Jul 20, 2018
Executives
Patrick Ottensmeyer - President and Chief Executive Officer Jeffrey Songer - Executive Vice President and Chief Operating Officer Brian Hancock - Executive Vice President and Chief Marketing Officer Michael Upchurch - Executive Vice President and Chief Financial Officer José Zozaya - President and Executive Representative of KCSM
Analysts
Ken Hoexter - Merrill Lynch Jason Seidl - Cowen and Company Allison Landry - Credit Suisse Ravi Shanker - Morgan Stanley Matthew Reustle - Goldman Sachs Christian Wetherbee - Citi Justin Long - Stephens Inc Thomas Wadewitz - UBS Scott Group - Wolfe Research Brian Ossenbeck - J.P. Morgan
Operator
Greetings and welcome to the Kansas City Southern Second Quarter 2018 Earnings Call. At this time, all participants will be 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, Pat Ottensmeyer, President and Chief Executive Officer for Kansas City Southern.
Mr. Ottensmeyer, you may now begin.
Patrick Ottensmeyer
Thank you very much and good morning everyone and welcome to the KCS second quarter earnings call. I will start my comments with just brief introduction on slide four, but you all know the casp and line up for our call no call changes, so I won’t spend anytime introducing us.
Slide five, just a couple of quick comments about the results, we had record quarterly revenues for the second quarter of 2018, revenues up by 4% from the previous year, volumes up only 1% which was a bit of and disappointment and I will talk about that in and couple of minutes. Operating ratio of 64.0% which was 50 basis points higher than last year, Mike Upchurch will review this in greater detail in a few minutes, but volume weakness higher casualty and fuel expense and PTC related cost including depreciation were some of the major contributors to the higher operating ratio.
We also produce record quarterly earnings per share, there were some tax items included in that number, but and as Mike will review in a few minutes as well. But I would still say solid earnings per share growth for the quarter.
Before I turn the discussion over to the team, I would like to make one additional comment on our volume growth and full-year outlook. Given our actual volume growth for the quarter and year-to-date to six months, we are revising our guidance which are previously been mid single-digit down a bit, while it’s a certainly no means out of the question that we could still achieve mid single-digit volume growth for the full-year.
At this point there is certainly greater risk and higher probability that will come in below that guidance. So, our current expectation is that full-year volume growth will be in a range of 3% to 4% which is kind of right at the edge of high, or low to mid single-digit growth.
I think for the past few weeks, Mike Upchurch and the Investors Relations team have been guiding to the lower end of our previous guidance range. So, hopefully this doesn’t come as a surprise to most of you on the call.
As Brian Hancock will show you in a few minutes there is a lot of strength in many of our most important long-term growth areas and while the major areas of disappointment was crude oil, which was largely a timing issue. And again Brian will talk more about that in a few minutes.
So with that introduction, I will turn the presentation over to Jeff Songer.
Jeffrey Songer
Thank you Pat and good morning. Starting with a review of operating metrics for the quarter on Slide 7, velocity of 27.5 miles per hour improved versus prior year while Dwell increase driven primarily by our northern Mexico terminals.
Congestion phase in Q1 and early Q2 has the [indiscernible] in the Houston area and we have been working hard to clear the cross-border traffic that backed up the Northern Mexico during that time. This congestion is largely behind us, and Dwell should continue to moderate through the rest of Q3.
Other highlights for the quarter include the announcement that we will purchase 15 new high horsepower locomotives with deliveries starting in Q1 2019. This provides a great opportunity for us to modernize our fleet with more efficient, more reliable and lower costs to maintain units and positions us to handle more line of [indiscernible] trains specifically in the refined products area.
Offsetting this purchase is the disposition of approximately 30 older switching and low horsepower units additionally, we look to reduce the least units that we have had online over the past several months. Overall, our active fleet will remain largely unchanged with the acquisition of these new units.
PTC work continues on schedule and we project to be fully equipped on our network by the 2018 deadline, approximately 60% of our subdivisions are in PTC revenue service that's up from 40% as reported at the end of Q1. We continue to experience only minor impacts to our operations as we move territories in [Q3] (Ph).
Turning to Slide 8. Our cross-border volume outlook is strong as Brian will outline in more detail.
We continue to work on operational improvements at the border to ensure we have capacity to achieve planned growth. In addition to the joint U.S.-Mexico customs facility, which began operation last summer we have now started our international crew operation.
This operation will improve fluidity, safety and security at the border and will provide public benefit by reducing the amount of blocked crossings in Laredo. Future technology enhancements such as [indiscernible] scanning of trains and data processing improvements are other opportunities to improve fluidity at the bridge.
Turning to Slide 9. This map shows 2017 foreign direct investment in Mexico.
Despite ongoing trade negotiations foreign direct investment in Mexico has grown. Prior capacity investments we have discussed such as Sanchez, [indiscernible] and on joint KCSUP trackage rights in Texas as well as future projects such as upgrades to the mainline between Monterey and [Matamoras] (Ph) and at the ports of Veracruz and Tampico all aligned with foreign investments into Mexico and related cross-border opportunities.
As indicated on the map, the highest concentration of foreign investment is in the northern and central regions that we serve. Brian will go into additional details around specific customer projects in these areas, specifically related to the refined products, plastics and automotive industries.
I will now turn the presentation over to Brian.
Brian Hancock
Thank you Jeff and good morning. I will start my comments on Page 11 where you can see second quarter year-over-year revenue was up 4% and volumes were up 1%, despite headwinds from the closure of large utility customer facility in Texas.
Both volume and revenue increased for five of our six business units, additionally in the second quarter we achieved record franchise cross-border Carloads and revenue benefiting from the growth in key areas such as refined products, plastics, automotive, and cross-border and mobile. During the quarter, our revenue per unit grew 3% despite mixed pressure from the loss of the long haul utility coal business and unfavorable FX impact.
Positive core pricing was in line with the first quarter pricing of about 3% and our outlook on pricing remains very positive as 2Q renewals were up from the mid single-digit range. The Chemical and Petroleum business unit revenue growth of 14% was primarily driven by plastics and petroleum.
The plastics revenue growth of 24% was driven by favorable domestic and cross border volumes and very strong demand in Mexico. Petroleum revenue grew 14% driven by strength in soft bond unit train and manifest refine products related to Mexico energy reform.
In Q2 Mexican energy reform carloads and revenue grew 84% and 57% respectively and we included an update on this important and growing business segment in the appendix of our earnings slide. Our strong performance and refine products was partially offset by lower heavy fuel oil volumes at the tool in Mexico and refinery continues to experience production challenges.
Revenue from our industrial and consumer business unit grew 3% in Q2, this business unit benefited from strong paper and appliance revenues due to tightening truck capacity and increase around paper demand, partially offset by lower metals revenue and length of haul was negatively impacted by shift in customer sourcing service. Agriculture and minerals revenue was up 1% year-over-year, growth in grain and ores and mineral was partially offset by food products due to a plant expansion project at one of our customers facilities that require temporary shutdown.
We are encourage that the congestion that impacted this segment during the first quarter has improved as evidence by better performance at the end of second quarter and early third quarter. Similar to the last quarter, energies revenue decline of 20% was driven by a previously announced closure of a power generation facility in Texas and by frac sand sourcing changes.
These declines were partially by offset by higher volume and pricing in our crude oil business driven by increase production in Canada with decrease pipeline capacity. In motor revenue increased 3% with mix performance by length, both U.S.
domestic and cross border business posted solid performance as we continue to benefit from truck conversion. This growth was partially offset by a 15% year-over-year decline in [indiscernible].
As we continue experiencing pricing pressures driven by weaker Mexican peso, we are actively pursuing strategies to regain this market share without suffering the long-term negative effects of unsustainable pricing concessions. Revenue from our automotive business was up 17% over prior you with improvements in both volume and revenue per unit.
Increases were driven by carry over inventories, increased plant production and growth in vehicles imported into Mexico through the port of Lázaro Cárdenas. We continue working with our customers to address inventory congestion by providing unique service solutions that address some of the temporary congestion and equipment issues being seen throughout the rail industry.
On Slide 12, we provide an outlook for the second half of 2018 for each of the business segments. As Pat mentioned, our full-year volume outlook maybe below mid single-digits, we still expect a sequential increase in the second half of 2018 as growth from key businesses accelerate and we benefits from easier constitute to hurricane impacts during the second half of 2017.
Starting to Chemical and Petroleum, Mexico Energy Reform continues to be a significant focus in 2018, volume growth from refine products accelerates in the second half of 2018 as additional storage capacity comes online. Additionally we expect plastics to grow in the second half of 2018 as new petrochemical capacity begins production.
We also expect to see continuing solid growth in the inner motor across the border and U.S. domestic range as we benefit from conversion of a freight currently looking like truck.
Lázaro Cárdenas will be a particular focus during the second half of 2018 as we evaluate our strategy to gain back that market share in a market that is ground zero for transportation impacts of changes in market flow and capacity in for Mexico City. These shipments also have an impact on our volume growth assumptions for the second half of 2018.
We will continue to see solid performance in our automotive business with growth trending ahead of most third-party estimates for Mexican production. In addition to increasing production in Mexico, our growth will benefit from market share gains with some of our biggest customers.
New equipment coming online during the third quarter will be a welcome support for this business there in the second half of 218. Our industrial and consumer business unit will continue to benefit from strong demand and tight truck capacity, particularly in the paper and appliance businesses.
We are closely monitoring the ongoing trade developments for any potential impacts on metals business as well as other segments. We expect our Ag and NIM volumes to be slightly up from second half of 2018 with steady demand in both grain and food products.
As previously noted, we expect our energy business to be down year-over-year and during the second half of 2018 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 customer volumes and the new contracts started ramping up towards the end of Q2 and have continued into Q3.
Over the last few months the question has been raised on whether we would continue to invest in Mexico at the pace we have over the last few years. As Jeff mentioned, we are continuing to work on both capacity and fluidity as well as origin and destination opportunities on online.
On Page 13 we wanted to provide just a short list of projects that have been publicly announced that KCS will be servicing. As you can see, we have over 20 customer projects as well as major opportunities at the ports of Veracruz, Altamira and Lázaro Cárdenas.
As referenced on this slide you can see that our cross-border business was up 19% in Q2, demonstrating that each line of business continues to grow as trade increases between Mexico and U.S. KCS continues to be confident in the economic decisions that are being made by our customers as well as those we are making ourselves.
As we have already mentioned foreign direct investment in Mexico remain strong and KCS will continue to appropriately invest to support the objectives and the growth plans of our customers. Now I will turn the call over to our CFO, Mike Upchurch.
Michael Upchurch
Thanks Briana and good morning. I will start my comments on Slide 15.
Carload volumes increased 1% while revenues increased 4% predominantly from rising fuel prices. Carloads and revenues were negatively impacted mainly due to the decline in our coal business resulting from the closure of the utility plant in Texas.
Excluding the decline in coal, volumes increased 3% and revenue 7%. And we did see strong sequential revenue growth at 7% with strong incremental margins of 60% plus.
Operating ratio increased from 63.5 in 2Q of 2017 to 64.0 in 2Q 2018. We experienced cost headwinds from higher year-over-year PTC expenses of approximately five million and six million in higher casualty costs.
In total, contributing about 150 basis points of the impact to OR. We also saw higher fuel prices that increased 33% in the U.S.
and 16% in Mexico. Our adjusted effective tax rate for the quarter was 27.6% lower than our guidance of 30%.
During the quarter we saw benefits from the lower guilty tax and the State of Missouri lowering their corporate tax rate from 6.25% to 4%. Our reported effective tax rate was 24.2% lower than our adjusted effective tax rate primarily due to new guidance issued by the IRS in April that lowered our repatriation tax by approximately $4 million.
We continue to believe our full adjusted effective tax rate will be approximately 30%. Finally, we continue to be encouraged by our discussions with various congressional offices and the treasury department regarding some relief of the unintended consequences of the guilty tax.
We believe there maybe additional interpretive guidance issued by the treasury department sometime this fall that may help us mitigate at least part of our current guilty tax provision estimate of $17.5 million for 2018. Reported second quarter diluted earnings per share increased 14% to a $1.45 per share while adjusted diluted EPS increased 16% to $1.54.
Average outstanding shares for the quarter were a $102.5 million, a reduction of more than three million share from the you ago. More details on reported and adjusted diluted EPS can be found on page 24 in the appendix and a more detailed P&L is available on page 23 in the appendix.
Turning to Slide 16, second quarter operating expenses increased 5% or $20 million over second quarter 2017. As I mentioned earlier expenses increased primarily due to fuel prices, depreciation which was predominantly from PTC and $6 million in casualties in materials and other expense line item which did include a negative year-over-year comparison due to a $2 million casualty credit we booked in 2Q, 2017.
Offsetting those increases, were foreign exchange benefits of $5 million of fuel consumption and efficiency savings of $3 million. Turning to Slide 17, second quarter compensation expense declined 2% or $3 million, drivers of lower compensation and benefit expense include $4 million in lower incentive compensation in 2Q, 2017 lower than expected benefit cost and foreign exchange benefits.
Offsetting those declines were a $2 increase from higher headcount and wage inflation of $3 million. Turning to Slide 18, second quarter fuel expense increased 17% as a result of a 33% increase in fuel price in the U.S.
and a 16% increase in the price of fuel in Mexico. Offsetting those price increases we experienced 4% lower GPMs reducing our consumption realized the foreign currency benefit of $2 million and additional $1 million in improve fuel efficiency.
Turning to Slide 19, let me briefly discuss our capital allocation priorities. As Jeff and Brian discussed earlier, our first priority continues to be investing in our various growth opportunities.
Our 28 CapEx guidance remains unchanged at $530 million to $550 million. We expect 2018 to be our third year in a row of declining CapEx spend and declining CapEx to revenue ratio.
We also continue to explore investment opportunities in venture that might drive more revenue growth on our railroad such as refined product receiving terminals in Mexico. During the quarter we repurchased 503,000 shares of our common stock on accumulative basis have now incurred $364 million to repurchase 3.4 million shares under the $800 million board authorized program we announced in August of 2017.
During the quarter we repurchased approximately 100 million of equipment on lease and now own approximately 77% of our equipment up from 20% in 2011. Overall, our strategy of owning more of our equipment has achieved in approximately 250 basis point improvement in OR.
And finally, we were very pleased to have Moody's upgrade our credit rating to be AA 2, and we look forward to the day, S&P also recognizes just how much our credit has improved in the more than five years since their last upgrade. And with that, I will turn it back to Pat.
Patrick Ottensmeyer
Okay, just a couple of comments here before we open up for the Q&A. Obviously one of the significant new development since our last quarterly call would be the elections in Mexico on July 1.
I think everyone knows how that turned out and as expected to Andres Manuel Lopez Obrador known as AMLO was the winner of the presidential election in a very wide margin. His Morena party coalition won 61% of the seats in the House of deputies and 54% of the seats in the Senate, which is obviously a majority but fall short of the two-thirds majority that would be required for any constitutional amendments.
Based on his postelection comments and messaging that has come from himself and his key staff and cabinet leaders, we really are pleased with that commentary and don't expect that he will pursue any constitutional amendments adverse to our interests or adverse to the economy and strength of the economy in Mexico. Obviously financial markets have been relatively calm and positive about this result.
Peso has appreciated about 5% and as you have seen in some of the data that we presented here in the second quarter both foreign direct investment in Mexico was up significantly and our cross-border business revenues and volumes also increased significantly. So it's very early on, I will say we like what we see in terms of the messaging, the dialogue with the U.S.
government leaders, meeting with the secretary Pompeo and Secretary of [indiscernible] and others that took place a few weeks ago, seem to be very positive off to a good start, but its early and obviously we will keep our fingers on the pulse and stay very close to the transition team as we move forward to the December transition of the government and see how things develop from that point on. In the past, I have offered suggestions for the headlines for our quarterly performance and outlook which I'm certain all of you find extremely helpful, particularly those who are writing research updates over the weekend.
When I look at our performance and commentary and the way we feel about the outlook, some of the potential headlines that comes to my mind are solid volume and revenue growth in most strategic growth areas. Very pleased with the performance in automotive, plastics, refine products, the growth in our cross order business was just outstanding.
As I mentioned at the very beginning, we are certainly disappointed with the 1% volume growth, but feel like the weakness is isolated to energy, some of which is crude oil timing and the international intermodal which Brian talked about in his comments and we will probably have some questions on that later on. Second half outlook points to improve sequential growth in both volume and revenue and I would finish by saying the long-term outlook shows multiple oversize growth opportunities in several of our strategic growth areas.
Feel very good about the future, long-term and short-term so all things considered we can ever feel too disappointed about any quarter which shows record revenues and earnings per share. While its very early on in the New Mexican Administration we are optimistic about the initial commentary that is coming from the new leadership team and the outlook for improved U.S., Mexico relations and possibly a revolution of Naphtha in the near-term.
So, with that I will conclude and open up the line for questions.
Operator
Thank you. We will now be conducting the question-and- answer session.
[Operator Instructions] Thank you. And our first question is coming from the line of Ken Hoexter with Merrill Lynch.
Please proceed with your question.
Ken Hoexter
Hi, great. Good morning.
Hi, Pat thanks for the thoughts there at the end. Maybe just expanding on that a little bit.
Can you talk a bit about the production challenges in energy maybe some of the timeline to get there? And then secondly on pricing, Mike you talked a bit about pricing maybe talk about when we should expect that it accelerating given some of the market tightness right now?
Patrick Ottensmeyer
Ken, what you mean by production challenges in energy?
Ken Hoexter
I thought that’s what was set up earlier in terms of getting the production in Mexico, the facilities I thought you said there was production challenges?
Patrick Ottensmeyer
Okay.
Brian Hancock
Yes. Ken, this is Brian I will take that.
Its primarily storage capability capacity in Mexico around refine products. As we have told you before there are at least four or five major storage facilities being constructed on our line right now.
The majority of those will be at least one or two tanks completed in the fourth quarter or early first quarter 2019. Right now we are moving a lot of the unit trends and then they are being offloaded directly into truck and so that will help us significantly and we have that storage capacity and space.
When it comes to pricing, what I would tell you is we feel very comfortable with where we are at both on our renewals as well as our same store pricing, we’d be feel very comfortable and we are going to be in that mid single-digit range moving forward and continuing into the accelerate into the back half of the year. Most of our major let's say opportunities on the refined products area.
There is just so many things that are happening, but we are very, very comfortable that we are going to hit that mid-single-digit range on our renewal. So hopefully that gives what you need.
Ken Hoexter
Yes and then my quote on pricing, on the timing for maybe given the timing and the market when we could see the acceleration you were referring to.
Patrick Ottensmeyer
Well I think it was Brian made those comments but I think you are going to see a pickup in third quarter based on the renewals in the second quarter.
Ken Hoexter
Great. I appreciate the time guys.
Thank you.
Operator
The next question comes from line of Jason Seidl with Cowen and Company. Please proceed with your question.
Jason Seidl
Thank you very much. God morning gentlemen.
Staying on pricing a bit, [indiscernible] between your core pricing in the quarter 3% renewals are 5% and that obviously those rounds going forward where is the strength coming from? And why do you think the market is jumping like this?
This is all of the tightness in the trucking space or are there other things that are working in?
Brian Hancock
Yes, Jason this is Brian. I would say we are seeing it fairly broadly.
We feel very comfortable in our automotive business, in our chemical and petroleum business, industrial consumer. So we see it fairly broadly, certainly intermodal domestically and cross-border as truck conversion continues to happen.
It's a great pricing environment for the intermodal carriers. So I feel that it’s pretty wide slot if you will around pricing.
We feel very comfortable. It’s a great environment for us and our customers are actively looking for options on rail and so we feel pretty good in that space right now.
Michael Upchurch
Jason, this is Mike. I might just add one thing.
The soft spot in pricing for us has been for a while intermodal in Mexico, particularly at the port at Lázaro where we are billing in U.S. dollars, truckers are billing in pesos.
So our service has effectively become 50% more expensive over the last five years given what has happened with the currency. But we are looking at some rebate opportunities types of volume increases that would help fill out some trains that aren't at maximum length.
So we want to look at those opportunities anywhere from 25% to 35% capacity left on those trains, if we can sale that out I think we might be successful and driving a bit more volume at Lázaro.
Jason Seidl
And that should help to incremental margin at Lázaro so much capacity. Let me stick with some cross border commentary because you mentioned that.
You mentioned it was like the strongest growth you have seen I think every cross border. What are the reasons behind that?
Are people trying to shift ahead of - I mean maybe issues with tariffs or with NAFTA or people really just starting some of the peak season a little bit early?
Brian Hancock
No I would say Jason I think that there is a couple of things that are driving, certainly there is more intermodal business our new service with [indiscernible] is continue to increase, our source with UP, continues to grow. We are also seeing some sourcing changes in field where product may have been coming from China or other places, it’s now coming in through the U.S.
and then down into Mexico into the steel plants, and so there are some sourcing changes in the steel area that are having a pretty significant impact on cross-border. It impacts our line of the length of haul, but overall we are very positive on the way that our cross-border business and the fluidity that Jeff and his team are creating at the border, we are going to continue to utilize that and try to feel each of those trains our as that business continues to grow.
Michael Upchurch
I would just add to that, because I don’t think you mentioned refine products that opportunity in spite of the some of the challenges in storage and facility and capacity that Brian mentioned earlier that business is growing very, very rapidly. So, we ask ourselves the same question, Jason if some of this sort of a little bit of blip in because of concern about what is going to happen with tariffs and trade, we just don’t see it.
I will jump on that one, because I’m sure there will be questions later on about the impact of tariff and so far we just haven’t see any impact, any negative impact in our business, even into the third quarter, because of tariffs that have been announced or threatened or both of those. And I will make one more comment about Lázaro, I think that is an important consideration as you all think about the volume weakness that we have seen in the first half.
Business is there and as I said in my comments there is a lot of strength in our business across the board, it feels to me like our business is stronger than our results reflect. And we have talked a lot about the timing of crude oil, but I think the international Lázaro intermodal business is another area of weakness and we have been very thoughtful about how we view at that.
So, the business is there, if we were more aggressive in discounting to retain or gain share back, I think our volume numbers would have been better. We are trying to be very thoughtful about how we deal with that as Mike mentioned with rebase, volume incentives other things rather than just cutting prices and we will continue to try to address that.
But I think it’s important to say that the core business is there, we have just chosen not to do what some of our customers might want us to do in terms of pricing reaction to maintain that volume.
Operator
Our next question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.
AllisonLandry
Good morning. Thanks.
So, just on some of your comments regarding Lázaro, Pat. How do we, in terms of the second half of the year, how much of a drag do you think that Lázaro could be in terms of total intermodal volumes are even your overall volumes.
Just, as we think about the worsening decline in the second quarter and that looks like comp in the back half of the year is pretty difficult. So, just trying to understand that this is an incremental risk to the second half of those?
Patrick Ottensmeyer
I will ask Brian to get into more detail, I don’t think there is incremental risk, I really think there is some upside, some opportunity to gain business back and share back, but again we are going to be very thoughtful. At the end of the day, I hope you appreciate this, we are going to be disciplined about how we price that business to maintain an acceptable level of profitability and returns.
And, but I think there is more upside and opportunity in the second half in international and motor.
BrianHancock
Yes, Allison this is Brian, I would say the only thing I would add to what Pat said, is whenever you end up in a situation where someone has made a pricing decision that impacts a large market like that, what happens as you get flow imbalance, and these end up in places they shouldn't be. There is not enough capacity to handle other pieces and so there is always a transition there is always a recalibrating of where that freight comes in, and we are right in the middle of that.
So we are actually trying to take advantage of some of the actions that have been taken in the past and be able to be a thoughtful provider that provides a secure way into Mexico City without taking an unsustainable pricing action that we just don't think it's something that that can last longer than a three or four month timeframe. And so we feel very comfortable with our plan that Mike kind of laid out, using the rebates, allowing people to use us, so I don't think there is additional risk and we are certainly looking to try to make those opportunities more prevalent here in the second half.
But it's certainly something that we are managing on a daily basis and our team is very engaged and understand what is going on all the ports on the western side of Mexico.
Allison Landry
Okay, so just to clarify it sounds like you are taking these actions as we peak and hopefully you will see some of the volumes come back a little bit. Is that fair?
Brian Hancock
Absolutely, most of the actions have already been taken Allison, so we are in the middle of it right now.
Patrick Ottensmeyer
And remember there is typically a build at Lázaro because the peak season and we are going to get some benefit from that in third and fourth quarter.
Operator
Thank you. Our next question is from the line of Ravi Shanker with Morgan Stanley.
Please proceed with your question.
RaviShanker
Thank you. If I can just follow up on the pricing commentary.
I think it's pretty interesting that you are getting mid-single-digit pricing on renewals but I think you also said that some customers may not be willing to give you business at the price you want. So how do you find a balance there between price that you are willing to take and the volumes?
The mid-single-digit is kind of above what we are hearing from any other rail on renewals. So does it make or maybe ease up the gas there and maybe find get some more volumes?
BrianHancock
Ravi this is Brian, I will take that one and then I’m sure pass it Mike, who has some input there. I would say that I think from a pricing environment we have so many new opportunities that are happening.
Pat mentioned refined products, the changes that are happening in both paper markets the way that box companies are used, they allow us for some additional opportunities. Intermodal obviously is an area right now where the entire market is seeing pricing capability.
We believe that we are being very thoughtful. We have responsibility obviously within Mexico to play within some regulations that allow us to be in the space where we create the maximum amount of value for the freight that we're moving.
So we are looking at continued opportunities in both our automotive space, long-term contracts that we put in place, industrial consumer, and the chemical and petroleum business. We are also looking at some additional businesses off of some of the ports that give us new opportunities with existing customers.
And so when you think about that we are being very thoughtful. We're in the space of making sure that we have not only market share gains that Jeff and his team are creating the capacity and fluidity necessary.
But like Pat said the business is there we just need to make sure that we are being thoughtful in the way that we go at, especially in that international intermodal business. It does not make sense I have said this before, it does not make sense to rush to the bottom of the barrel from a pricing perspective because of the weakness in the peso and the weakness in some of the other things in some of the other poor areas.
So, we feel like we have a great strategy, we are going to continue to monitor it every day with our customers and we get a lot of feedback from them. So, I think we are in a very balanced position right now.
Michael Upchurch
Ravi, just going to add one point, Pat I think did a pretty good job of summarizing the disappointment around few of our components of the business, call I think that story is well known, we talked about that almost a year ago. Lázaro and then crude, the crude was just the timing issue for us.
So, I think when you look at the rest of our business, we see a lot of strength in pricing and we use a lot of discipline with our network organization or marketing organization and finance all collaborating to make sure that we are getting the kind of yield and incremental margins that we are targeting.
Ravi Shanker
Got it. Also it’s kind of hard to predict what politician would do when they go off, but when the new government takes over end of this year.
Basically you understanding do you think economic priorities and things like maybe addressing competition and the concession are like top of mind for them? Or do you think there are other social priorities that will come first.
I’m just trying to get a sense of how quickly off they take over will be known kind of what the impact is for you guys?
Patrick Ottensmeyer
José Zozaya, is on the phone, so I might key this up and then ask José to comment as well. I think if you look at the main messaging of Amlo and Marina is about corruption security other things that are of very high important to Mexicans and doing with economic improvement in the economy by reducing or eradicating the cost and consequences of corruption.
So far based on what has been said in the messaging both public and private in and meetings that we have had it doesn’t appear that there is certainly no anti-America, anti-Naphtha. They seem to very much appreciate the economic in the investment foreign investment that has clearly benefited Mexico.
So, I guess the answer to your question is we don’t expect that to be top of mind in terms of major changes and the strategy or approach that the new administration is going to take once the transition occurs. José, any additional commentary there.
José Zozaya
Okay. Just to comment on that in the meetings, we have with new elected President that [indiscernible].
Operator
Thank you. The next question comes from the line of Matt Reustle with Goldman Sachs.
Please proceed with your question.
Matthew Reustle
Thanks for taking the question. Curious when you factor in the sound is the first half of some of the momentum that you have going into the back half.
Is the full-year of our improvement are achievable. And particularly when you lookout to 2019, do you expect that given that what you’re saying about the quality of the carload the pricing and the tailwinds that are going to there.
Is that where we could see a material change and improvement?
Michael Upchurch
Yes, Matt this is Mike. I will take that one.
Obviously we are now where we want to be through the first half of the year with respect to our OR. We are slightly worse than we were a year ago.
But our goal continues to be full-year improvement in the operating ratio. We have got some momentum in the business as we have been discussing here for the last 20, 30 minutes.
And I think that volume will allow us to continue to improve our operating ratio. Believe me nobody here is taking their eye off the ball in terms of improving OR and we have certainly incentives tied to that as well.
Matthew Reustle
And then to follow up to your earlier point that you are not seeing any accelerate demand as a result of the trade overhang. Do you think there is any pockets of pent up demand, just trying to get a sense of whether the business would be operating any differently if all the headlines overhangs right there.
Michael Upchurch
Yes, that’s a tough question. We ask ourselves that all the time and the way we feel about it is we really haven't seen any tangible evidence that companies are pulling back or withdrawing.
There is a lot of press earlier this year I guess it was last year about Ford. I think that was kind of misunderstood Ford did cancel a plant in Mexico, but they built it in China.
And there are just a lot of examples that we have seen where customers have taken a hard turn or reverse course. We don't know what we don't know and when I say that, I mean, we don't know that there are companies that have discussed projects or right on the cusp or on the verge of making investments in Mexico that haven’t moved forward because of those concerns.
Our sense is that there is some of that, but it's very hard to quantify. And then you just look at our business, look at our cross-border volume growth.
I can tell you there is in spite of all the rhetoric and the concern about the election and NAFTA and all of those things in the refined products and the energy segment people are going actually full steam ahead. If we had capacity and facilities and terminals that could handle more business, we would be growing faster than we are in that segment.
So they are not hesitating at all to move into those markets and pursue those opportunities. And then you just look at the foreign direct investment stats that Brian and Jeff talked about, so it certainly doesn't feel like this overhang is causing any serious delays or traffic was to be growth in Mexico.
Operator
Thank you. The next question comes from the line of Chris Wetherbee with Citi.
Please proceed with your question.
ChristianWetherbee
Good morning guys. I want ask a little bit about the volume sort of outlook.
So 3% to 4% Pat I think is the new number, you gave one in the first half, you started looking for I guess mid single maybe even a little bit better than the broadcast. I know we have the comps and we have some of the ramp up in some refined products.
But maybe if you could unpack that a little bit maybe by quarter. Do you expect to see that come back here in 3Q?
Or do we have to wait more to 4Q and get some of that storage to open up in Mexico before we see those types of growth rates realized?
Michael Upchurch
This is Mike. Maybe I will give that one of the shot.
Obviously we are 1% volume growth through the first half of the year. The comps get much easier for us in the third quarter given the Hurricane that we dealt with last year.
But, when you begin to put the building blocks together, we think there is an opportunity to see a couple of percentage point increases as a result of comps related to the Hurricane. We think there is a point around refine product, we think there is a point around crude, and then I think area that is highest risk for us right now would be intermodal given all the issues that we have discussed in getting some return back of volumes to the port of Lázaro and that could be Lázaro plus other intermodal about two points.
And that’s how we get to the, our low end of the mid single-digits and we will see whether we are right or not, but hopefully those give you the building blocks and that means the rest of the business continues to stay healthy and grows at about same rate that it did in the first half.
Patrick Ottensmeyer
And I will add one big caveat to that commentary and that is we are not forecasting the Hurricane this you. And obviously that’s a wild card, so some of the comps and some of the commentary about the second half of the year is clearly driven by the fact that we had a big Hurricane impact last year, bigger than normal and we just, we don’t know what is going to happen this year, so, that’s a complete wild card, but I just fall back on what I said a couple of times here.
It really feels to me and I think to us the business is stronger than the results would indicate and don’t want to make excuses but crude oil was timing, intermodal is part of a thoughtful and intentional strategy, the business is there, we are trying to figure out the way you get back without as Brian said going to the bottom of barrels. So, we will continue to be discipline about that, but the business is there, we just got a find to way to get it back on our railroad in a way that make sense.
BrianHancock
I just want to add one thing, this is Brian. We are seeing some strength in the couple of areas in Lázaro that I do want to talk about, we are importing more vehicles into Lázaro than we had thought.
Some of our customers are up over 60% and what they are bringing into Mexico from other areas, these are for vehicle consumption in Mexico. So, Mexico as a trading partner is been very successful on Lázaro is a big part of that port strategy for them.
And we are seeing some success there. So, we are picking up some additional volume in Lázaro that we didn’t have before, we talked a little bit about the steel, sourcing changes, but again there is a lot going on down in the Port of Lázaro.
So, we think that there is a very good strategy, we can keep going down the path we are, watching it daily, but making sure that we are competitive not only in intermodal, but in automotive, steel, carload and certainly the their export volumes that they are sending out to the Asian and to the Western side of South America. So, we feel very comfortable with the way we are operating down in Lázaro.
ChristianWetherbee
Okay. That’s really a helpful guys.
I appreciate all of that. And then Mike, I just wanted to make sure I understood your comments earlier in the call about incremental margin.
I think you were giving that some numbers sort of the call for the quarter and maybe there is a 50% incremental margin number that was associated with sort of the coal business. I just wanted to understand if that’s right and then when you think about sort of these potential tailwinds to volumes as you move into the back half of the year it’s sort of 50ish, the right number.
I don’t want to get too specific with the guidance, but how do you think about the incremental and an environment where major growing closer to mid singles?
Michael Upchurch
Yes. I think the incremental in 2Q were more around 25%.
Not to get into the game of excluding things but we had a tough casualty quarter that probably would have gotten us a little bit closer to that 40 to 50% range. The sequential incremental margin was low 60% that was my comment.
And I think it's safe to say if we execute against the volume forecasts that we have here that's going to allow us to continue to target and generate roughly 50% incremental margin. That's been our long-standing goal.
If we continue to see the volume that we are seeing here in July play out through the rest of the year I think we will be in pretty good shape.
Operator
Our next question comes from the line of Justin Long with Stephens. Please proceed with your question.
JustinLong
Good morning. So wanted to follow-up first on Lázaro.
First how much of the market share headwind would you say the function of truckload competition versus competition from other ports? And secondly as we think about your ability to recapture some of this market share based on the changes you have talked about do you have a target on where you would like to see market share go relative to where it is today?
Michael Upchurch
Yes. Just what I would say is up until I would say, probably the April timeframe the majority of the competition was truck, was peso-based there are obviously pricing pesos were priced in dollars from an international perspective and so there was a significant deviation there between the two truck and rail.
I would say in Manzanillo, there were a couple of things that were done from a pricing perspective, not only from a shipping line perspective out of Asia. But those rates were cut, I would say from a shipping line perspective to the point where there was really no reason for us to change that volume.
So I think the key is making sure that we understand how the shipping lines are going to use us, how the competition in truck is going to use port of Lázaro. We feel very comfortable that the program we put in place makes us more competitive than any other mode based on the volumes that they would be able to bring into that now.
We understand that most of the decisions around those things are made in early parts of the year, February, January as when those bids happened. So we're looking at capitalizing on congestion that may be caused by some of the other things that are happening at some of the other Western ports.
So it's a very complex issue, it certainly is multimodal and multi-pork, but we feel very comfortable. If our customer and those that are looking for options into the Mexico City area take advantage of the programs that we have offered for the back half of this year they will not only having more secure transit into Mexico, better service, but also be very, very cost competitive.
So I think it’s a good strategy and I think we are in the right space and we will see just what happens.
BrianHancock
Let me chime in here and address your question about market share specifically. We don't like to lose business.
We have capacity on trains and on intermodal trains that we would like fill up and get some of that business back. We don't really have a market share target., we are going to be thoughtful and careful and make sure that we price this business and disciplined about returns and profitability because it's a big driver of our volume weakness.
I think it's a big opportunity for us going forward if we can kind of reach agreement with our customer. Certain amount of this is brinkmanship and negotiation, we think we have a better service, we have a more secure service and we have a lot of other business in Lázaro, automotive and others, petroleum that is competing for capacity.
So, again I hope you guys give us some credit for being disciplined about this, we could have shown better volume numbers and we have been more aggressive in responding to the market and the pricing but just to make sense for to do that.
JustinLong
Thanks. That’s all really helpful color.
I think secondly, Mike I just wanted to touch on a few guidance items. I think last quarter you talked about DNA coming in at around $360 million for the full-year that Mexican fuel exercise tax credit being about $35 million.
Any update to those two numbers and also curious if you could comment on your expectations for instance in the back half?
Michael Upchurch
Yes. No, we are still in that range $360 million for the full-year for depreciation.
The tax credit, exercise tax credit there are continually moving that up and down, it’s hard to predict but I think that’s probably still a pretty good estimate. I think as we look out through the rest of the year, we feel pretty good about expenses, there are no great headwinds, I think you will see a little bit of step up in comp given the volumes that we have been discussing here, that will drive some incremental fuel from the volume perspective but those would be kind of our key headwinds going throughout the year.
And I think you have a second part our that question that I don’t recall now.
JustinLong
Incentive comp in the back half, I know there were some abnormal trends last year with the Hurricane. So, wanted to get your thoughts around that?
Michael Upchurch
Yes. You saw in the slide on comp and benefits that we have a decline in incentive comp on a year-over-year basis.
If the performance doesn’t move up, I would expect we will continue to see year-over-year declines, but we are not really prepare to give you any specific guidance on that. Too many open items, we try to accrue based on our forecast, actual results for the first six months and forecast for the back half.
But, I think it’s safe to say it will be lower than it was in 2017.
Operator
Thank you. The next question is from the line of Tom Wadewitz with UBS.
Please proceed with your question.
Thomas Wadewitz
Yes. Good morning.
I got a couple of on the volume side for you. I know there is been a lot of discussion on this, but a new approach on Lázaro intermodal.
What, it sounds like you were to put some of that in front of the customers. What is the response and what is the kind of conviction level, I think Mike you said that if I understood right, we do think you have two points of added volume growth from the response of the Lázaro.
And just trying to get a sense of your conviction visibility that they took place?
Michael Upchurch
Yes. That’s Lázaro slash Intermodal.
You remember Lázaro is about 25% of our overall intermodal business.
Thomas Wadewitz
Okay. Yes, specifically in Lázaro, just seeing those volumes go instead of being down 15% being up year-over-year, is that good visibility or how do you think about that?
Michael Upchurch
I think that we are, I think the customer feedback has been positive. I think what you have to remember though is again those decisions have been made from a port and from a protocol perspective.
And it’s so really going to depend on what happens on the ground at the other ports if this congestion, if there has to be rerouting and if there has to be other decisions where capacity drives up. So I think we are in a very interesting capacity constrained world right now, specifically in the Mexico City and this just changes on a weekly and monthly basis.
So what I would say is we're watching it closely. The customers are positive on the fact that we address the pricing issue against the peso, but I would say there are also very - they want to understand the volume commitments they want to understand and we as well.
We are not in it for the short-term, we are not in it to try to make one quarter or another, we are trying to have good long-term relationships with these carriers that make it very secure, very cost-effective way for them to ship into Mexico City using rail. And I think that's what they're seeing in our strategy.
So hopefully we will see benefits if we continue to see pricing that’s I will call irrational in certain modes. We are in the middle of the fight there is no doubt about it.
Thomas Wadewitz
So what do you think it turns positive or just kind of less where as if you look at second half on Lázaro volume.
Brian Hancock
Certainly less worse, the opportunity is there, the business is there for it to turn positive. And I just want to - I think I have said this thing two to three times now.
So we haven’t changed our strategy. The market changed and we held our discipline.
We think that's the right way to approach it. We think we have got a superior service, we have got superior security and the capacity is certainly there, but we are going to remain disciplined in our response to changing markets and make sure that we handle this in a way that generates an acceptable return and acceptable profitability.
Michael Upchurch
And Tom when we look back over the last five years given the depreciation of the peso, we are far better off having stuck with price, both from a revenue and margin standpoint. So that's why we feel pretty strongly about how we have handled the pricing strategy and the impacts in the market.
Brian Hancock
Disciplined.
Operator
Our next question is from the Scott Group with Wolfe Research. Please proceed with your question.
ScottGroup
Hey guys thanks. Good morning.
So why don’t you just talk one more again on is the Lázaro rebate. So I think you said that because the peso there is sort of like a 50% effective change in your cost versus trucking cost.
What percent rebate are we talking about here? And I guess when you said disciplined obviously it got a lot of attention how do you get comfort that rebates don’t spread to the existing book of business?
And maybe just with that is this also showing up it all in cross border just because I see cross border intermodal revenue per car was down a bit in the second quarter as well.
Michael Upchurch
I will take it of those. No, we don’t see its spreading to our book of business, it's tied to growth.
And the cross-border revenue per unit, I think is primarily driven by the very short length of haul that we have on the U.S. side connected to the BNSF service.
Brian Hancock
Right, and the fact that we get paid on empty there that have a lower rate than the full loads, but that’s been good business for us, the volume growth we have seen from BNSF.
Patrick Ottensmeyer
So Scott I would tell you from a percentage perspective we don’t obviously give that kind of information out, but what I would tell you as you have to take into account a couple of things. Certainly there is a vessel portion of a movement from Asia, there is a rail or England portion we have to look at the way that truck is handle inside each of the ports, specifically around trains load and train shipment and then you have to look at the capacity out of each one of the ports.
So, I would tell you it’s customer-by-customer, it’s certainly dependent upon where the product is coming from and going to from a shipping line perspective, but we are working very closely with our shipping customers and in a very fluid environment. So, certainly something that’s important, but we are not obviously going to continue those types of percentages.
ScottGroup
Okay. And then I just wanted to ask about the change over to the international cruise.
I don’t think you get any questions there. Is this in your mind a more of a volume or cost opportunity.
And maybe just with this change over to the international cruise. Just refresh us, what your capacity on across border trains is going to go to and what the current number of trains is today?
Jeffrey Songer
Yes, Scott this is Jeff. This initiative is all about fluidity and growth, it’s not a cost saving measure for say, we are actually hiring and adding a few cruise on the US side to get these trains from these refine products trains mainly on across the border below from Allman, Corpus Christi down to the bridge.
This simply change a few minutes of a very train that was across the bridge, so it’s a capacity place Scott, its volume play. It’s also a safety play, it’s a public benefit play for reducing while crossing that stop either going south well capacity at [indiscernible] train that’s stop and have their crude change on the middle of the bridge coming north are subject to maybe more [indiscernible] than trains that want to roll right through there.
So, currently we have seen some good benefits this year already with the other initiatives, the customs improvements we saw last year, we are pushing probably over the last couple of months at an average of 25 to 26 trains across the bridge. Right now we started down national cruise world and running maybe four trains a day with international cruise.
It will take us quite a while to qualify all trains with cruise for the international cruise to operate on. So, it’s a long-term initiatives, it’s going to continue to gain in this marginal time on every train across the bridge until we get this fully implemented.
Michael Upchurch
I think the key thing is as Jeff mentioned it’s a capacity for growth, its security, it’s safety. We are not reducing American jobs, we are not exporting American jobs to Mexico, this is all about growth and more efficiency.
We have been working on this for five or more years, it’s very complicated project and very complicated initiative. And as you have heard us say many times in the past what we are hoping to achieve here not just with the cruise, with customs, with security, with inspections, with FRA all of those agencies have been supportive of what we are trying to do here.
We are basically trying to replicate at the U.S.-Mexico border, the processes that exist today at the U.S.-Canadian border. So, that’s’ an important consideration, I think just so people on the phone don’t think that we are trying to do something that’s unprecedented here or just ridiculous in terms of being aggressive, we are just trying to replicate systems that already exists in other places.
Operator
Thank you. The next question comes from the line of Brian Ossenbeck with J.P.
Morgan. Please proceed with your question.
Brian Ossenbeck
Hey thanks good morning. I just want to come back to AMLO, I guess there was a comment early about the government getting sworn in at the end of the year but congress will be constituted on September 1st.
So there is a possibility Marino could still get the two thirds Constitutional majority with some party realignments. They already have the 50% plus one of the local side.
So how do you handicapped this outcome? Do you have any visibility to any changes that might be coming Congress aside from what we have already seen in the polls.
Patrick Ottensmeyer
No I mean nothing other than what we have heard in the messaging that has come from the leadership from AMLO himself and from his key advisors and transition team. I think our view is and Brian you guys got a pretty good resource capability that in Mexico so we get a lot of insight from your own people there a bit.
He sort backed off some of the early promises or statements that he made about reversing energy reform and even in public infrastructure projects like the high-profile Mexico City airport. What he said recently as he is going to look more at the contracts and seems to be looking and shining a bright light on possible corruption that may be involved in energy and in airport or public works projects as opposed to just reversing course.
He has said things about wanting to maintain a strong national energy entity. So making sure that PEMEX continues to exist and survive and be relevant but way short of saying things like he wants to reverse energy reform.
So again based on what we have seen and the messaging that has come out of the administration it just doesn't seem like he has put constitutional reform at the top of his list. José anything to add to that?
José Zozaya
No just a confirmation of what you just said on the right conversations that we have had with his team. They have also assured to us that they will review some of the contracts, and that’s not lucky for other things but to find out if there was some corruption from the contracts.
Patrick Ottensmeyer
You guys I think some of the data and the insights that we have gained overtime is coming from many of you on the call or your research capabilities that if he can really get at corruption there is - I have seen numbers recently that that could be two or three points of GDP for Mexico if he can really make a significant headway in reducing corruption and the economic drain that results from corruption. I think he has announced the 40% reduction in his own compensation.
And then because of the way the rules work in Mexico that will filter down to all other levels of government so austerity, corruption, security, those things really seem to be top of his agenda as opposed to any major changes in constitutional reform or economic policy. But as is the case with all transitions in government, we will engage with the new leadership and we will stay very close to what is going on and try to make sure we are active in not only informing, but influencing the path forward.
Brian Ossenbeck
Okay. Thanks, Pat and Jose for the comments there.
Just one quick follow up for Brian. Frac sand sourcing changes those topic for a while now but just take it from any specific if there are actually starting to see some declines in the Permian and some production impacts from all particularly capacity.
So, maybe franchise is a bit different, but connected just wanted to get your updated thoughts on that as well. Thank you.
Brian Hancock
Yes. Brian, I would say that we concur with that we are starting to see sand coming in from other areas.
Certainly our customers are using a lot of sand, but I would tell you there are some sourcing changes that are occurring in the market, we are not sure where they are actually going to land out, but certainly it’s impacting the Permian Basin and we are seeing it. So, I would concur with that, but we are, we still have a significant amount of sand moving and we are just stay close to it, but it looks like to me that we are going to have both brown and white sand use for quite a while in this area.
So, that’s where I would land on that.
Operator
Thank you. There are no further questions at this time.
Mr. Ottensmeyer, I will turn the floor back to you for closing comments.
Patrick Ottensmeyer
All right. The Friday afternoon in July, I will go back to my suggested headlines for the quarter.
Solid volume and revenue growth in most strategic growth areas particularly cross border growth, weakness in volume, we feel is really isolated primarily to energy some of which is crude oil timing and obviously coal which is pretty well understood. And we talked a lot about weakness in intermodal with some of which is intentional and thoughtful as we try to respond to changing market environment.
Second half outlook points to improve sequential growth in volume and revenue. In the long-term outlook, this is multiple oversize growth opportunities that we still feel very excited and enthusiastic about the longer-term outlook.
So, feel free to use any of those headlines that you want and have a great weekend and we will talk to you all in 90 days. Thank you very much.
Operator
This concludes today’s teleconference. You may disconnect your lines at this time.
Thank you for your participation.