with Susquehanna.
Please proceed with your question.
Mike Upchurch
Hi, Bascome.
Bascome Majors
Good morning. Thanks for taking my question here.
Following up on the carload business a bit some of your comments earlier the truckload capacity market that we're seeing right here and the rate increases I mean that's arguably unprecedented here. In intermodal certainly seems to be anything across the rail industry but carload it just feels like some of the larger class ones have been slow to regain mobile share in the kind of market we've seen over the last call it three to six months.
And you guys have been its KSU user growth oriented railroad for a long time; do you have an opinion on why the larger class ones have not been able to grow this carload business more aggressively in this backdrop?
Brian Hancock
Yes, I would tell you Baskin. This is Brian.
I try not to speculate on anybody's business except our own. All I can tell you is I feel very comfortable that we are a great modal solution for the customers that we serve and we are being asked to do more by many of those customers in the Southeast.
There's a lot of growth, there's a lot of construction certainly paper is strong, the steel market continues to strengthen with construction and so we feel very comfortable and at least the things that our customers are telling is rail is a great option, so you have to ask everybody else how it impacts them but they're excited about rail as an option in the capacity constrained environment and we feel very good about that.
Bascome Majors
All right. So to paraphrase you feel very good about the carload outlook for the broader industry going forward.
Brian Hancock
I feel very good about the carload volumes for Kansas City Southern Railway. Yes.
Operator
Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.
Scott Group
Hey, thanks morning guys. So you guys mention sort of uncertainly here on the elections couple of times.
I'm just wondering is that purely sort of macro NAFTA uncertainty or as you think about bigger picture implications of the election is there anything specific to rails meaning is there anything policy wise from Obrador good or bad in your mind from -- for the rail industry I don't know maybe that's a question for Warren.
Warren Erdman
Yes, we actually have Jose Zozaya our President in Mexico on the call. Jose, do you want to address that?
Jose Guillermo Zozaya Delano
Yes, I just wanted to comment that we have been able to get in touch with Obrador and all the candidates teams and talk about this in our concession terms all of them have expressed directly to us their interest on respecting their concession terms and of course the rule of law. So we feel very confident in that sense.
Warren Erdman
I might add that a strong associate of Mr. Obrador was before the Wilson Center in Washington and he indicated that they would be supportive of any NAFTA agreement reached before the election.
I think that's a pretty strong sign in favor of a good outcome.
Scott Group
Okay, good to hear. Thank you and then maybe it's Mike one for you just sort of long-term, so I think we all tend to focus on your growth opportunities long-term.
I want to ask you about long-term operating ratio, so obviously seeing some pretty remarkable improvement in CSX this quarter and maybe some of the arguments about short length of haul don't apply anymore, so I know it's been a few years since you've given us sort of a breakout of U.S. versus Mexico OR but a few years ago your OR in the U.S.
is around 70%, do you think that that's an OR that can go to the low 60s and do you have opportunities or things you're working on to get us there.
Mike Upchurch
Well, preface it by saying we haven't provided any long-term OR targets but I think as a team we all agree and are committed to continuing to improve our OR. I think in our case we believe growth top-line growth at profitable and good margins is going to allow us to continue to generate great year-over-year EPS returns.
Typically comes in three pockets, growth which we think we'll do just fine, pricing environment continues to look pretty solid and we have some additional cost opportunities. We haven't really fully implemented trip optimizer which is a fuel saving technology on the locomotives that will lead to some future benefit the insourcing that we talked about will continue to allow us to right-size our expenses and I may have Jeff comment on this because I think you're going to see this transition take place here in 2018 labor productivity is something we're very focused on.
Jeff, do you want to comment a little bit?
Jeff Songer
Yes, you know, Scott, [indiscernible] we talk about and haven't maybe talked about the fuel in the specifics. Those things continue to move forward we haven't -- we've basically have been out and running that on the U.S.
side only. We've got some labor things that are just now concluding here from Mexico that are going to enable us to really utilize that technology and gain some more efficiencies in the fuel specifically in Mexico.
Mexican productivity we're continuing to work on things with crew size, train length, all the initiatives that are out there in the industry were certainly focused on you take an example like a BN train that started off is growing well but it's still not at capacity, so with that deters from train length a bit but in a good way and that we have a lot of capacity remaining on that train to continue to grow and add it's profitability there. I think there's that's where we're focused and those things will translate them into the specific operating metrics such as intermodal train links as those businesses grow over time.
Operator
Thank you. Our next question comes from the line of Brian Ossenbeck with J.P.
Morgan. Please proceed with your question.
Mike Upchurch
Hi, Brian.
Brian Ossenbeck
Good morning. Thanks for taking my question and please send my condolences to Pat and his family.
On the -- just going back to the fluidity and network and some of the challenges last several months and just really like there's pretty little resiliency to come back from disruptions I know you've had quite a few in a row but you just talk about your confidence and you're seeing some of these costs, rate and things improving in the second quarter. And how much of that the rate specific to Houston and just thinking of the ramp up in plastics that looks in general growth in freight carloads, you talked about earlier is that really the pinch point that can handle that sort of growth or is that risk that we could see another bottleneck to go further down the road here?
JeffSonger
Yes. We are pretty specific we have seen our STB response that that territory South Texas, Houston and that has been the choke point if you will and I think you've heard that from others in the industry what I hear as well from others in the industry is resources are being added.
I know we along with others in that area have been spending a lot of CapEx on capacities specifically us with trackage rights across our Laredo subdivision. And so I don't think it's a lack of certainly resource on our end.
As I mentioned right now the demand the excess demand in climbing out of these sluggish periods if you will it just takes more resources that I don't see what I'm measuring right now is our re-crews have improved a bit since Q1 peaks if you will, so that's a clear sign for me. I mentioned also the other detour routes which clarifies for me that other routes within in and around Texas, in and around congested areas are starting to improve it as well.
So couple of tangible signs for us here we're seeing things regain fluidity we're seeing some of these cost metrics come back down a bit. As I mentioned I still think we're going to have some impact in 2Q but some intangible signs that things are improving.
Brian Ossenbeck
Okay, thanks Jeff and then into the second half of the year I think we've enough resources have been put in place to handle, what you're expected to see in terms of volume growth?
JeffSonger
Yes, for us again as I say if you look at our headcount it outpaced volume we generally like that to go the other way but because of congestion, as volume has pressure those assets are here. So I mean the Q1 impact was that expenses are a little elevated but the second half of the year impact should be there we've got adequate resources to handle these opportunities we certainly to plastics continue to look a lot at cross-border refined products opportunities and then the Canadian crude has been mentioned.
So with kind of the slowdown in the coal that line for us Kansas City to go to Southeast has plenty of capacity, we got adequate resources from a crude base to where if and when as much as that crude wants to start flowing into the Gulf we\re ready to handle it.
Operator
Thank you. At this there are no further questions.
I’ll turn the floor back to Mr. Upchurch for closing comments.
Mike Upchurch
Okay, thank you. Appreciate everyone joining us on the first quarter call.
Look forward to talking to you in July about second quarter and of course all of our thoughts and prayers go out to Pat and his family. Thank you very much for joining us.
Operator
This concludes today’s teleconference. You may disconnect your lines at this time.
Thank you for your participation.