Union Pacific warns about downstream impacts of KCS merger

UP also expects 2021 volumes to be 6% higher than 2020

By Joanna Marsh for freightwaves.com

Any merger involving Kansas City Southern (NYSE: KSU) and either Canadian Pacific (NYSE: CP) or CN (NYSE: CNI) should be scrutinized by regulators to ensure that the combined railroad doesn’t cause downstream impacts to the value of competing railroads, the head of Union Pacific (NYSE: UNP) said Thursday.

CP and Kansas City Southern (KCS) last month agreed to merge, while CN made a bid for KCS on Tuesday. For both combinations, the end result would be a railroad connecting both coasts of Canada and then south to the U.S. and Mexico.

“We see a lot of long-term value impacts that are not in our best interests. … We’re going to first and foremost focus on making sure we protect our interests,” Union Pacific (UP) President and CEO Lance Fritz said during the company’s earnings call to discuss its first-quarter 2021 financial results.

The Surface Transportation Board (STB), which must review the merger, needs to ensure that a proposed merger enhances competition and doesn’t put competing railroads at a significant disadvantage by restricting access, Fritz said. The board must ensure that UP has fair and equitable access to the gateway at Laredo, Texas, where UP shares access with KCS. Fritz said UP’s operations account for two-thirds of cross-border rail traffic.

STB can ensure UP has access through impositions and remedies once it has received and reviewed operations plans by the merging parties, according to Fritz. 

“We as a railroad determine the best routing, and that’s always with an eye toward the best service product that meets the needs of the customer,” Fritz said. “That’s what gets problematic inside a potential acquisition. The combined carriers might have an opportunity to go through inferior routing through a commercial construct, and it’s not best for the customer and it’s not best for the market.”

Fritz confirmed that UP is not presently contemplating a merger or acquisition with another Class I railroad and that it views long-term growth opportunities as those that expand its reach, such as through new intermodal terminals or transload opportunities and siting new industries on existing real estate. Improving service performance such as car velocity is another way to find long-term growth, executives said.

While both merger proposals seek to capitalize on converting truck volumes to rail, part of the challenge is that the railroads in Mexico — Kansas City Southern de Mexico and Ferromex — view those movements as short-haul, which means that while the market is “big” for conversions, it is also “pick-and-shovel work to convert,” Fritz said. 

Port congestion and outlook into the remainder of 2021

UP executives acknowledged the congestion at West Coast ports, saying it has had conversations with ocean carriers and the ports.

Various factors contribute to the congestion, including challenges on the dray side and the lack of warehouse capacity, which means that warehouses can’t take containers, according to Kenny Rocker, UP executive vice president for marketing and sales. There are also labor issues at some terminals, and the long-haul trucking market is tight, Rocker said.

For its part, UP has been increasing the footage of its trains serving the ports from 65,000 feet of capacity last summer to 68,000 feet in November and 80,000 feet in April, according to Eric Gehringer, executive vice president for operations. 

UP expects 2021 volumes to be 6% higher than 2020 amid the strengthening U.S. economy, continued efficiency gains, and sales and marketing wins, executives said. Among the commodities that could pick up or remain elevated volume-wise as the year progresses are automotive, plastics and grain. 

Should economic activity strengthen beyond expectations, particularly for intermodal, UP will make sure it “stays ahead of it” by working with West Coast ports in the Los Angeles basin as well as the Pacific Northwest, pre-placing locomotives and ensuring it has adequate train crew staffing, and coordinating with customers and knowing their plans, executives said.

First-quarter net income for UP fell 9% compared with a year ago amid a 4% decline in operating revenue. Net profit was $1.3 billion, or $2 per diluted share, compared with $1.5 billion, or $2.15 per diluted share, in the first quarter of 2020.

For more on UP’s first-quarter 2021 results, go here.

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