Kansas City Southern's (KSU) CEO Dave Starling on Q2 2014 Results - Earnings Call Transcript

Jul.18.14 | About: Kansas City (KSU)

Kansas City Southern (NYSE:KSU)

Q2 2014 Earnings Conference Call

July 18, 2014 08:45 AM ET

Executives

Dave Starling - President and CEO

Pat Ottensmeyer - EVP of Sales and Marketing

Mike Upchurch - EVP and CFO

Jose Zozaya - Executive Representative and President, KCSM

Analysts

Chris Wetherbee - Citi

Bill Greene - Morgan Stanley

Thomas Kim - Goldman Sachs

Jason Seidl - Cowen & Company

Justin Long - Stephens

Brandon Oglenski - Barclays

John Barnes - RBC Capital Markets

Jeff Kauffman - Buckingham Research

Tyler Franz - Raymond James

Cleo Zagrean - Macquarie

Operator

Greetings and welcome to the Kansas City Southern Second Quarter 2014 Earnings Call. At this time, all participants are in the listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

This presentation includes statements concerning potential future events involving the Company, which could materially differ from events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the Company's Form 10-K for the year ended December 31, 2013, 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 Web site, www.kcsouthern.com.

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

Dave Starling

Thank you and good morning. Welcome to Kansas City Southern's second quarter financial results. Joining me this morning are Pat Ottensmeyer, EVP of Sales and Marketing; Mike Upchurch, EVP and Chief Financial Officer. And José Zozaya, KCSM’s President and Executive Representative is joining by telephone and will be available for questions later-on on the call.

I will handle the operations segment this morning and by now I am sure everyone is aware that the changes have been lead in KCS’ operations department. And for the time being the section has under operations report directly to me. While all the Class 1 railroads had faced challenges this year, KCS’ operating metrics have remained strong, actually among the best in the industry. We have excellent people in place at levels throughout our operations department and they continue to perform at a very high level.

Most of you know that my rail background and first and foremost in operations. To this day I enjoy being out on the railroad and joining the morning operating conference call. While I don’t see this as a career change for me, you should understand that we will take our time to ensure we get the organization and the personnel right. We were looking ahead to a new tranche of business opportunities at KCS over the next five to 10 years in its imparity that the transportation organization is working in collaboration with finance and marketing to ensure optimal service to our customers and profitability for our Company. Teamwork and respecting your counterparts is not negotiable.

Okay, let’s turn now to a second quarter overview. KCS reported a 12% year-over-year increase in revenues. It has been the case for the last few quarters the revenue gain was primarily driven by grain, which was up 58% in the second quarter. Revenues from our five strategic growth areas were up 18% and accelerated significantly from the first quarter. Pat will provide more color about some of these areas in a few minutes.

Our solid business growth was complemented by equally strong operations. Together the two were the primary catalyst (taking) [ph] as recording a 67% adjusted operating ratio, a whole 2 point improvement from a year ago. Finally, the second quarter adjusted diluted earnings per share of a $1.21 was 26% higher than last year.

Briefly turning to how we have performed year-to-date relative to our January guidance. You see that we are right on target on our mid-single digit volume forecast, having grown 5% through the first six months. Revenue growth of 11% was a bit higher than our high single-digit projections. However, when you exclude the outsized year-over-year impact of grain, our increase was 7%. I feel we have been consistent in our message that first grain revenues would show strong year-over-year growth of the second half of 2013 through the first half of 2014. And second, the grain comparables will get very hard in the second half of 2014 through the first half of 2015.

The severe drought of 2012 has had an abnormal impact on grain comparables and we're moving back to more traditional measured growth in grain. So far year-to-date KCS has improved its adjusted operating ratio by 1.9 points. We expect to hit our target for 2014 of a 1 point to a 1.5 improvement or even a little better.

Finally, KCS adjusted diluted earnings per share increased 22% year-to-date, outpacing our mid-teens projection for the year. While we're pleased with our first half EPS performance, we are not prepared to change our guidance for the full year. There is a few reasons for this.

I have already discussed the grain comparables get harder in the second half. In addition, we just don’t have clear enough visibility on our coal business in the months ahead. You'll remember that one of our utility customers closed down a number of generating units after September last year. We don’t know if that will happen again and we don’t know if some of our utility customers will seek to expand their whole stockpiles as a hedge against rail service issues with originating carriers that have impacted cycle times in 2014. In short, while we expect the second half to be good for us, there are a few variables which will impact our growth rate and that leads us to remain cautious.

The next chart illustrates that KCS continues to achieve excellent productivity as measured by carloads per employee. KCS remains an industry leader in this area (whilst) [ph] it’s maintaining its good, efficient operations. It’s no secret that the rail industry as a whole is battling through a number of capacity challenges which will take some time to resolve. Nevertheless, in the face of these challenges, KCS continues to provide solid operating performance and as the industry works through its issues, we expect KCS operations to improve further and then be an industry leader in areas highlighted on this slide.

With that I will turn it over to Pat.

Pat Ottensmeyer

Thanks, Dave. Good morning everyone. I'll begin my comments on slide 10. As you heard earlier, revenue for the second quarter was 649.7 million on volumes of 573.6000 units, both are new quarterly records for KCS. Revenue per unit increased by 5%, due primarily to increased length of haul as our cross-border revenue increased by 24% versus last year. Major factor in the RPU growth was the strength in cross-border grain. Foreign exchange was a slight negative during the quarter, reducing revenues primarily in our automotive business unit by about $5 million or about 80 basis points.

Moving to the major business units, as you can see on this slide, except for energy, we have very strong growth across our entire portfolio. Chemical and petroleum revenues increased by 6% on volume growth of 3% versus last year. All major commodity groups have growth in this group with particular strength in petroleum shipments in Mexico and agricultural chemicals in the U.S. Our Industrial and Consumer business recorded revenue growth of 10% on a 7% increase in carloads. The headline here was our metals business which represented about 85% of the revenue growth in this business unit.

Revenue in our metals and scrap business grew by 21% on a 17% increase in volume. In the past, you have heard us talk about the growing number of steel plants in Mexico and the strength in Mexico auto manufacturing and our performance this quarter is a consequence of those factors. Our housing and construction related business were also very strong during the quarter with revenues in our lumber and plywood commodity group increasing by 35% compared to last year. Our Pulp and Paper business was a bit weak with both volumes and revenues lower by less than 1% from last year. We did see some extended downtime as some of the paper plants we serve which we expect to improve over the remainder of 2014.

As was the case in the first quarter, our Ag and minerals group were the star performers this quarter with revenue increasing by 33% on volume growth of 21% from last year.

Revenue per unit was up 10% due largely to an increase on our cross border shipments [Technical Difficulty] higher than last year. The payments and earlier revenue in our grain business increased by 58% from last year and I can also tell you that our cross border grain revenues increased by 89% from 2013.

The story here is very similar to what you heard last quarter and that would be easy comps. Due to the drought of last year you all know the story about the first half, first eight months of 2013 and this will begin to change as Dave mentioned in the third quarter. Although as you’ll see in a minute we are increasing our full year outlook for Ag and Min based largely on year-to-date performance rather than a significant change in the outlook for the second half of the year. As I mentioned earlier our energy business unit was the only area where we saw weakness from the prior year and that weakness was in both utility, coal and crude oil, where revenues fell by 7% and 37% respectively from last year.

No doubt that our utility coal business could have performed better this quarter, were it not for congestion and service problems experienced throughout the North American rail network. We’re not going to attempt to quantify the impact here but the good news is this, we do believe that there could be some additional volume and revenue coming in the months ahead above normal seasonal trends as utilities build stock piles from their current low levels. Service improvements will be the key to realizing that opportunity.

The crude oil story this quarter is very similar to what I reported at the end of the first quarter, we experienced a dramatic shift away from light, crude moving through the Gulf Coast due to new pipeline capacity coming on-board. In April I reported that the impact of this would be most pronounced in the first quarter and second quarter and that we will see some improvements in the comps in the second half of the year as new terminals for heavy Canadian crew become available and operational. That is still our view.

Frac sand business continued to show strong growth trends with revenues and volumes increasing by 21% and 27% respectively. Intermodal revenue grew by 14% on volume growth of 7% versus last year. Cross-border revenue in our intermodal business grew by 30% from last year. Our domestic U.S. intermodal business was also quite stronger and shorter with revenues and volumes growing by 29% and 18% respectively. This is primarily our Dallas business to and from the Southeast and mid-Atlantic region. Revenue growth related to our Lázaro Cárdenas intermodal business was 6.4% higher compared to last year.

Finally revenues in our automotive business unit increased by 25% on volume growth of 23% versus last year. Foreign exchange had a negative impact on revenues of about 5%. Revenue and volume growth this quarter were both positively impacted by favorable comp from last year due to an extended outage of plant we serve in Mexico.

We estimate the impact of this to be about $3.7 million, in other words had that outage not occurred, revenues last year would have been about $3.7 million higher than what we reported. We are clearly beginning to see the benefit of the new auto plants in Mexico including the growth in cross-border revenue in this group. Cross-border revenues here were up 71% from last year.

Moving on to slide 11, as I mentioned earlier our cross-border revenue increased by 24% from last year to a new record level of $163.2 million. We saw a growth in all major business units except for industrial and consumer which was down slightly due to a decline in cross-border paper shipments. The major growth drivers here were Ag and Min which was up 54% including cross-border grain which I mentioned earlier was up 89% from last year. Intermodal was up 30% and automotive while smaller than the others grew by 71%.

Moving to Slide 12, you can see the profile of the five strategic growth areas that we’ve highlighted in the past. Collectively they grew by 18% during the quarter, in spite of the 37% decline in crude oil from last year. I will point out the crude oil currently represents less than 5% of the total revenue from these five commodity groups and less than 1% of total (KPS) [ph] revenue. The reasons I mentioned a moment ago we feel as the negative comps for crude oil will begin to improve in the months ahead. The key point from this slide is that our main growth markets continue to produce oversized growth and the outlook for each is very positive. At some point in the future we will add Mexico energy markets and Gulf Coast ethylene opportunities to this slide. And I’ll show you more about that in a few minutes.

Moving to Slide 13, we’ve updated our outlook for freight revenue for the full year of 2014. As you can see the only change we have made from what we discussed with you in April is an increase in the outlook for Ag and Minerals from single-digit revenue growth to our current view which is for double-digit revenue growth for the full year. As I mentioned earlier this is driven primarily by strength in the actual year-to-date results which were better than our previous outlook and some improvement in the third quarter outlook.

The year-over-year comps begin to get much more difficult in August, September timeframe as the third quarter and fourth quarter of last year were very strong for our grain business. The only other business units that I will explain here is energy where we’ve seen year-to-date revenue about 1% below last year but we are still expecting single digit revenue growth for the full year.

We are expecting utility coal comps to be flat in 2013 in the second half of the year which would be an improvement to what we’ve seen so far. As I mentioned earlier, we could see some potential upside based on rebuilding stock piles from current low levels but that will be dependent upon improvements in the cycle times we are currently experiencing.

Finally, our crude oil comps will improve in the second half of the year for reasons I’ve already covered.

And now just talk about the other business units, there really is no change from our previous commentary and our full year projections and expectations shown here are very consistent with the year-to-date results in each of those.

Now moving onto more fun stuff, on slide 14, very pleased to talk more openly about our plans for the Port Arthur crude terminal and specifically to inform you that we have finalized negotiations and executed agreements with Global Partners LP to develop a 200 acre site on which they will build a rail terminal to handle heavy Canadian crude oil. I am sure most of you saw our joint press release with Global from July 8th, if not, it’s still on our website so you can take a look at that.

Slides 14 and 15 provide a high level summary of our agreement, a little bit about Global, which is a publicly traded master limited partnership and a current drawing of the planned rail terminal. I am sure you’ll have a lot of questions which in the interest of full disclosure now we will probably not answer to your complete satisfaction. We are not in a position to share revenue or volume projections with you at this time. Here is what we’re prepared to say. We feel the Global is an excellent choice as a partner on this project since they have developed a successful business model in the East and on the West Coast, which they intent to replicate here in Port Arthur. They’ve told us that this project is part of their three-coated strategy and they share our excitement about the potential for Port Arthur and the U.S. Gulf Coast markets.

Global’s initial focus will be to deliver heavy Canadian crude oil to Port Arthur and the U.S. Gulf. We’ve talked with you previously about the size of that market and the potential for crude by rail which we continue to believe is substantial. At this point, we do not know the specific origins or gateways that we will be using but believe it will be a combination of both Canadian Pacific and Canadian National origins and over the multiple KCS gateways.

As you can see on slide 15, the initial terminal design will be capable of handling two 120 car unit trains per day and 340,000 barrels of storage capacity with water front access to serve the local refineries by barge. Given permitting and construction uncertainties associated with a Greenfield site such as this one, we are currently expecting a completion date of late 2016 or early 2017. I can assure that Global will be very happy to open sooner than that if all goes well through the process. Between now and then however Global will be aggressively pursuing business opportunities in this market and will be using other KCS terminals and facilities in the area to handle that business.

That's really about all the detail we are prepared to provide at this point, we just like to reiterate that we are very excited about this long term opportunity and pleased to have commenced our partnership with Global on this project.

Moving to slide 16, we have more fun stuff to share with you. Since our first quarter earnings call, there have been public announcements of two additional new auto plants to be built in Mexico over the coming years. Of course you are all familiar with the Nissan, Mazda and Honda plants that have been opened in the last few months as well as the Audi plants that is currently under construction in Puebla. In the last 90 days, both Nissan and Infiniti in a coproduction arrangement with Mercedes Benz and BMW have publicly announced plans to build new plants in Mexico.

The Infiniti and Mercedes plant will be located in Aguascalientes where the other Nissan plants are located, the new BMW plant will be located in San Luis Potosi on the KCSM network and very close to our (inter port) [ph] intermodal facility. As you can see on this slide at full announced production levels these two new plants will add about 450,000 new vehicles to the current Mexican production capacity. When we include the 173,000 vehicles at the new Audi plant which will open in 2016, these three facilities will represent an increase of about 15% in Mexican auto capacity.

At this time it’s too soon to know how these facilities will impact our volumes and revenues and routings, however based on preliminary discussion with these producers we believe the impact of these new plants will be to extend the time period for superior automotive growth for KCS. I’ll talk about that in a second. Even better news is that we believe there will be likely be more new auto plants announced in Mexico possibly even in the near future.

Moving to slide 17, we introduced this slide in our earnings presentation for the first time last quarter. Just to remind you what we are trying to illustrate here is the time period during which we are expecting superior growth for each of our key long term strategic growth areas. Since this slide focuses on longer term growth opportunities some of which are not yet producing revenue or volume, we have added Mexico energy markets and Gulf Coast ethylene plants.

Based on the two new automotive plants announced in Mexico, as I just mentioned, you can see that we have extended the period of expected superior growth for automotive beyond 2018. Just a couple of other comments, you can see that we expect superior growth in crude oil beginning in 2015 even though we do not expect the global Port Arthur facility to be completed until 2016 or 2017. The reason for this is that we will have other new facilities in the Port Arthur, Beaumont and Baton Rouge markets opening in late 2014 or early 2015 that we expect to drive this growth.

Finally, I'll wrap up with slide 18, since I've covered most of these points already, I'll just make a few closing comments. We see no significant change in the economic outlook in either the U.S. or Mexico for the rest of the year. The GDP forecast you see here are down a bit from what we showed in the first quarter and based on most recent estimates for the U.S., they are down even a little bit below what we show on this slide. But we certainly still see evidence of economic growth for the rest of the year. I have already talked a lot about grain and Mike Upchurch will get into more detail about the impact of the second half grain comps on our guidance for the full year revenue which is as Dave Starling covered earlier, our outlook for full year revenue growth remains in the high single-digits area. While our official outlook for coal is to be flat for the second half as I mentioned earlier, there could be some upside if the cycle times improve and utilities are able to build inventories.

One thing I haven’t mention yet is pricing. We still believe that the pricing environment is positive and we continue to expect the price increases will be above inflation. If we look at all of the contracts or rate quotes, that we renewed during the second quarter, our weighted average rate increase was 3.6% that’s different than same-store sales and that is an indication of what we can expect to see in the future based on rate adjustments that were agreed to during this last quarter.

I'll close by saying that our new business pipeline continues to be strong and growing and we still believe and feel very good about our long-term growth prospects. And with that I'll turn the presentation over to Mike.

Mike Upchurch

Thanks, Pat. Starting on slide 20, our second quarter volumes grew 7% and revenues 12%. Excluding the negative impact of foreign exchange revenues actually would have been up 13%. Our adjusted operating ratio improved twofold points to 67 and good expense management led to incremental margins in the quarter of 44%. Our adjusted EPS grew 26% during the quarter, representing strong adjusted operating income of 20% and lower adjusted effective tax rate resulting primarily from discrete items in the second quarter of 2013. Our effective tax rate for the second quarter was 33% and we now expect full year effective tax rate to be approximately 34%.

And it might give you just a little color behind the lower tax rate in the second quarter. We did benefit from a one-time discrete item which lowered our effective tax rate by about 1% in the quarter but for the full year that gets blended and we still expect to be around 34% for the year.

For additional details on our condensed quarterly income statement, please refer to that information back in the appendix. On slide 21, we just wanted to help reconcile our reported to adjusted EPS. As you can see in the second quarter, we did have a $0.05 charge related to lease termination cost which resulted from the purchase of $171 million of equipment under lease.

This program continues to allow us to generate improving income statement result not only in operating income but net income. In the second quarter of 2013, we incurred sizable debt retirement cost of a 111 million that negatively impacted EPS by $0.70. These costs were incurred in connection with our refinancings after we achieved our investment grade credit ratings. And during the second quarter of 2014, we did generate a $0.04 gain primarily from currency hedges which more than offset a slightly negative impact to income taxes from the currency revaluation of our U.S. dollar debt Mexico. And then in comparison, we incurred a net $0.12 charge in the second quarter of 2013 related to items.

On slide 22, our adjusted operating expenses excluding the lease termination cost of 8 million, increased 9%. I will cover more specific details on our expense changes in the following slides but volume based drivers were clearly the largest contributor causing about 60% of our expense increase or $22 million for items such as crew labor, fuel consumption, repairs and certain purchase services such as trackage rights, lift charges, switching and joint facilities charges.

Lastly I might point out that foreign exchange benefited expenses by 5 million and had no material impact on operating income given the negative we saw from foreign currency on revenues.

On Slide 23, our compensation expenses increased 6 million due to higher operating headcount to support increased volumes and wage inflation of 4 million, while FX reduced expenses by 2 million.

And as you can see in the bar chart our quarterly average employee headcount increased 2.3% which is still far below the 7% volume growth we experienced in the quarter evidenced that we continue to efficiently manage our labor costs.

On Slide 24, purchased services increased 13 million, largely from volume based expenses, again things such as joint facilities, switching car maintenance, trackage rights and intermodal left which contributed about 6 million to the increase. We did have higher track repairs and maintenance of three and legal and consulting fees were up year-over-year by 2 million.

Turning to fuel on Slide 25, we saw fuel expenses increased 15 million or 16% and that was largely driven by increased volumes and GTMs. GTMs in the quarter increased 12% from a year ago and is reflective of increased long haul grain shipments. Price also contributed to a $5 million increase in fuel price as we saw the price per gallon increase $0.08 year-over-year and that was largely the result of increase in fuel prices in Mexico. And then FX and efficiency gains reduced our fuel expense by a total of 3 million.

We did have a slight negative lag impact of 900,000 in the quarter again largely because of increasing fuel prices in Mexico.

Slide 26, we introduced this format in the last quarterly call our equipment cost continued to decline as we purchased more equipment under existing lease and replace the expiring leases with purchased equipment. Specifically we saw equipment cost decline 9 million year-over-year while depreciation increased 4 million creating a net $5 million benefit in operating income.

On Slide 27, I wanted to share a few details about our planned use of cash that we’re generating from our operations. First and foremost we will continue to invest in our business to support these growth opportunities that Pat discussed earlier. And as we guided to on the first quarter call, we continue to estimate we will spend approximately 28% of our revenue on capital this year.

Second, our next priority will be to provide shareholder returns via dividends. As you know earlier this year our Board of Directors approved a 30% increase of our dividend.

And then lastly we will continue to be selective in terms of purchasing leased equipment that is both earnings accretive and generates positive NPVs. During the quarter we purchased an additional 171 million of locomotives and equipment and now have increased our ownership percentage from roughly 20% a couple of years ago to 50% and in total have purchased in excess of $600 million of leased equipment.

On Slide 28 and 29, I wanted to provide a little bit more detail on our guidance. As you can see in the bar charts we have reported strong revenue growth of 10% and 12% in the first and second quarters respectively. However as illustrated in the black portion of the bars we have seen a significant boost to our revenue growth rates as of the result of easy grain comparisons which added 5% and 4% respectively to the first two quarters of the year.

Currently despite strong crop conditions we expect grain revenues to be flat in the back half for the year, thus eliminating a sizeable portion of our first half of the year 2014 growth rates. Additionally due to continued uncertainty about a significant coal customer shipments in the back half of the year and natural gas prices now hovering around the $4 range, we believe our coal revenues could also be flat over 2013 levels. Accordingly we are confirming our high single-digit revenue guidance we issued back in January and we’ll continue to keep you posted as our coal and grain situation becomes more clear.

Finally on Slide 29, given the commentary about our grain and coal revenue projections, we currently believe third quarter EPS will be up low double-digits compared to the 22% year-to-date increase that we’ve seen so far. And just for clarity we do define low double-digits as the range of 10% to 13% and believe that we’ll be at the upper end of that range for the third quarter.

For now we believe we can achieve the upper end of our mid-teens full year EPS guidance but if grain and coal shipments do accelerate over our current forecast and July is off to a reasonably good start, it is possible we can deliver upper teens EPS growth for the year.

So with that, I’ll turn the call back over to Dave.

Dave Starling

Okay, thank you Mike. I’ll open it up for questions. I would caution everyone we’d like to keep it to one question and one follow up. We have a lot of people in the queue this morning. So out of respect of getting everyone’s question answered, please keep to the one question and one follow up. Thank you.

Question-and-Answer Session

Operator

We will now be conducting a question-and-answer-session. (Operator Instructions). Our first question comes from the line of Ken Hoexter, Bank of America. Please proceed with your question.

Ken Hoexter - Bank of America

Mike, Pat and Dave, thanks for the great insights here. But if we look at -- I just want to understand maybe your outlook here a little bit more on the grain side. Are you looking for volumes to turn negative or hold levels as we move into the back half? And then maybe a little bit longer term maybe if you can give insight on the volatility and we should expect as we move into 2015 and beyond for the two markets?

Dave Starling

Ken, I’ll start, and then turn it over to Pat. Last year we had a great harvest, great grain movements, we didn’t have as many of the congestion problems. Not all of the grain that comes to KCS originates on our system. So we are still dependent on origins that are off our line. So one bit of caution we have is some of the service related issues that could somewhat smooth out the harvest. As far as the harvest itself it looks like it’s going to be a record grain crop. Also what happens when you still have the service issues it does affect the car supply so there is nothing wrong with the harvest, there is nothing wrong with the potential movement of grain, we’re just unsure of what the philosophy is going to off our system and the car supply. Pat?

Pat Ottensmeyer

Yes, I don’t have a lot to add. I guess fairly consistent with what we said in the past we’re -- the comps are getting harder the second half is going to look a lot different than the first half. The third quarter should still be up because when we really didn’t see the strength last year until the backend of the third quarter but we think the fourth quarter could actually be down. Longer term grain has been kind of a slow growth market and when you introduce things like floods and draughts you get a lot of volatility. But over the long term it should be a slow growth market for us.

Dave Starling

And Ken to throw in a little more color I think one reason we’re having a strong quarter in grain now is because the grain has somewhat been smoothed out by the availability of cars and service. So we’re having a stronger quarter than we normally would simply because there is still grain in the elevators to be moved from last year’s harvest.

Ken Hoexter - Bank of America

And that was actually the reason for the question, because it looked like third quarter should still see some nice -- at least uptick relative to the slower third quarter start last year. But then Pat, I appreciate that on the fourth quarter.

And then my follow up just on lease conversions, Mike you mentioned what you spent so far you’re now up to 50%. Is there a target or a timing for additional conversions?

Mike Upchurch

Yes, I think as we indicated a few years ago when we started this effort it would likely take us five to eight years to really execute that strategy. We’re roughly three years into it. I think as we look out over the next two to three years, we’ll probably be able to complete that and move that low 50% range to maybe somewhere in the mid-60s, which would be a target. And that’s about what the ownership has progressed through the industry.

Operator

And the next question is from the line of Allison Landry of Credit Suisse. Please proceed with your question.

Allison Landry - Credit Suisse

I realize that this is somewhat early but I was wondering if you could give us any insight with respect to the ethylene plants coming online in the next few years. And if there is any ballpark for whether you’re in any serious discussions with customers? I know in the past you’ve mentioned that you were doing test runs with one potential company that’s building a facility to move in polyethylene to Asia near the Port of Lázaro. Have there been any other discussions or developments like this with other potential customers and do you have any sort of broader thoughts on the role that rail could play in exports?

Dave Starling

The punch line I guess is still too early to quantify volume, revenue, routings all of that stuff. We are in serious discussions with a couple of producers. Still believe that this is going to be a very sizeable opportunity for us, both in potentially in hopper car business as well as intermodal picking up on what you said, we are having discussions with a couple of producers in the Gulf Coast really at the stretch between Houston and Corpus who are interested in loading these containers and/or these products in intermodal containers for shipment to Mexico, South America and Asia.

So it’s just too early to know how this is going to affect us but we are in pretty serious discussions with the couple of major producers and hopefully we’ll have more to share on that over the course of the next few quarters. Believe it still is going to be a big opportunity for us and we’ll have more information to share as we get more insight.

Pat Ottensmeyer

Might add Allison that we do have property in that area, we think we are very strategically located with some of our yards in that area.

Dave Starling

And again the timing of this as we’ve indicated on the chart is really a 2016, 2017 for the bigger plants, bigger customers that we’re talking too, these plants all take, facilities all take a long time to build and this is still two to three years out.

Allison Landry - Credit Suisse

I apologize for the multiple questions within the question. But if I could just squeeze one follow up and then this will be quick. But Pat I assume that when you’re referring to the potential for more auto plants to be announced. Kia recently stated that its seriously considering building a 300,000 unit facility in Monterrey by 2017? I was wondering if you could share any thoughts on the probability of that.

Pat Ottensmeyer

We’ve read those reports, I think it’s probably likely that there will be an announcement sometime soon but at this moment it’s still not official.

Operator

Our next question is from the line of Scott Group of Wolfe Research. Please proceed with your question.

Scott Group - Wolfe Research

Want to ask about the implications of the guidance for the third quarter. Is there anything unusual that’s keeping you -- I think we all understand that the grain comps getting tougher, but grains, that was an easy comp and we shouldn’t expect that going forward. But is low double-digit, low teens is without grain, is that the right way to think about the earnings growth going forward or is there something unusual in the comp or that you're not expecting this quarter that’s limiting the earnings growth this quarter?

Pat Ottensmeyer

Well Scott remember our guidance was for mid-teens EPS growth for the year and I did make a comment that we’re at the upper end of that guidance. And if possible, we could do better than that depending on what happens with the grain shipments and coal. And the dark cores with coal as we’ve seen over each of last two years with a significant customer and natural gas now being $4 I think it actually dip below 4. What impact is that going to have on our volumes? So those are the unknowns for us but don’t read too much into that, we did say upper end of our mid-teens guidance.

Dave Starling

I might add to that Scott, we wish we could tell you more about coal. We know the demand for coal is right now is high at the plants we have because some of the stock piles are low, so if more coal could come through the pipeline, we could move it. So we don’t control that and that’s why we have to give you the message the way we are. If we control all the way to the origins we would probably be changing the guidance, but we don’t so until we have a more clear picture of how that coal and grain and are going to move we think we’re being very honest with you.

Scott Group - Wolfe Research

And then just last question Dave or José on the line. Can you give us an update about on the legislative front of Mexico and what you’re expecting in the back half of the year on that?

Dave Starling

Yes, I’ll take that one and then José can comment. We are working with the government in Mexico today. We think we are making good progress. We think our message has been delivered on the importance of the railroads in Mexico. They are reading that loud and clear and we’re very hopeful that we’re going to come out with a good solution sometime later in the year. But right now I am not losing any sleep at night. José.

Jose Zozaya

I just complement that we are in a very much better position now that where we were at the beginning of all this discussion with the expectations that the senate starts again; we adjourned the discussions with them with a different point of view from senators and deputies.

Operator

Our next question is from the line of Christian Wetherbee of Citi. Please proceed with your questions.

Chris Wetherbee - Citi

Pat maybe we could just start maybe on the crude side. Just want to get a rough sense of sort of the walk up to Port Arthur's opening, (I guess you said) 16 potentially 17. You obviously have it as strategic growth initiatives starting in ‘15. Can you give us a little bit more detail on maybe some context of how we should think about that volume opportunity starting in ‘15 and others Beaumont Baton Rouge and a few other opportunities or a few other destinations opening up? Just give us some color around that that would be very helpful.

Pat Ottensmeyer

Okay, well as I mentioned we’ve got a couple of facilities Beaumont, another facility possibly in the Nederland Port Arthur area and then Baton Rouge which we expect to start delivering crude, hopefully in the fourth quarter of this year. So we could see a ramp over the course of 2015 again depending on the timing of these facilities opening that could start with three to four trains a month and grow from there over the course of the year and then as the Port Arthur facility opens up, obviously that’s going to add a lot of additional capacity. But I think it’s going to be a bit of a slow ramp, could start seeing some things moving in the fourth quarter of this year and then into 2015 and just kind of ramping up over the course of the year.

Chris Wetherbee - Citi

Okay, that’s helpful and then may be a follow-up. Dave, just thinking of setback and thinking about the operations and open it through a margin potential or sort of potential of the business as you look out over the next couple of years as you are sort of going to be in-charge of this side of the business for a little bit of time here. How should be think about the opportunity? I know we have the 1 to 1.5 points for this year but when you look at sort of the other players in the industry and where they are sort of at or targeting from a margin perspective, is that something that you should be, is that sort of a target for you as well? Is that something we should be thinking in the same context, are there may be limitations or better opportunities?

Pat Ottensmeyer

Well we've got some contracts in Mexico we will be working on this year on the locomotive side it will benefit us going into next year. But with the money that we we've Chirs on expansion capital and the locomotives we're adding. I think it’s going to be a combination of revenue growth and improved operating metrics that our operating ratio should continue to improve. We've been very reluctant to throw some target out there where we are going to be five years from now. I think what we've done over the last five years coming from the 82s, down to the area of 67, I think we'll continue that march but we are not going to throw a target out there.

The other question you have that I think all of us have to be cautious of, if we have an opportunity to look at business that fits well in our network and is an area that we have a lot of capacity, you got to be careful that you are always looking at the operating ratio. Revenue and margin are wonderful things. So, I think we may take a little bit different look at it but there is no doubt we'll continue to improve. We are not going to set a goal out different than we've done in the past.

Operator

The next question comes from the line of Bill Greene with Morgan Stanley. Please proceed with your question.

Bill Greene - Morgan Stanley

Mike, can I ask you to comment a little bit more on the CapEx, 28% of revenue it’s a big number, presumably there is some equipment in there too. But you've only sort of targeted (Europe) [ph] 5% or so volume growth number. So, is this the anticipation of sort of 2015 and beyond having much higher growth rates in traffic or is this a catch up or is it just related to the equipment cost and will come back down to a more normal level?

Mike Upchurch

Yes, Bill I think last quarter we talked a little bit more about the specific issue. We added -- we're ordering 85 new locomotives this year and certainly some of that’s related to, they are all incremental by the way in that replacement because of our view of traffic on a longer term basis particularly going into 2015. And then remember the tier 4 requirements kick in on January 1, so these units are actually about 15% cheaper than the tier 4 and that was the reason we stepped up the capital this year.

Bill Greene - Morgan Stanley

So, do you think you will be able to deploy these in a way that’s going to be incremental or is this just because of a regulatory decision that you kind of hold forward some CapEx?

Dave Starling

Bill, this is Dave. 45 of those locomotives will be delivered in the third and fourth quarter, so they are really being purchased going in to 2015. I don’t know if you heard or not but we're being told that EMD will not build a tier 4 locomotive in 2016. So, you're going to have one supplier that’s going to build locomotives in 2016, so all of us are very concerned that the order book is going to be filled and the volume is going to be there which we think it will. And the last thing we want to do is be short of locomotives and turning down revenues. So, we're going to be aggressive on locomotives for this year and you will see us into ‘16 as well.

Bill Greene - Morgan Stanley

Okay, fair enough. Thank you. The other question I had was on capacity and pricing, so when we look at a lot of the different parts of the overall transport network now, we're starting to see congestion and some tight capacity in various markets. Does the same go for cross-border and for Mexico? Are we seeing the kind of driver shortages and inability to get truck transportation there that would create either a more substantial volume opportunity for you or a pricing opportunity for you?

Dave Starling

Not within Mexico, Bill, but certainly cross-border on the U.S. side. All of those factors are helping to drive our growth, so we think that we will have some benefits, some opportunities because of those factors on both driving our volume growth and the rate environment.

Operator

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

Thomas Kim - Goldman Sachs

Hi. On the auto side, can you break out how much of the growth came from the new plant that opened in Mexico? And then to what extent the [indiscernible] facility contributes to growth that would be helpful? Thank you.

Dave Starling

We really don’t breakout by customer or a facility, but clearly we’re starting to see the three new plants ramp up, we did have some issues with one of them having a quality hold, but we don’t really break that out. As far as the General Motors question, again I’m not sure I understand your question about General Motors.

Thomas Kim - Goldman Sachs

It was just -- there was a line redesigned last year and I’m just wondering to what extent we’re now going to see that contribute to the growth as well?

Dave Starling

Well as I mentioned, it caused us some weakness in the second quarter of last year that we've quantified as 3.7 million that we think we lost last year because of some service issues, but going forward we should be back to kind of normal comps in the third and fourth quarter.

Mike Upchurch

Tom this is Mike. It was worth about 5 points on the growth rate, but that was then offset by the foreign exchange.

Thomas Kim - Goldman Sachs

Okay. That's great. And then just on the grain side, can you remind us what your mix is for cross-border and how much more I guess the length of haul actually is?

Mike Upchurch

Our cross-border grain in the -- cross-border is about 52% of our total Ag and minerals business. And as I mentioned, year-over-year cross-border Ag and Min was up by 54% and grain was up by 89%. And the length of haul and the RPU were obviously significantly longer on our cross-border business than our domestic either U.S. or Mexico.

Thomas Kim - Goldman Sachs

Right. And suffice it to say with an anticipated record crop again sort of this harvest season, should we anticipate that the length of haul -- do you some have specific capacity constraints that would inhibit your ability to continued benefits from more shipments to Mexico and obviously better length of haul?

Mike Upchurch

Well I think Dave in his comments that the Grain business is really going to be a function of the equipment availability not just on our local network, but across the industry and cycle times. So yes, I think with the inventories that are coming in to harvest and the harvest, the expectations for a very big crop, I think the whole industry is going to be somewhat constrained to handle and keep up with the grain demand.

Operator

The next question is from the line of Jason Seidl with Cowen & Company. Please proceed with your question.

Jason Seidl - Cowen & Company

Thank you. Good morning gentlemen. I want to go back to coal and grain in the near-term here; you guys seem to be a little bit cautious due to some service issues in the rail network as a whole. If they don’t improve considering its coal and considering its grain, could that just push where you guys actually start taking it on to maybe the fourth quarter?

Dave Starling

This is Dave. It's happened somewhat with grain into this quarter. Traditionally we would see a dip in grain, that's been fairly strong. As we said, the same thing could happen with coal. The other thing we don’t quite have a handle on yet in talking to some of our regulated customers, the regulators actually control the stockpiles. So when the rail industry was very, very efficient, then the stockpiles were 30 days. So there is an expectation now that the regulators may say because you got so short this increase that we need to increase the stockpiles to 45 or 60 whatever that amount is. Now we don’t have information that that's going to happen, but we know that many of our customers have gotten extremely low in their concern.

So that could be an opportunity even going into next year I’m trying to rebuild the stockpiles and even increase the base stockpile. So if that happens that's going to be good for us, it will be good for the industry.

Pat Ottensmeyer

It could result in sort of a leveling out of what we have in both of those businesses of what we normally see as sort of the seasonal impact at least for the next six to nine months.

Dave Starling

Now having said that you got to look at the flip side of it, we have unregulated plants that are trying to compete with natural gas, and the way the price of natural gas is going down again. So it’s such a mixed bag right now in coal. That's another reason that we are just reluctant to increase our guidance right now simply because of the uncertainty of what's going to happen in the coal world.

Jason Seidl - Cowen & Company

Okay, that's a good color guys, I appreciate that. And looking at a little bit longer term in terms of your capital needs, it looks like there is some longer term additional growth prospects that you guys have sort of added to your list. Where should we start thinking about the longer term CapEx levels for you guys and sort of where do you think that you might be constrained on either the equipment side or maybe even the yard side?

Dave Starling

Well, we’ve always done our long-term five, in fact the five year plan now we roll it from a quarter to quarter rather than take a snapshot once a year. So we’re looking at it quarter to quarter. We’ll be adding capacity this year in four of our yards. We do it all in phases. So we’ve got a five year plan for those yards so we kind of spread the capital, increase the capacity. We still have sidings we’re adding, sidings we’re extending. The one thing that we think we will get more aggressive on and it’s because of the unit-trains is we will get more aggressive on locomotives because we have to have power. The railroad share power but when one railroad in another part of our interchange point gets tight on power then they’re going to keep their power there. They don’t share as well.

So we have to be cautious that we are not a victim of not having enough locomotives to take care of our own system when the other railroads that we work with get tight on their own power. So I think you’re seeing all of us starting to spin more on locomotives. Because number one; the lead time will increase because and I’ll correct myself earlier I said EMD, I am dating myself as progress rail has purchased EMD so I apologize [indiscernible]. But it is a progress rail, so they are pulling out of the market for one year on (two to four) [ph] you may see some short term decisions for the railroad (settlement) [ph] power. I know everyone was tight this year. And that’s our life blood, you can’t pull it with power. So, I think you’re going to see us all purchasing power and making sure we have the sufficient amount even when our neighbors are constrained.

Jason Seidl - Cowen & Company

But you didn’t mention anything in the car side so you feel pretty good with your current car capacity?

Dave Starling

No, you’ll see us working out with a long term plan, that we'll present to our Board in November that will be a long term car order and it will have grain cars, auto cars. We’re looking across our commodity group, we don’t see this growth slowing. And we’re somewhat concerned that with what’s happening in the crude by rail industry that they're going to take a lot of the shop capacity in the U.S., building crude cars so we got to make sure that we don’t become a victim of not being able to get a car built. So we’re going to have a long term strategy putting together our needs for the next one to five years. And we’ll probably be able to talk more about that on our November fourth quarter call.

Operator

And the next question is from the line of Justin Long with Stephens. Please proceed with your question.

Justin Long - Stephens

First question, I wanted to ask about congestion. What do you view as the key to resolving the congestion issue right now? Is it more equipment that you just talked about? Is it investments in infrastructure? Or do you just need volumes to slow down a little bit to help balance the network?

Dave Starling

Well, we’re against volume slowing down, so you can -- we definitely don’t want that to happen, its capacity, its engines, its (cruise) [ph] and I think you’re seeing the railroads cooperate with each other. We always have but I think we’re very aware that we really are recognized as a system, as a network. So we’re handing detours rather railroads on the line where we add capacity the other railroads are detouring some trains for us where they have capacity. So I think you’re seeing the railroads work very well together and I applaud the BN for the billion dollars they’ve committed to stand-up in the Bakken. I think there is a recent article of Matt Rose in Railway Age that would be worth reading, where Matt talks about the volume just getting out ahead of the infrastructure and how it just it came so fast it was impossible to keep up with it.

So we’re all stepping up. I think there were four railroads, maybe five, that announced increasing their capital budget this year, so none of us are going to turn down volume or none of us are not going to react to the volume. So we’re all going to spend what we need to do to handle the volume because I just don’t see this railroad renaissance changing. This nation is not, this country is not spending money on the highways and bridges and I think the railroads are going to be rewarded for the capacity they’re adding. I know we've been rewarded this year already. We have not had some of the problems the other lines have had and I think it’s because of our capacity program. So we’re not going to slow down.

Justin Long - Stephens

Okay, great. That’s helpful. And as a follow up in terms of resolving the congestion issue, do you think it's something that we could see in the next couple of quarters, does it take longer than that? And also how does all of this impact the pricing environment? You mentioned 3.6% pricing on renewals in the second quarter. Is that the best way to think about the pricing environment going forward? Or just given the tightness we’re seeing in capacity across multiple modes of transportation. Could we see pricing accelerate over the next year?

Dave Starling

I think again looking at contracts that we’re currently in negotiations with and renewing it feels like our customers are more interested in securing capacity than pushing for rate increases. I feel like we’re kind of in an environment where we said the last few quarters low to mid-single digit pricing, pricing above inflation, I don’t expect that to change much. On the capacity and the service issues, we have just got to improve that kind of separately from the rate and the pricing discussion that shippers are across all modes of transportation, trucking industry, you are hearing a lot more about capacity issues and rail business is strong and capacity is getting more valuable. So, that should equate to people, shippers being willing to do what it takes on the rate side to secure capacity.

Operator

Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.

Brandon Oglenski - Barclays

Thanks guys and good morning. I am just going to actually going to keep it at one question here. Thinking about the cost side in the OR may be from a different angle. Mike, is there anything in the budget process that says well if we can sustain these growth rates, we do need to start taking headcount up, we need to start hiring ahead of this or when you laid out that initial guidance and I think you said in the last couple of calls, may be 100 basis points on the OR sustainable in the long run, if we get this type of better growth, can we see better leverage on that cost structure?

Mike Upchurch

Yes, I think so. We've always guided to the 100 to 150 basis points and given where we are at right now, we are going to be towards the upper end of that range. I mean we always have opportunities to take cost out of the business and I think we have commented extensively on the leased equipment. We've talked about third-party maintenance agreements that are expiring over the next few years that we think we can take additional cost out but it really does largely become volume gain where you have a certain fixed cost structure here, so if the volumes are scaling up at these levels, it should be good for our operating ratio.

Operator

Our next question is from the line of John Barnes of RBC Capital Markets. Please proceed with your question.

John Barnes - RBC Capital Markets

Good morning, guys. Nice quarter, two quick questions. Number one, I know you've noted that you don’t want to be out there with some target on the OR but I am just curious that with the amount of growth you've got coming on to the network, you played a very compelling case there. Is there any likelihood that may be that OR improvement takes a bit of a hiatus, as that volume ramps up and then begins to reaccelerate as you reach some critical level of volume in each of these opportunities?

Dave Starling

That’s a good point. There is no doubt there is stair stepping and when the volume comes, when does it come, I mean we have the gateway from Kansas City to St. Louis which is a very underutilized and in the last two years we've seen the business triple on that line. So, when you can do that on an existing asset that goes straight to the bottom-line, not straight to the bottom-line, but it's got a very good margin when you are on-boarding traffic in an area that’s challenged then it can cause your cost to go up.

So, yes there is no doubt you will get into some stair stepping but I think that’s just part of the business that always happens but we think operating ratio will continue to improve and there is a lot of levers involved in the operating ratio as Mike explained.

John Barnes - RBC Capital Markets

Okay. And then in terms of the CapEx, you talked about the five year plan, so I have got two questions there. Number one, is your five year plan given these growth opportunity you see, CapEx elevated at this 20% of revenue for that period of time or does it begin to scale back at some point during your forecast period? And then given there is this mix of growth between Mexico and the U.S., how do you ensure that what’s necessary in Mexico doesn’t somehow capital star the U.S. operation?

Dave Starling

Well, we look at it as one railroad. We don’t look at it as Mexico and the U.S. in fact our challenge is that Laredo is just another point on the map. So, locomotives run through, the cars run through when we look at our capacity model from Mexico City to Kansas City, we don’t stop looking at it at Laredo. So, it’s all the same pool of capital. The volume growth right now if you look at our one (arrow) [ph] chart that shows the continued growth we're going to have through 17, 18, 19, 20, we're going to put in the necessary amount of capital to make sure we can handle that volume. I mean it’s a great story for us, one thing I love about our Board, they've never gotten concerned about capital as long as the revenue growth is with it.

So, we don’t apologize for capital. We'll just tell you that our maintenance capital is coming down, one time we were about 11% of our revenue also on maintenance. We've got that down to 9%. We think it will come down to about 8.5% because our network is stable. We have invested a lot in it, so the other capital that we're going to spend is going to be for growth. So, we're going to spend the amount we need. We'll look at the equipment but then there is still be a driver on what that capital spend will be based on locomotives. You got to have the power to pull these unit trains. I think the other roads are -- everyone is discovering that. You can’t -- you got to have the locomotives.

Operator

Our next question comes from the line of Jeff Kauffman with Buckingham Research. Please proceed with your question.

Jeff Kauffman - Buckingham Research

I am just going to beat the CapEx horse here a little bit more. Most of the questions have been answered but may as well ask one, right. You've talked about the locomotive aspect of the capital plan for the next couple of years. But as we entertain the idea of energy reforms, say two to three years out. As we look at some of these new complexes coming into Louisiana. What are the kinds of capital investment which you have to make to prepare for the growth?

Dave Starling

It will be the yards, it will also be double tracking, extending sightings CTC. It will be all those things that help maintain our velocity. So true locomotives is just one item but the reason I think I mentioned locomotives so much, there is two manufacturers out there. We just got to make sure that we stay in the queue and don’t get smothered by the big guys. I mean I think BN ordered 500 locomotives. So KCS comes to the table and says I need 25, you might be in trouble. So we've got to be very thoughtful on how we plan our locomotive purchases.

The rest of it we control, the sightings, building, the yards we don’t have to go to a manufacturer to do that. The rails available, the tires are available, that’s your own workforce or contractors. So that’s what you’ll see us concentrating on and we have a very robust capacity team that meets every quarter and starts to make the determination on how we stay out ahead of the volume.

Jeff Kauffman - Buckingham Research

So I guess given the way BN is investing to alleviate its own capacity shortages. I guess what you’re getting at is until 2017 the rest of the industry’s ability to add locomotive power is going to be somewhat constraint?

Dave Starling

No I didn’t mean that, I just meant we have to be careful on what is out there. In other words, this year because of some credits they had, two of the railroads are still ordering some tier three locomotives because of credits they had. So I think we just all have to be cautious on what is going to be available not only on the locomotive side but on the car side. So that’s why we’re getting out ahead, we’re actually -- we’re placing orders for locomotives now for 2015.

Operator

Our next question is from the line of Tyler Franz with Raymond James. Please proceed with your question.

Tyler Franz - Raymond James

I know I have kind of asked this before, but where do you stand from your cash tax paying status both in the U.S. and Mexico. It seems like you’re still fairly sheltered, maybe when that might abate?

Mike Upchurch

We are, we’re paying a higher cash tax rate in Mexico right now than we are in the U.S. and I don't know if you have followed some of the legislative focus on the short line tax credit and the bonus depreciation right now our view is that before the end of the year there is a likelihood that that will pass bonus depreciation as an example would allow us to push out another 100 plus million dollars of cash taxes for a couple of more years. So it’s pretty substantial for us. And you’re right the cash tax rate's still quite low.

Tyler Franz - Raymond James

And then Dave, Pat, just kind of a big picture question, but you’ve got this outsize growth in the cross-border volume. The fact that you’re tonne miles still continue to outpace the carload growth. Is it safe to assume that your length of haul continues to go up maybe even to call it record levels? And when you look ahead and we think about modeling, shouldn’t this kind of again generally speaking put an upward bias on your revenue per car? Maybe even productivity or even margins?

Dave Starling

So I’ll cover the revenue, yes as our cross-border business continues to grow intermodal automotive, you have the revenue per car is obviously going to grow. Our revenue per unit on our cross-border is significantly higher than what you see in terms of the domestic Mexico and domestic U.S. So we should see and I think you've seen it over the last several quarters our average revenue per car has continued to move up. And it’s not just intermodal and automotive, we’re seeing good growth in steel and obviously the grain business but that’s kind of recovering from the drought more than growth.

Pat Ottensmeyer

And I’ll speak to the length of haul, I think some of the issues on the length of haul for us are a lot of our unit trains, because they’re governed by the loading and unloading facilities. So a lot of our unit trains we don’t see a big change some of the crude and grain trains for instance because of again the facilities, the origins are the destinations.

Operator

And then coming from the line of Cleo Zagrean with Macquarie. Please proceed with your question.

Cleo Zagrean - Macquarie

My first question is a follow up on the [indiscernible] line, in terms of the impact of strategic growth areas, especially cross-border intermodal and automotive on margins. You addressed the positive impact on pricing. How about the impact on margins from just the one-sided nature of traffic and maybe the function required to sustain the high volume growth rates.

Dave Starling

Well right now it’s the impact on margins so particularly I think intermodal is pretty -- is very strong because we have capacity on existing trains. So when we add additional containers, the incremental margin is very high. You’re really -- you're not adding more locomotives, you’re not adding crews, you’re adding a little bit of fuel.

As we grow we will get to the point where we will have to add new train starts, we don’t see that in the near future, but certainly as we grow we continue to get the conversion that we expect. We will add new train starts which could, Dave mentioned the kind of stair step effect we could see a situation where our incremental margins decline as we add costs and add trains, but that will improve our capacity and improve our velocity and train performance and transit times, which should also help drive some of the growth.

So we fully expect that there will be some of that stair stepping in the future, but right now and for the foreseeable future as we add intermodal volume, the incremental margin is quite high.

Cleo Zagrean - Macquarie

Thank you very much. And my follow-up relates to the petchem opportunity related to Mexico, U.S. specifically how is this new plant [indiscernible] going to affect your traffic now closer border with Mexico in case you are involved or helping out the Mexico imports of derivative of polyethylene products from the U.S. and maybe on the positive could you participate in global exports from that plant out of Mexico?

Dave Starling

Possibly. It’s hard to know how that's going to affect us; I mean the markets -- the large market is growing. We don’t see it having a big impact on our shipments cross-border from the U.S. to Mexico. Again as I mentioned, it’s a growing market and we just don’t expect it to have a major impact. But clearly as more capacity comes on, we could see some shift in sourcing. But as you mentioned, there could be export opportunities, there are even opportunities for us to move intra-Mexico from that facility, so it's an unknown, but it’s a large market and we expect to see growth there across all of our plants.

Operator

Thank you. And Mr. Starling I would like to turn the floor back to you for closing comments.

Dave Starling

Okay. Thanks everyone for being on the call, it’s been a long call so I’ll be kind to everyone and not have any closing comments other than thank you for your participation. We felt like we had a great quarter and we think we’re going to have a great back half of the year. So thank you.

Operator

This concludes today’s teleconference. You may now disconnect your lines at this time. We thank you for your participation.

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