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Kansas City Southern (NYSE:KSU)

Q1 2013 Earnings Call

April 19, 2013 8:45 am ET

Executives

David L. Starling - Chief Executive Officer, President, Director, Chief Executive Officer of The Kansas City Southern Railway Company and President of The Kansas City Southern Railway Company

David R. Ebbrecht - Chief Operating Officer, Executive Vice President, Chief Operating Officer of The Kansas City Southern Railway Company and Executive Vice President of The Kansas City Southern Railway Company

Patrick J. Ottensmeyer - Executive Vice President of Sales & Marketing

Michael W. Upchurch - Chief Financial Officer and Executive Vice President

José L. Zozaya - President of KCSM

Analysts

Christian Wetherbee - Citigroup Inc, Research Division

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Allison M. Landry - Crédit Suisse AG, Research Division

Ken Hoexter - BofA Merrill Lynch, Research Division

Keith Schoonmaker - Morningstar Inc., Research Division

Brandon R. Oglenski - Barclays Capital, Research Division

William J. Greene - Morgan Stanley, Research Division

David Berge - Moody's Corporation, Research Division

Justin Long - Stephens Inc., Research Division

Thomas Kim - Goldman Sachs Group Inc., Research Division

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

Scott H. Group - Wolfe Trahan & Co.

Jason H. Seidl - Cowen Securities LLC, Research Division

Operator

Greetings. Welcome to the Kansas City Southern First Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

This presentation includes statements concerning potential future events involving the company, which could materially differ from events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the company's Form 10-K for the year ended December 31, 2012, 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 can be found on the KCS website, www.kcsouthern.com.

It is now my pleasure to introduce your host, David Starling, President and Chief Executive Officer of Kansas City Southern. Mr. Starling, you may begin.

David L. Starling

Thank you. Good morning, and welcome to Kansas City Southern's first quarter earnings conference call. Joining me this morning on the call is Executive Vice President and Chief Operating Officer, Dave Ebbrecht; Executive Vice President, Sales and Marketing, Pat Ottensmeyer; and Executive Vice President and Chief Financial Officer, Mike Upchurch. And also José Zozaya, our President and Executive Representative from Mexico, is also on the call.

As always, we have quite a bit to cover this morning, so in the interest of time, I'll get right to it. We usually don't lead off our overview section with a refinancing bullet, but I think this time it's worthy of an exception. Attaining investing grade status has been one of the primary corporate goals of KCS for a number of years, certainly from the point we had to refinance some debt in December 2008 at 13%. With S&P's upgrade of KCS in March, KCS officially met the threshold to be classified as an investment-grade company. With Moody's upgrade this past Wednesday, KCSM is now rated investment grade by the 3 primary agencies, S&P, Moody's and Fitch. To come so far in a little over 5 years is an accomplishment, which we are quite proud of at KCS.

And being a company which never rests on its laurels, we are quickly investment-grade status to work, as we announced last week, to access the debt market with the intention of further reducing interest expense while also lengthening the maturity of our debt portfolio. Mike Upchurch will have more to say about that in his section.

KCS again enjoyed excellent growth in some of the most dynamic business sections like crude oil, which saw revenue growth by 369%; cross-border intermodal, which grew by 71%; and automotive revenues, which climbed 31%. Unfortunately, the fantastic growth we experienced in those areas was partially offset by the impact of last year's historic drought on our grain business, which was down 38%. The effects of the drought somewhat masked what was in fact a good quarter for most of the rest of our business segments. If you take grain out of the equation, our reported consolidated volumes were up 4% and revenues were up 6%.

Three things stand out related to our first quarter grain story. First, the problem is totally the result of the drought. Our customer base is solid, the demand is greater than ever and our service is excellent. While the demand is there, it's the product that is in short supply, and that's the reason for the fall-off in volumes.

Second, the good news is the U.S. has a more normal-sized harvest this year. KCS is in a position to have a very strong fourth quarter, with potentially a record number of shuttle trains moving between the U.S. and Mexico.

The third key point, despite the low volumes, is one of our principal commodities. KCS improved its operating ratio compared to a year ago. This could not have happened without the contribution of strong operations and excellent resource planning and deployment.

Going to our first quarter results for the quarter. Consolidated volumes were up 2%, and revenues were up 1%. I already discussed the impact of the drought on our first quarter.

Another factor which affected our first quarter was this year's early Easter and last year being a leap year. This impacted both our carloads and revenues by over 1%.

Now this is inconsequential in terms of full year outlook, but the reality is the last couple of weeks of the quarter provided us with some tough comps. Of course, this also means that the early April comps are easier and that's given us a nice start to the second quarter.

The KCS operating ratio improvement from 71.2% in the first quarter of 2012 to 70.5% in 2013. One other challenges we faced in maintaining a good operating ratio in the first quarter was that unlike the coal business, where we don't own the coal cars, the utilities do, we do own or lease the grain cars. That means we had considerably more idle assets than we normally do. In addition, because we're forecasting strong grain movements later in the year, we could not do any significant rationalization accrues. So all things considered, we are satisfied with our OR in the first quarter.

Finally, our reported diluted earnings per share for the first quarter was $0.94 compared to $0.68 a year ago. As you remember, starting in the fourth quarter last year, we started to provide an adjusted diluted earnings per share number, which excludes the impact for foreign exchange below the line. For the first quarter of 2013, our adjusted diluted EPS was $0.89, which compared to $0.80 adjusted diluted EPS for the first quarter of 2012.

Go to the next slide, update for first quarter 2013. During our fourth quarter call, Pat and I emphasized that because of the poor corn harvest, the first half of 2013 would likely not be as strong as the second half. Well, I guess you can say we didn't disappoint, at least in so far as projecting early 2013. Our grain numbers ended up being somewhat worse than we anticipated, which, depending on this year's harvest, could marginally impact our final year's percentage revenue numbers.

Anyway, first quarter carloads were up 2%. We're still confident that barring another horrible drought, we'll end the year in the mid single-digit range in terms of volume. In other words, on guidance. First quarter revenue grew by 1%. Clearly, we have some ground to make up to hit our high single-digit revenue growth number for the year. Can we do it? Yes. But given there's still nearly 5 months before the new crop is harvested, we will continue to experience some pretty anemic grain volumes for a while. The initial word we're hearing is this year's crop should be better. In fact, it could be a record. But last year, at this time, we were hearing of a possible record harvest as well. And we all know how that turned out. So right now, it would be prudent to project KCS' full year revenue percentage increase in the mid-single-digit range, with the hopes that we might do some better.

Our core pricing is right where we said it would be for the year, in the mid-single-digit range. We feel good about staying in that range. Our 70.5% first quarter operating ratio looks good relative to our guidance. That we'll improve over last year's 69.9% adjusted OR number. And last but not least, our capital budget will probably take us somewhat higher than the 21% we guided to, probably more in the 24% range, primarily due to our decision to purchase more equipment and our projected carload growth in certain commodities. Mike Upchurch will have a bit more to say about our capital budget later.

I'll return at the end of the presentation with a couple of final thoughts. But right now, I'm turn it over to Dave Ebbrecht.

David R. Ebbrecht

Okay, thanks, Dave, and good morning, everyone. Turning to Slide 9. This chart clearly represents our consistent ability to control cost and scale expenses. Even when facing such a significant decline in our grain business, it really bodes well for our operating team on both sides of the border to react so quickly to market fluctuations. We also had a very challenging comp to overcome as Holy Week and Easter fell in the first quarter instead of the second. On a daily basis, we pay very close attention to leading indicators and inbound volumes to quickly and efficiently adjust our operating plan to ensure we contain our operating cost. We remain very confident that we will continue this trend and remain very flat for the foreseeable future as we accommodate the increased volumes projected for the remainder of the year.

On Slide 10, you can see the continued positive results for our headcount controls. We will see occasional dips in this efficiency metric due to seasonal variations in carloads shipped from quarter-to-quarter, but the overall trend will continue to remain very positive. We also made the decision to not cut back forces in areas where we know the grain volumes will return in order to avoid future hiring and training costs. The most recent dip in efficiency is part due to in-sourcing of contracted services in Mexico upon expiration of the service term. All this -- although this in-sourcing shows a slight inefficiency on the chart, it saves us $5 million a year in contracted expense. We will also continue to evaluate other contracted services and may increase our headcount further by taking some more work in-house, where it clearly makes sense financially.

On Slide 11, you can see that all of our operating metrics continue to remain in a very good range for the first quarter. Velocity continues to set new records, averaging well above 28 miles per hour. And some days, we're seeing numbers in the 30s. Dwell and car efficiency are well positioned in the range we need them for the execution of our transportation service plan. The maintenance sway [ph] and slow order miles are also in a very good sustainable range.

It is also important to mention that while we keep our productivity metrics at record levels, our safety performance continues to improve and remains best-in-class. Operations will continue to scale costs well below the solid growth projections throughout 2013, and we look forward to having a great year. Now I'll turn it over to Pat for the sales and marketing update.

Patrick J. Ottensmeyer

Thanks, Dave, and good morning, everyone. I will start my comments on Slide 13. As you saw earlier, total revenue in the quarter grew by 1% from last year, while carloads increased by 2%. As Dave Starling previously mentioned, the first quarter revenue and volume growth were lower than the guidance we gave you for the full year back in January.

There are a few important things to consider before you look at the first quarter and draw conclusions for the rest of 2013. First, last year was a leap year, so we had an extra day of revenue in carloadings in 2012.

Second, as Dave Ebbrecht mentioned, Easter was in the first quarter this year -- and the second quarter of 2012, which also contributed to the negative comps. We estimate the impact of these 2 factors was a negative swing in revenue of about $13 million and approximately 17,000 carloads. Excluding those negative factors, revenue and carload growth would have been 2.5% and 3.5%, respectively.

Third, as you can see quite clearly on this slide, our Ag & Minerals business was down significantly from the first quarter of 2012, which was due, as Dave Starling mentioned, to the lingering effect of the drought conditions and the impact on our grain business in the United States last year. Had grain been flat the last year, we would've added another 5% to revenue growth and 2% to carloads. So adding the impact of cross-border grain to the leap year and Easter effect, we would have been in the area of our full year guidance that we gave you in January.

Finally, we had a new administration take office in Mexico in December of 2012. And is normally the case, new budgets are not approved until March of the following year, and government spending is adversely affected. It's not possible to quantify the impact of this on the economy or on our business, but we clearly saw an impact in our some of our business units.

So the point of all this is that we feel the quarter was heavily impacted by timing of certain events and not necessarily a reflection of what we expect for the full year. However, the weakness in grain was definitely more pronounced than we expected, and we now feel that it will be difficult to recover as the year goes on. So that is why we're taking our full year revenue guidance down a notch from what we expected in January. As I'll show you in a few moments, Ag & Minerals is the only business unit where we have reduced our full year revenue guidance.

Revenue per unit increased in 5 of the 6 business units that fell overall due to mix. The main driver here is the shift in mix of our business away from Ag & Minerals, specifically cross-border grain, and growth in intermodal. As I've mentioned in the past, this does not mean that yields, as in contribution or margin, are declining or getting weaker. It simply means that our portfolio mix is shifting and more of our growth came in lower RPU businesses.

Revenue in our Petroleum and Chemical business was flat due to lower volumes, offset by higher RPU. One thing that is probably worth mentioning is that unlike some of the other railroads, we do not have crude oil in our Petroleum and Chemical business unit, so our comps to some of the other railroads are not as bad as they appear on the surface. That said, we did experience some general weakness, as well as some plant maintenance outages in this group during the quarter. We are not seeing trends that would suggest a cyclical turning point, nor are we hearing that from our customer base. We have seen some strengthening in this business in the first 18 days in April, with revenues and volumes higher by 10% and 4%, respectively from last year.

Industrial & Consumer business revenues were up 4% on a similar increase in RPU. Volumes were essentially flat to last year. We had a negative impact of maintenance outages of some of our larger customers during the quarter, which did not occur in the first quarter of 2012. We believe the impact of this was a negative swing of about 1% on revenues and 2% on volume.

I've already spoken about Ag & Minerals, but the story behind the number is that it gives clearly cross-border grain, where we saw revenues fall by 38% and carloads by 31% from last year. We're all well aware of the drought conditions in the U.S. last year. It hit us hard in the last 2 quarters, and we don't expect this situation to improve until possibly September of 2013.

You'll also notice that our results were worse in this business than most of the other rails, and that is because KCS is more heavily concentrated in export corn than the rest of the Class 1s. To put this in perspective, according to USDA data, total U.S. exports of all grains was about 12% lower in the 2012 crop year than 2011. However, export corn was 45% lower than the previous year. So clearly, the corn crop, which is our main staple, was affected worse than other grains.

With that in mind, I will reiterate a comment that I made in the past, and that is our cross-border export corn franchise is very strong and getting stronger and strategically well positioned. There's absolutely nothing wrong or broken with our export corn network. We just didn't have a crop last year. We connect the most productive grain growing region in the world, which is just north of Kansas City, to one of the largest importing regions in the world, which is in Central Mexico. Assuming that we have a decent crop in the U.S. this year, our grain comps should be good in the last 3 to 4 months. But we now expect that Ag & Minerals business unit to be down for the full year, which is the change in the guidance that we gave you in January.

Moving on to Energy. During the first quarter, we did see growth in crude oil, and frac sand more than offset the declines in utility coal. Revenue volume -- the revenue and volumes in utility coal were lower by 7% and 9%, respectively. Overall, our intermodal growth continued at high levels, with revenues increasing by 17% on volume increases of 9%. Our cross-border business represents almost half of our total intermodal growth, and revenues were 70% higher than last year and volumes grew by 81%.

Finally, our Automotive business unit continues to be very strong, with revenues growing by 31% and volumes by 18% over last year. What's exceptional here is that we are still experiencing this kind of growth in automotive in a year that we consider to be a bridge year to the new plants opening in later in 2013 and 2014. I'll provide an update on those plants in a few minutes.

Moving on to Slide 14, cross-border revenues were 10% lower than in the first quarter of last year, and more than all of that decline was attributable to cross-border grain. You may remember that cross-border grain was very strong in the first quarter of last year, which makes our comps this year look even worse. Excluding the impact of grain, our cross-border revenue would've been 11% higher than last year. Cross-border intermodal and automotive continue their strong performance, increasing by 71% and 53%, respectively. As I mentioned last quarter, assuming we have a decent corn crop this year, we should see growth and certainly stronger comps returning in the second half of this year.

Moving on to Slide 15. You can see that our top 5 strategic growth areas continue their strong performance with combined year-over-year revenue growth of 36% versus last year. Together, these businesses represent 19% of our total revenue, and these will be the main drivers of our growth for the next several years. Crude oil, intermodal and automotive were the leaders of the group, with growth rates comparable to what you've seen in prior periods. Lázaro Cárdenas growth improved from last quarter, as some of the factors we explained to you in January improved or reversed.

Moving on to the market outlook slide, we have updated our revenue guidance from that which we gave you in January. As you can see, our full year guidance is the same in every business unit except for Ag & Minerals. And again, the headline there is cross-border grain. In addition, this guidance is generally consistent with the results we showed for the first quarter back on Slide 13. We have a little bit of catching up to do in Chemical & Petroleum. But for the full year, we still believe we will be in plus territory. As I mentioned earlier, we have seen some strengthening in that group so far in April.

For Ag & Minerals, which I think I have covered pretty completely, we have moved our outlook to low double-digit decline from a single-digit increase that we expected in January. Leaving the outlook for everything else exactly as it was in January, this will take our company -- total company revenue guidance down from high-single to mid-single digits for the full year.

On Slide 16, you can see the year-over-year volume and revenue growth through April 17, which spreads out the impact of Easter and leap year, and we've also adjusted on this slide to remove the impact of cross-border grain. What you can see is that we would have been in the range of full year guidance had it not been for these factors.

Moving on to Slide 18. I put this slide in with the belief that a picture tells a thousand words. We've talked a lot about the new auto plants in Mexico, and this is a very recent photograph of the major new plants. As you can see, with the exception of Audi, which has not yet broken ground, these are all very well along the way to completion. The Nissan plant will begin producing cars this year, and Honda and Mazda will open in the first quarter of 2014. Production from these 4 plants alone will represent a 30% increase in Mexico auto manufacturing.

In addition to these plants, we believe there will be even more auto facilities coming into Mexico over the next few years. And as we've talked in the past, this is a very exciting opportunity for KCS.

Slide 19. I wanted to take a moment to bring everyone up to date on the status of our negotiations regarding the development of a crude oil terminal in Port Arthur, Texas. We've seen heightened discussion in the analyst community, and we just want to make sure everyone understands what we are up to. We are currently in negotiations with a potential partner to develop a unit train unloading and storage terminal on property that KCS owns in Port Arthur. That property is highlighted in red on this map. We are not in a position to identify our partner or discuss details regarding timing, volumes or revenues, so please don't ask questions. What we will discuss are the reasons we are so optimistic about this potential opportunity, and what gives KCS a seat at the crude oil table.

As you can see on this slide, Port Arthur refineries import about 1.7 million barrels of crude oil each day. Because many of the refineries have also invested in coking capacity, there's a natural draw for heavy crude like that produced in Western Canada. Even if or when the Keystone pipeline is completed, we believe it will be able to handle only about half of this demand. The current rail terminal unloading capacity can handle less than 3% of this demand. As I said earlier, we are in negotiations with a potential partner, and we hope to be able to announce the transaction very soon. However, if for whatever reason we don't come to terms with this group, we are confident that other options would be available for us to capitalize on this market opportunity.

Finally, I'll finish with some summary comments about our market outlook. Again, I think I've covered the situation in Ag pretty completely. Our franchise is very strong. But we need a crop, and that is going to take some time. So don't -- we won't see things improve until later in the fall and in the third quarter.

Utility coal comps will begin to look better over the course of the year. We've sort of reached a new normal level in our utility coal business, so the worst is behind us. And growth in the new energy markets will offset the weakness -- any weakness in utility coal going forward.

The pricing environment continues to be good, and we will still see pricing gains in the mid-single-digit range. I think we've covered the auto plants, that are coming on stream in the next 12 months. And we continue to be very excited about the health and growth of our new business pipeline.

With that, I'll turn it over to Mike Upchurch.

Michael W. Upchurch

Thanks, Pat, and good morning, everyone. I'm going to start my comments on Slide 22. Our reported EPS for the quarter was $0.94, and on an adjusted basis is $0.89. And as you know, we began reporting adjusted EPS to exclude the impacts of foreign currency.

During the quarter, we had a net $0.05 benefit due to foreign currency that was comprised of really 2 items. First, the improvement in the peso during the quarter contributed to higher income taxes of approximately $0.03 per share. And I'll provide more information on that impact on the next slide. And then second, during the quarter, we began to hedge this foreign currency risk, and based on the improvement in the peso, had an $0.08 after tax gain primarily related to our hedge.

And I might just comment, as you work through the math on this slide, in Mexico our tax rate is lower; it's 30%. So despite a 38% drop in our grain revenues, our adjusted EPS still grew at a double-digit rate, which we think is impressive earnings growth.

On Slide 23, with respect to our tax rate during the quarter, you can see on the left-hand side of the slide the reconciliation solution from the U.S. statutory rate of 35% to our first quarter effective rate of 34.3%. And I might just comment on a couple of items there. We did in the quarter have some benefits from tax credits, short line tax credits that were signed into law in early January that lowered our effective tax rate by 1.2%. And then, because of the strengthening peso, since December 31, that actually had the impact of increasing our tax expense by 2.3%, as you can see in that red block.

As you probably remember, we are required to revalue, for tax purposes, our U.S. dollar debt that we have in Mexico. So when the peso strengthens, it creates taxable income. And conversely, when the peso declines, it creates at tax deduction. So during the quarter, in the table on the right, you see the peso improved by 40 basis points. And we've given you over kind of a rule of thumb that every 10-basis-point change in the exchange rate usually impacts income taxes by approximately 50 basis points. And you can see that, that relationship held fairly true to form by increasing our effective tax rate by 230 basis points. Historically, this change in income taxes hasn't impacted our cash tax taxes since we haven't been a cash taxpayer. However, that changes in 2013, and we believe hedging that cash tax risk associated with foreign currency swings is in fact a prudent strategy.

And for the year, you can see our guidance in the table in the right, fairly consistent with what we gave you in January, with FX, 36%; without FX, 34%.

On Slide 24, let me give you a little bit more detail on the hedge. What we're trying to show here is the foreign currency hedge helped to offset our higher income tax expense due to the improving peso. In the first quarter column, you can see our first quarter increase in the income tax expense resulting from the revaluation of our U.S. dollar-denominated debt in Mexico. I would note that, that $1 million increase excludes the first quarter impact of retiring the 12.5% notes, also excludes some other differences related to some intercompany debt. And then we had a $3 million after-tax gain on our Mexican peso exposure, which relates to our net monetary assets that we're required to revalue at the balance sheet date.

So our unhedged position in the first quarter would've resulted in about a $2 million income statement gain. However, we did hedge that foreign currency risk, and in the quarter, had an after-tax $6 million gain, so we had a total of $8 million positive benefit to the P&L in the first quarter.

And then in the far right-hand column, what we've tried to illustrate is that given the current exchange rates, we would expect our income tax expense to go up for the year by $8 million. After the peso exposure, it would be an unhedged $6 million loss. And having put the hedge in place essentially mitigates all of that increasing cash taxes. So I think a simple way to think about this is we would've had higher tax expense in the quarter if not for the hedge, and we think that was a prudent strategy to execute.

On Slide 25, let's review our overall expense trends. You can see that we really were flat year-over-year, $390 million a year ago. $390 million in this current quarter. So I think we did a remarkable job managing the expense side of the equation. And we had higher fuel prices in the quarter. We had some negative impact on FX, but that's largely offset from a revenue perspective. We did have the increased depreciation expense due to our higher asset base. And then those were offset by a reduction in compensation expense of $2 million; a $4 million decline in Materials & Other, primarily the result of lower casualty expenses; and $6 million in other declines as a result of cost efficiencies, commodity mix of traffic, and a favorable legal settlement in the first quarter. To give you a little bit of guidance, we do expect depreciation cost to be around $220 million for the full year, that's up slightly from the $215 million we've guided in January as a result of some incremental CapEx spending.

So overall, we think our expense management was exceptionally strong during the quarter, considering that we had a fairly material decline in our grain revenues and did incur some fixed expenses in the quarter around equipment and crude costs that we estimate to be in the neighborhood of $4 million.

On Slide 26, our overall compensation cost declined $2 million year-over-year, largely due to a reduction in the incentive expense. And as Dave has already communicated to you, our average headcount went up 37 employees, but that's less than 1%. And on an average quarterly calculation, about 21 of that increase was the result of the in-sourcing of the track maintenance agreement that will increase compensation but deliver an overall net $5 million a year reduction in our expenses; that offset reduction being in purchased services.

On Slide 27, a couple of points on our fuel expense. You can see our fuel expense went up from $88 million to $91 million. That was largely price driven. You can see in the bar charts that we were at $3.02 in the first quarter compared to $2.84 a year ago. We were relatively flat in our fuel expense on a price per gallon in the U.S. But we did see an increase from $2.54 in the first quarter of 2012 in Mexico to $2.88. So we're still paying less per gallon in Mexico but generally moving closer towards global prices.

On Slide 28, I'll give you a quick update on the use of our cash. As we've communicated previously, our first priority is to continue to invest in our business, to capture our growth opportunity. And in that regard, we have increased our CapEx, the revenue planned spend for the year, to 24%. This increase is largely the result of the incremental spend on equipment to capture the automotive growth that Pat discussed and equipment needs to support our grain franchise.

In terms of optimizing our capital structure, Dave already mentioned that we received the upgrades from both Standard & Poor's and Moody's. And we also, during the quarter, retired the 12.5% KCSM notes, partly with cash and partly by drawing down on our credit facility. And we also just last week announced the tender offer for a variety of different issues at our KCSM subsidiary, which I'll review in more detail on the next 2 slides. And then lastly, we announced an increase in our dividend for the first quarter to $0.215.

Finally, on Slides 29 and 30, I wanted to review the key elements of our recapitalization plan that was recently approved by our Board of Directors. First, we currently have a tender offer outstanding, which I'm sure many of you have seen. We're up to $650 million of our KCSM bonds, which currently have coupons of 8%, 6 5/8% and 6 1/8%. We have 2 key goals in mind in refinancing this debt. Now that we're investment grade by all the rating agencies, we believe we will be able to access the markets for longer maturities. And our goal would be to extend overall maturities to closely match industry average.

Second, we do expect the lower interest rates and reduce our 2013 interest expense to between $84 million and $88 million. And that's just going to be dependent on the amount of current notes that are tendered, market conditions and specific maturities that we may choose to issue for any new debt. Additionally, depending on market conditions, we may choose to refinance some of our KCSR term loans, which would allow us to extend the maturity. This may actually slightly increase our interest expense because those notes are at less than 2% today, but given the current debt markets, we believe provide us extremely attractive rates. And we think that's a prudent capital management decision.

We may also purchase certain leased equipment and convert those assets to owned assets, continuing a strategy we outlined 2 years ago to take advantage of reducing our exposure to leased assets. But generally, we're at less attractive terms than owning those assets outright.

Overall, we expect to lower our interest expense significantly from peak levels in '09 and would expect the cumulative benefit to be somewhere between $0.10 and $0.15 when compared to 2012 earnings.

And then lastly, on Slide 30, I thought I might take a quick opportunity to provide some additional details. What we've outlined here are various components of the recapitalization. And when you look at the first column, our GAAP debt could actually increase depending on the success of purchasing equipment under lease. While those assets don't really create any incremental financial obligations, we will fund those current off-balance sheet leases with debt, thereby increasing our GAAP debt. However, the rating agencies do include those off-balance sheet leases in their debt calculation, so there's potentially no overall increase in our rating agency debt.

And then finally, in the last column, we have tried to illustrate that while paying off the 12.5% note and refinancing various other notes, we'll provide overall interest expense savings. We could see some slight incremental interest expense by refinancing the term loan, financing assets purchased under lease and any financing of tender premiums and transaction fees. And again, we expect our interest expense to be somewhere in the $84 million to $88 million range. We will get some offsetting benefits in OR because of the reduced leases. We'll provide some further updates on guidance once we complete these transactions.

So with that, I'd like to turn the call back over to Dave Starling.

David L. Starling

Thanks, Mike. Before opening up for questions, I'd just like to emphasize that KCS management remains very positive about 2013 and even more bullish than ever about the next few years. Our major growth areas of crude oil, automotive and cross-border intermodal will continue to ramp up. As Pat said, we hope to have more announcements related to crude very soon. Regardless of any announcements, KCS crude business will continue to expand at a high rate. This all-new profitable business should continue to grow.

I'd also mention the new automotive plants. The kind of growth we'll experience with Honda, Nissan and Mazda opening new plants, followed by Audi and then others in 2015 is unprecedented. No railroad has ever before experienced the opening of multiple new plants over a 5-year period, to say nothing of the expansion of the existing ones.

I could go on and on, but I'll end up by saying when you combine the new and expanded business coming online with the opportunity to significantly restructure the company's debt profile and strengthen our balance sheet, it's pretty easy to understand why we at KCS are very bullish about the future.

Now, with that, I'll open it up for questions. I'd like everyone to stay to 2 questions. We've had complaints that some of the analysts don't get their questions in, so we're going to be a little more strict and hold everybody to 2. And as sweet as Ashley is, she's going to cut you off after 2. So with that, let's begin.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Chris Wetherbee of Citigroup.

Christian Wetherbee - Citigroup Inc, Research Division

Maybe your first question, just on the grain side. I see the comps and they do get a little bit easier, I guess, as against the back half of the year. But, Pat, maybe can you give us a little bit of guidance on how we should be thinking about kind of the severity of the declines, at least in the shorter term, call it second quarter or so? Is there anything the changes the dynamic now that you have a new contract I think that started earlier this year. Does anything change the dynamic in the near-term or we're just going to have to wait for September before we see these volumes moving?

Patrick J. Ottensmeyer

We're going to have to wait till September, Chris, maybe August, with some of the new facilities that's openings further south, where the harvest might be a little earlier. But I think you're going to see a little bit. And if you look at the first quarter revenues, second quarter should be a little bit better, just seasonally. Third quarter will probably be very close to the first quarter. And then we're expecting the fourth quarter to kind of return to historical normals. So the next 2 quarters are going to be weak.

Christian Wetherbee - Citigroup Inc, Research Division

Okay. That's helpful. And then my second question would just be kind of on the run rate of kind of operating expenses that you have as it stands right now. I think, Dave, you mentioned that you were unable to cut back crews as much as you would have like because you're anticipate better harvest in the back half of the year. Can you give us a sense of kind of how that impacted, I guess, the first quarter or so and maybe how that plays out over the next quarter or 2? I don't know if you have kind of a sense or granular on the number there, but just trying to get a rough sense what it might have done to the OR in the quarter.

David R. Ebbrecht

We're confident that we're going to be able to continue to control the expenses at the rates we have and keep them relatively flat. We're just choosing to hold on to employees to make sure we do training, like putting them in engineered training, and cut them back, different ways that we can keep them engaged, preparing for the third and fourth quarter volumes surges. But it takes us about 3 months to hire employees and then another 4 months to train them. And we think it would be fruitless to go ahead and furlough these employees only then to have to rehire others.

David L. Starling

And, Chris, with the new millennia, if you lay somebody off 30 days after they come out of training and then you call them back in 3 months, they may not come back. They may have said, "This wasn't the kind of industry I thought it was going to be, I'm going to good move on." So Dave and I talked about it. We think it's a prudent decision. And then when the harvest does come and volumes are there, we'll have ample crews to move them. This could be a great fourth quarter on grain if the weather cooperates.

Operator

Our next question comes from the line of Tom Wadewitz with JP Morgan.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

So, Pat, I'm going to ask you something. I'm not sure if you can you give any directional color on it and you can probably guess where it's going. But the crude by rail, is there a time frame where you, say, you've got this discussion with one kind of unidentified party, is there a time frame that you put on that and if it doesn't kind of come to fruition, then you move onto the next? Or is there any kind of time frame you have in mind that's reasonable for getting an agreement? Is this kind of a 1-year process and that shouldn't be longer than that? Or just any kind of commentary you can provide on how we should think about the timing for a potential agreement.

Patrick J. Ottensmeyer

I think it's a matter of a few weeks. Let me say it this way. And again, we are in good negotiations. It's been very high-level participation, Dave and the CEO on the other side. And I don't -- we really don't expect that there are any major differences in terms of wrapping this up. But I think we'll know with this party in a matter of a few weeks.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. And so that's -- that could -- it could work or it could be the case, you have to move on, but at least that resolution with the current party would be just a couple of weeks?

Patrick J. Ottensmeyer

Correct.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay, let's see. And the second question, you showed us some pictures on the auto plants, which is very helpful. It looks like there's a lot of work that's been done on 3 of those. How would you view the -- I guess there's some noise recently in terms of the yen weakening and how that might affect the outsourcing strategy for some of the Japanese manufacturers. 3 of the 4 plants are Japanese manufacturers. Do you think there's any risk at all related to the yen weakness on those 3 plants? Or do you think in the future that would affect at all the opportunity in Mexico?

Patrick J. Ottensmeyer

I don't see it, Tom. I was in Mexico visiting with a couple of our automotive customers, including visiting the Nissan site at Aguascalientes. We did not hear any reversal, any indication that they are weakening their view of Mexico. There are a lot of other reasons why the auto companies are choosing Mexico just other than currency: labor costs, which is impacted by currency; the fact that Mexico has more free trade agreements than any other country in the world. So they're looking at Mexico primarily to serve the U.S. market, but they're looking at Mexico more and more to serve other markets in South America, other markets in the world; transit costs, et cetera. So there are more factors than just currency, but the direct answer to your question, Are we seeing or hearing anything that would suggest a weakening of the enthusiasm or interest in putting plants in Mexico? No. I've mentioned this in the past as well. But in addition to the big auto plants, there are a large number of Tier 1, Tier 2 suppliers going in to support these plants. I drove -- several weeks ago, Dave and I were in Mexico. We drove past an industrial park in the Salaya area, which is near the Honda and Mazda facility. There were 8 or 9 buildings going up in that facility simultaneously. And eventually, Honda told us there will be 19 Tier 1 and Tier 2 suppliers locating in that facility. So the ripple effect is pretty big with finished vehicles, and we just aren't seeing any indications that the enthusiasm for Mexico is waning.

David L. Starling

Tom, this is Dave. One thing I might add, the other thing we're learning about the plants is they have additional capacity, additional expansion property, so they are already -- when they built this, it's almost like it's in phases. So they all have bigger footprints to expand into at a later time; so, very encouraging for us.

Operator

Our next question is from the line of Allison Landry of Crédit Suisse.

Allison M. Landry - Crédit Suisse AG, Research Division

While we're on the topic of automotive, I was wondering if you could give us an update on the Port of Veracruz and the expected build-out of infrastructure? I know in the past you talked about a targeted completion sometime in mid-2013, so I was wondering if that's still on track. And at this point, do you have a better sense of what share you might be able to capture there?

Patrick J. Ottensmeyer

Allison, the rail project is under way at Veracruz will be finished by the end of this year and operational when the new plants open. So the rail access for us in and out of the Port of Veracruz is going to be improved. The one thing that we aren't seeing and so far we haven't seen any movement is announcements about additional terminal capacity being built at Veracruz. So the rail access will improve our ability to serve Veracruz, but for finished vehicles, the Port of Veracruz is pretty congested. They're going to need to do more than just improve the rail access to add capacity there. And we just haven't seen any announcements. We know they have plans at the Port of Veracruz to add both finished vehicle terminals as well as intermodal terminals, but their plan is to finance that with private capital through concessions. And at this moment, they do not have even a bid package out in the market for a concession for intermodal or automotive. So we're struggling to kind of understand how this is going to change the landscape at Veracruz. The rail access will be better, but the bottleneck will still be the terminal capacity for finished vehicles and intermodal.

Allison M. Landry - Crédit Suisse AG, Research Division

Okay. And then maybe this is a question for José. There's been a lot of talk recently about energy reform in Mexico and the potential liberalization of PEMEX under the new administration. I was wondering if you could divide any perspective on what you're hearing in this regard, and what it could potentially mean for KSU over the longer term.

José L. Zozaya

Yes, the lobbyists [ph] just last night, they finalized that -- they have submitted [ph] the reforms on the telecommunications law. They are working one by one, and it is expected that the next one to start working on will be the energy reform. There is a lot of expectation on that. They say they have an agreement between the different parties. And we think that after that reform is approved, there's going to be a lot of new investments and growing in that business and mainly a lot of foreign investments coming in to do some certain kind of contracts. It's not that PEMEX is going to be privatized, but a lot of the works that PEMEX is doing internally now is going to be shared in a different ways, or as in fact what I've been hearing, are for different companies. And that could be providing certain and different kind of services for the company. And especially they will be looking also for more drilling in deep waters also. I don't know if that answered your question or you want to ...

Allison M. Landry - Crédit Suisse AG, Research Division

The increased foreign investment with, say, its U.S. companies or that sort of thing. That does answer my question.

Operator

Our next question is from the line of Ken Hoexter of Bank of America.

Ken Hoexter - BofA Merrill Lynch, Research Division

Pat, maybe you can just start off on the grain crop a bit. It seems like you kind of gave guidance in January, but if the crop runs from kind of August to July or somewhere thereabouts, what got much worse that you have to go back here in April and change the outlook? I guess, just what changed within the last 3 months, given that we're still within that same crop year?

Patrick J. Ottensmeyer

What changed was really in Mexico. What we expected to happen was that the U.S. side of our business would be weak because we knew and understood fairly well, pretty well, the growing conditions and the inventory, et cetera, in our origination territory. What we expected was more movement in Mexico coming from other carriers and pulling grain off of their regions. So that didn't happen. In other words, we expected more grain could be coming to us at the border that we would move in Mexico. And so we underestimated the severity of the drought and the crop -- and the impact on the crop in other parts of the U.S. So that was the surprise for us.

Ken Hoexter - BofA Merrill Lynch, Research Division

I appreciate the insight. Quite clear. Then, Michael, you talked about kind of the sourcing contract opportunities over time. Is there -- as you look to continue to improve that operating ratio, are there other opportunities or sizable ones that are -- we're going to see step functions? Or is this more kind of rolling additional ones in? I'm just wondering if there's some large opportunities left on the table here.

Michael W. Upchurch

Yes, there are still a number of equipment maintenance related contracts that we continue to believe we can pursue better rates on, either with the outsourced provider or in-sourcing that. So, but plenty of opportunity ahead of us.

Ken Hoexter - BofA Merrill Lynch, Research Division

Anything, I guess, near term?

David L. Starling

Let me answer that one. The date to these contracts, the companies we deal with know the dates. It's much better for us to tell you after it's done than talk about it before or in the middle of the negotiations.

Operator

Our next question is from the line of Keith Schoonmaker of Morningstar.

Keith Schoonmaker - Morningstar Inc., Research Division

I guess for variety, maybe return to the auto franchise story, strong auto growth even in the period, with volume up 18%. I guess as we think about the 4 sort of unprecedented plants coming out in such a quick pace, can you comment on the rail's position relative to other alternative modes or railroads as far as capturing most or all of this volume? Can you give us some direction on maybe the magnitude of what annual increases these might represent to the franchise? Like within the next 3 or 4 years, is this 5% or 10% gain for the auto franchise? Or what sort of order of magnitude do you think, given the likely share?

Patrick J. Ottensmeyer

Well, I'll talk in terms of the impact of the overall market and kind of stick to some of the guidance that we've given in the past. But if you look at the 4 plants and then we know there are more coming on, but just look at the 4 plants that I highlighted in the slide. The finished vehicle production at those plants alone will represent about a 35% increase in auto production in Mexico. We have, at the plants that we serve today, we have anywhere from 25% to 80% of the market on a plant-by-plant basis. We don't know in the case of these 4 because the awards are not complete. We don't know yet what our market share is going to be, but if you look at our network, we are very well positioned to serve these plants and move vehicles to the population centers in the Eastern half of the country. Laredo is the best gateway to move these vehicles to where they ultimately want to go, which is the big population centers in the Southeast, in the Midwest and the East Coast. So again, putting that in perspective, these 4 plants will increase finished vehicle production by 35% over the next 3 or 4 years. Now, if you look at our Automotive business, what we call automotive is just finished vehicles and some auto parts moving in boxcars. When you look at the ripple effect and look at what is auto related in our revenue base, we have estimated and said previously that it's about 16% to 18% of our total revenues are auto related. So that would be finished vehicles. That would be intermodal auto parts that show up in our intermodal business unit. It would be steel, plastics, all kinds of other components that are related to finished vehicle production. So the punchline is, the market that we serve in Mexico, the production of finished vehicles is increasing by 35% over the next 3 to 4 years. And our auto-related businesses is 16% to 18% of our total revenue.

Keith Schoonmaker - Morningstar Inc., Research Division

Okay. If it could switch to a quick operations question. In the last couple of quarters, it would seem operations is really hitting on all cylinders, with velocity in '12, 28 miles an hour in 17 or 18 hours. Can you see further improvement from these excellent rates or what would this require?

David R. Ebbrecht

I would say that our operating metrics are operating at peak efficiency right now, with the current volumes that we're seeing. We look at velocity as a range that we want to stay in to be able to execute our service plans. And it really depends where we're looking at, but as we accommodate higher and higher growth, what we'd like to do is make sure we keep in that range. And we should see slight dips from -- every now and then, but if we're in the 27 to 28 range of velocity numbers, we're very satisfied that, that enables us to be able to make our connection plans from terminal to terminal.

Operator

Our next question is from the line of Brandon Oglenski from Barclays.

Brandon R. Oglenski - Barclays Capital, Research Division

I want to ask a question on efficiency and the impact on the operating ratio. With the lower outlook for Ag volume and Ag revenue, does that impact the level of efficiency gains and operating ratio gains you can get this year? Does that just make it a little bit tougher now?

David R. Ebbrecht

I would say that we have a lot of opportunities out there to reduce cost across multiple areas of our expense controls. And we're continuing to refine our operations and look for those areas such as fuel, equipment turn time, utilization and other areas in the network that we can take out costs from, not to mention some of the maintenance contracts that Mike just referred to. So there are still opportunities out there. But grain, as we know, with us owning the equipment and as it does not move, we will absorb some increased expenses that we have to overcome in other areas.

Brandon R. Oglenski - Barclays Capital, Research Division

Okay. And if I could just shift gears a little bit. Pat, intermodal growth was pretty good in the quarter. But sequentially, we've been down on absolute terms 2 quarters in a row now. Obviously, that's a lot of seasonality. But should we expect you guys to be exceeding peak volume levels as we had through the second and third quarter in the intermodal business?

Patrick J. Ottensmeyer

Exceed peak volume levels?

Brandon R. Oglenski - Barclays Capital, Research Division

Well, from the last third quarter?

Patrick J. Ottensmeyer

Yes. I mean, you look quarter -- year-over-year, we're still seeing nice increases. The cross-border is still the smaller bucket of our main pieces of business in the intermodal business unit, but it's growing faster, and so we would expect those growth rates to come down at some point. But I think overall, we'll see our intermodal business grow on a year-over-year basis.

David L. Starling

I think what you -- as the base gets bigger, we're very happy with double digit.

Operator

Our next question is coming from the line of Bill Greene of Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

Pat, some of this we were talking about a lot last year was with the whole coal issue and, obviously, with that, gas prices up, I'm curious, number one, if you're seeing any reaction in the utilities. So do you feel like the stockpiles at a point where we're pretty good on the forward outlook for coal for you? But also, can you update us on -- there were some talk that you might have some plant closures? And I'd just love the update there as well?

Patrick J. Ottensmeyer

Yes. Our stockpiles are probably a little higher than normal across the network. But we are seeing and hearing from our coal customers that the outlook is brighter, with gas prices being where they are today that the mood among our utility customers seems to be brighter. And the talk of plant closures also seems to be diminishing a bit. We have one plant that announced that they were shutting down a couple of their generating units until the peak summer season. They are still indicating that they're going to open that -- those units up for the summer, and so we're still somewhat dependent on the weather in that case. But the overall mood and the outlook that we're hearing from our utility customers is better, certainly better than it was a year ago. You'll see our comps recently are very strong because we were sort of at the depth of the depression this time last year. So our coal comps are going to be decent for the rest of the year.

David Berge - Moody's Corporation, Research Division

Okay, great. And, Mike, just one quick question on materials. Is this a good run rate? Because this was down quite a bit from last year, as well as where we were modeling. So I think you mentioned a casualty adjustment. Is this a good run rate to you going forward?

Michael W. Upchurch

Yes, it's priced slightly higher than what we saw in the first quarter, but there are a lot of different items that run through materials and other, but we did have a true-up in the first quarter on small casualties.

Operator

Our next question is from the line of Justin Long with Stephens.

Justin Long - Stephens Inc., Research Division

I was wondering if you could talk a little bit about the lease-to-own strategy on locomotives. You mentioned that briefly in the remarks. But I'm wondering if this is something that kicks in more during 2014 and beyond, just given your somewhat elevated CapEx levels this year. And if you could just walk through how you see that playing out in terms of timing and how that 80-20 split could change over time and the cost savings associated with that.

Michael W. Upchurch

Yes, this is Mike. We've talked about this for the last 2 years. And clearly, over time we have leased more equipment than we've gone out to acquire and own. And generally, that's done at not as favorable of a term. And as our balance sheet's improved, it gives us the ability, I think, to go in as these leases roll off and begin to acquire those assets, and we should see some nice improvement, both from an NPV perspective and in the P&L, particularly in operating ratio. It's a situation where some of these leases are longer-term leases. They could go out 8, 10 years. So it may take us a little while to go from 80-20 lease-to-own to 50-50, which is closer to what the industry average is. But when you look at our equipment rents as a percent of revenue, they're about 300 basis points higher than the rest of the industry. And so over the next few years, we think there is an opportunity to maybe pick up a couple hundred -- 200 basis points, somewhere in that range, in operating ratio improvement. And we've done some of that, as we've announced, and we have the potential to do some others. But I wouldn't want to say too much more because we are actively looking at some of those transactions right now. But it will definitely help us close the gap in operating ratio.

David L. Starling

Justin, this is Dave. I'd might add to that, that this is not a 1- or a 2-year strategy. This is a multiyear strategy because we don't want to pay penalties to these leasing companies. We're just going to be opportunistic when the leases come up. And also, instead of leasing equipment now, we're purchasing. So I think that's, again, something that we couldn't or wouldn't do on in the past. So that moves the needle very slightly, but it's going to be multiple years before we get to that 50-50.

Justin Long - Stephens Inc., Research Division

Great. I appreciate that. That's helpful, helpful detail. I was also wondering if you could talk a little bit about the trends you're seeing at Lázaro and your expectations there going forward. I know fourth quarter was a little bit of a disappointment and there were some onetime items. We saw modest volume gains in the first quarter. But do you still have confidence that volume growth in -- from that port will re-accelerate closer to the double-digit levels or so that we've seen historically?

Patrick J. Ottensmeyer

Well, yes, they will recover. Keep in mind that for the better part of 4 years, Lázaro was growing faster than any port in North America. And as is usually the case when you have that kind of performance versus the same period of time. Sooner or later, it's going to converge back to a more normal level. And I think we're seeing a little bit of that. But I mean, the outlook for Lázaro is extremely positive. Hutchison is investing and adding capacity at their terminal. I think I told you back in January that they're adding 6 ship-to-shore cranes before -- sometime in the second quarter. APM just had their groundbreaking. They've announced they're going to spend $900 million dollars over the next few years building a second concession container terminal. So the outlook at Lázaro is very positive. It's going to be a great growth area for us for many years to come. There's a new auto facility going on there, but we should probably get used to and expect that growth rates are going to decline just because they have been so high for several years. There is nothing wrong about Lázaro. It's everything we've said in the past. There's just an abundance of land, it's natural deep water. The port authority has done a terrific job building out infrastructure, rail infrastructure that we benefit from but haven't had to pay for, highways, bypasses, bridges. It's just a phenomenal place.

Operator

Our next question is from the line of Thomas Kim with Goldman Sachs.

Thomas Kim - Goldman Sachs Group Inc., Research Division

I kind of wanted to ask on a grain side whether we might see any changes to trade patterns. And maybe more explicitly, could you give us an idea of what percent of your grain moves are from Canadian producers that go cross border to Mexico, and could we see greater opportunities to diversifying your grain business?

Patrick J. Ottensmeyer

For us to diversify? Is that what you're asking? Is there opportunities for us to diversify our grain business?

Thomas Kim - Goldman Sachs Group Inc., Research Division

Correct, yes.

Patrick J. Ottensmeyer

Well, it's one of those things where we are kind of -- what's the phrase? -- we are where we are, and so we can only draw from certain territory. In a commodity market, you're not going to move grain a lot of distance out of route from its normal pattern. So we are primarily a corn railroad. Some of the things that are happening and we -- some of the things are happening this year that we've talked about that will improve our origination capability are the 2 new elevators that are opening this year in time for harvest, one in Western Missouri and one in Western Illinois. So those are very important strategic investments that our customers and partners are making, and they will improve our ability to control originations on our network. And this is obviously a ridiculous thing to say, but had those facilities been open last year, we would have been in a much different place right now with our origination capability. But as far as expanding, we haven't seen -- we don't draw a lot of grain out of Canada. There's some talk with the change in the Canadian Wheat Board that maybe moving wheat down into Mexico from Western Canada would be possible. We'd certainly like to do that if things develop a certain way, but we haven't seen it yet.

Thomas Kim - Goldman Sachs Group Inc., Research Division

Great. If I could switch topics and ask Mike with regards to the depreciation rate. Could we assume that what we -- that what we had seen in the first quarter could continue? Is that the sort of the pace in terms of your overall run rate [indiscernible] incremental increase of depreciation like revenue, as an example?

Michael W. Upchurch

Yes, it's really a function of our capital spend for these growth opportunities. I did make a comment to give some guidance on depreciation, and I stated it was $220 million for the year.

Operator

Our next question is from the line of Anthony Gallo of Wells Fargo.

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

Assuming that Port Arthur is built out something like the discussions that are taking place now, what do you think your mix of Canadian versus, say, Bakken crude is going to be over the next couple of years? And then my follow-up question is, what are some of the dynamics we need to think about with the Canadian crude coming South? And I'm thinking about it as, CN, for example, can come pretty far south. So where did they need to come onto your network? Where don't they have to? And maybe if you could put some color on that, that would be appreciated.

Patrick J. Ottensmeyer

Okay, if you look at our mix of crude oil right now, it's about -- it's well balanced, actually, between Canadian, Bakken and West Texas. So we would expect to see going forward for the next 2 to 3 years, probably a good mix, maybe something like 40% Canada, 40% Bakken and 20% West Texas. Longer term, we think the business that's probably more sustainable over the long haul is Western Canada, because the Port Arthur market is a little more biased towards heavy Canadian -- heavy crude because of the coking facilities that the refiners have there. We're working with both CN and CP. The CP can originate Western Canada and Bakken over Kansas City. And CN can originate Western Canada over Jackson, Mississippi, which is our main interchange point with CN. But certainly, CN gets down into to the Gulf Coast, so they will be delivering crude oil to their own termination facilities, but they don't get to Port Arthur. And Port Arthur wants the crude. So we would expect to take Western Canadian crude to Port Arthur over Kansas City and Jackson.

Operator

Our next question comes from the line Scott Group of Wolfe Trahan.

Scott H. Group - Wolfe Trahan & Co.

So a couple for Pat first. In terms of the new auto plants coming online over the next year or so, can you -- when do we get a sense on if you guys are going to be moving those volumes North to the border? How do we think about that? And just one other thing on Mexico for you, Pat. How does your network align if we start to see a shale and oil development down in Mexico?

Patrick J. Ottensmeyer

Okay, on the autos, Scott, I think as I said, our network is very well positioned, if you look at where these vehicles are made and where they want to go, which is the population centers in the U.S. About 80% of the vehicles generally at these new plants are going to go for export, and most of that will be U.S., some Canadian, Eastern Canada, where, again, we've got -- our network is very well oriented to move into Eastern Canada and some to South America. So we will move some of these vehicles to Lázaro Cárdenas. In fact, one of the manufacturers we're looking at using Lázaro Cárdenas, moving onto vessels to go to the West Coast of the United States. So the distribution pattern is different for each plant. But again -- and the awards have not been made, so we can't be very specific about market shares and routings and all of that at this point. But our network really is the main attraction and just very well oriented to move these vehicles from where they're made to where they're going to be sold. Same thing, though, for our parts. We move a lot of auto parts down into these plants, both from the U.S., the Great Lakes region, as well as from Asia coming in through Lázaro Cárdenas. Second, on crude oil, in Mexico, we get pretty frothy when we think about the opportunities here. And I don't know if you've seen this. In some of the presentations I've given recently, I show a photograph, a Google Earth shot, that I saw a few months ago flying down to Mexico. Then if you look down on a clear day in South Texas, you see just dozens or hundreds of little white dots on the landscape which are all the drill pads in South Texas. Then you cross the Rio Grande and there's nothing. So you know there's oil and gas in that part of Mexico. In fact, some of the geological estimates say that Northern Mexico has more significant, more substantial reserves than the Eagle Ford region in Texas. We're very well positioned to serve that, both with crude oil and frac sand and other materials going in. So as Dave mentioned, the current administration is very interested in opening that market and exploring that opportunity with private capital. We don't know exactly what that's going to involve or the timing, but if they do open up, and you see northern Mexico develop anywhere near where the Eagle Ford region is today, that will be a big opportunity for us. We've already started talking to potential partners, transload operators, who are very interested and eager to get into that market. But the timing of that is uncertain at this point. It could be big.

Scott H. Group - Wolfe Trahan & Co.

Yes, that's great color, Pat. Just to follow up real quickly on the auto question, because there are new plants, do you feel like you can have better...

Patrick J. Ottensmeyer

Scott, you've had your 2. It's gone long. The next caller.

Operator

At this time, we've reached the end of our allotted time for Q&A. We have time for one final question, which should be coming from the line of Jason Seidl of Cowen.

Jason H. Seidl - Cowen Securities LLC, Research Division

A quick question, and it's more regarding on the capital spending side. One, with all these auto plants coming online, are we going to see a slight uptick in some of the spending for you guys? And if so, where?

David L. Starling

This is Dave. I think you're going to see it. We're already starting to accumulate AutoMax cars. That's the preferred car for the Mexico auto manufacturers that provides a lot of protection. It's got a very high utilization. We've been able to run that car in closed loops between some of the plants down to Lázaro for export and bring imports back in. So we've added substantial cars this year. You'll see us continue to do that. We're also relooking at our grain fleet. We have a lot of older leased cars. We may start to roll out of that. That may be one group that we want to perhaps own 50% of the cars. Fortunately for us, on the crude side, all we have to do is provide locomotives, so we're well positioned at the locomotive side. We've got pre-approval from our board to upsize our local fleet based on opportunities or revenue. So it's going to be a moving target, but it's all going to be justified by growth.

Jason H. Seidl - Cowen Securities LLC, Research Division

Okay. And the next question is actually one -- is an incoming one that I just got. With the auto plants relocating, I mean, is it going to shift the supply chain around for where the parts are going? And do think that you might lose some of your parts traffic anywhere or are you going to potentially pick up some parts traffic?

Patrick J. Ottensmeyer

I think we will pick up some parts traffic. And initially, I think you'll see it coming from Asia to the port of Lázaro. But we don't see anything in the distribution, the flow of parts to the plant that we're serving that are going to be negatively affected by the new plants. We think we're going to get growth in parts, in steel. We're already seeing it. I think I showed 2 or 3 quarters ago an update on the steel plants that are being built in Mexico to serve the new plants, the new auto plants. So at this point, we kind of see that whole ripple effect as being a positive for us.

Operator

Mr. Starling, I turn the floor back over to you for closing comments.

David L. Starling

I know the call has gone long. And I appreciate everyone's patience. And I appreciate you keeping it down to 2 questions. I think it's helped everyone participate. We hope that the length of the call is because everyone has a lot of interest in our company and our growth, but we look forward to talking to you next quarter. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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