Kansas City Southern (KSU) Q3 2020 Earnings Call Transcript

Kansas City Southern (NYSE: KSU) Q3 2020 earnings call dated Oct. 16, 2020

Corporate Participants:

Ashley Thorne — Vice President, Investor Relations

Patrick J. Ottensmeyer — President and Chief Executive Officer

Jeffrey M. Songer — Executive Vice President and Chief Operating Officer

Sameh Fahmy — Executive Vice President, Precision Scheduled Railroading

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

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

Analysts:

Allison Landry — Credit Suisse — Analyst

Chris Wetherbee — Citigroup — Analyst

Jonathan Chappell — Evercore ISI — Analyst

Justin Long — Stephens — Analyst

Amit Mehrotra — Deutsche Bank — Analyst

Ravi Shanker — Morgan Stanley — Analyst

Tom Wadewitz — UBS — Analyst

Jason Seidl — Cowen — Analyst

Scott Group — Wolfe Research — Analyst

Allison Poliniak — Wells Fargo — Analyst

Ken Hoexter — Bank of America — Analyst

Presentation:

Operator

Good morning, and welcome to the Kansas City Southern Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. Please note this event is being recorded.

It is now my pleasure to introduce you to Ashley Thorne, Vice President, Investor Relations for Kansas City Southern.

Ashley Thorne — Vice President, Investor Relations

Thank you, Joe. Good morning, and thank you for joining Kansas City Southern third quarter 2020 earnings call. Before we begin, I want to remind you that this presentation contains forward-looking statements within the meaning of the Securities Exchange Act as amended. Actual results could materially differ from those anticipated by such forward-looking statements as a result of a number of factors or combination of factors, including but not limited to the risks identified in our Annual Report on Form 10-K for the year ended December 31, 2019, and in other reports filed by us with the Securities and Exchange Commission, including our quarterly report for the quarter ended September 30, 2020.

Forward-looking statements reflect the information only as of the date on which they are made. KCS does not undertake any obligation to update any forward-looking statements to reflect future events, developments or other information.

And with that, it is now my pleasure to introduce Kansas City Southern’s President and CEO, Pat Ottensmeyer.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Thank you, Ashley and good morning everyone. I will just skip over Slide 4, the presenters and participants on the call are the same as in prior quarter. So let’s go directly to Slide 5 with a quick recap of the third quarter and a bit of a preview of what we see in the period ahead.

As you saw in the press release, our third quarter results, revenues were 12% lower than the previous year on volume reduction of 4%. Third quarter operating ratio of 58.8%, was an all-time best for Kansas City Southern, a 190 basis point improvement over the prior year on an adjusted basis.

Third quarter earnings per share of $2.01, 11% above prior year on an adjusted basis, primarily foreign exchange which Mike will talk about later. $1.96 which was 1% above 2019. The headline story for this quarter is clearly operating ratio, and more specifically our ability to hold the PSR driven efficiency improvements and cost savings generated over the prior year and a half, as our volumes and revenues experienced a truly unprecedented roller coaster ride, with the steep decline in the second quarter and then the very sharp recovery in growth during the third quarter.

The fact that we were able to hold these operating efficiency and cost improvements and produce a meaningful reduction in operating ratio versus last year and a 640 basis point reduction in operating ratio from the second quarter of this year is solid validation of the substantial and sustainable improvements to the way we run our network that have resulted from our PSR transformation. Fahmy and Mike Upchurch will get into more detail about those improvements in a few minutes.

Looking ahead, we are reinstating and slightly improving our outlook for — on a number of topics. As you see on the bottom half of the slide, our 2020 capex guidance will remain as it has in the previous quarter of $425 million with the outlook for ’21 and ’22 at roughly 17% of revenue. We are increasing our guidance for full year 2020 free cash flow from $500 million to $550 million, which as Mike Upchurch will cover later on, is a 30% increase in free cash flow from 2019. We are now expecting full year adjusted EPS to be slightly higher than last year. And we are very pleased to announce this morning an accelerated share repurchase agreement for the repurchase of approximately $500 million in KSU shares to be executed as part of our previously announced $2 billion share repurchase program.

Really looking at our performance for the quarter, our recovery in business, our confidence in the sustainability of our operating efficiencies and the outlook for our business and coupled with our outstanding liquidity and cash position, financial position, that they were taking this step to announce this $500 million accelerated share repurchase program.

So with that, I will turn the presentation over to Jeff Songer and then be back for some concluding comments in a few minutes.

Jeffrey M. Songer — Executive Vice President and Chief Operating Officer

Okay. Thank you, Pat, and good morning. I’ll start my comments on Slide 7 with a quick update on our COVID-19 status. We continue to operate with only minor impacts to our workforce and continue to manage as diligently as we have since the outset of the pandemic. We are maintaining a close focus on safety of our workforce as we enter the fall season and feel positive that our efforts will continue to show good results.

Moving to key operating metrics for the quarter, velocity of 14.5 miles per hour improved 4% year-over-year but declined sequentially. Dwell of 22.9 hours increased 13% year-over-year and sequentially. Two primary factors affected the sequential performance of our key performance metrics and dwell in particular. First a rapid shift in volumes, which ended the quarter 60% over the Q2 trough. The red line added to the key metrics chart illustrates the pronounced swings in volume, we have seen throughout the year.

We’ve responded to these extremes throughout the year by rightsizing resources continually evolving our service plan and maintaining our daily focus on execution. Second, we incurred back to back hurricanes in the Gulf region during the quarter. As we have seen in prior years, these events led to outages across several segments of the network and created a backlog of traffic. The impact was more pronounced on cross-border traffic traversing this Gulf region.

Confounding the hurricane impacts again were the rapid rebound and cross-border traffic, with those volumes up 34% sequentially and 10% over prior year. We are confident that ongoing and future PSR initiatives that Sameh will describe in detail will allow for continued improvement and key metrics as the network stabilizes.

Turning to Slide 8, progress against overall key PSR goals was mixed. Dwell and velocity were challenged during the quarter as I previously described, while train length and fuel efficiency are exceeding their goals. We are very pleased with how quickly the team has responded to rapid swings in volume over the past few months by rapidly incorporating changes in our service plan, we have been able to make significant strides in areas such as train length, train start reduction and fuel efficiency in a short amount of time. These improvements are reflected by the outstanding cost control performance that Mike will review in his presentation.

Ongoing capacity investments will continue to support network fluidity and we have accelerated work on several siding extensions and yard expansion projects this year, some of which will be complete by year’s end to early 2021. Finally, you may have seen during the quarter that we have secured a US Presidential permit for construction of a second international rail bridge at the Laredo, Nuevo Laredo gateway. While there are many other steps in the Mexican and general construction permitting processes, this is a positive first step and we have started preliminary design, scheduling and cost modeling for the project.

I will now turn the presentation over to Sameh.

Sameh Fahmy — Executive Vice President, Precision Scheduled Railroading

Yeah. Thank you, Jeff. Good morning. So like Jeff said, this was a very exceptional quarter. That swing of volume was unprecedented, 60% increase in a very, very short period of time. And then compounded at the same time was back to back hurricanes. So it was the equivalent of like an 80% increase in volume that we had to absorb in a very short period of time and it’s a testament to the resilience of the KCS team, headed by Steve Truitt, our VP of Transportation. Who — he and his team worked diligently and very, very hard, including the long Labor Day weekend, day and night in order to recover from Hurricane Laura which caused us washouts for about four days, bought outages, bridge collapse, you name it. So we had like four days essentially when we couldn’t run traffic, on the very critical north-south territory [Phonetic] between the US and Mexico.

So the team managed to get through that, the velocity is back and that torqued actually this morning. The velocity in the US is 17 miles per hour. So we are back to where we need to be, we still have room to grow, as I’m going to explain in a few minutes. But the team did a great, great job, and they did it without going through the temptation of just pulling — bringing in assets from storage, bringing locomotives or adding crews and — in disproportionate numbers, which is the typical way that railroads have had always done it before PSR.

You are measured in your response and you’re doing the right way and you right size and keep going and address the problem, not the symptom. So you go to the bottom of the problem and not throw assets at it. So the team did all this and managed to get through it. And we maintained the learnings that we did during the pandemic, which is very important. And you can see it on the graphs, the volumes have dropped only by 4%, Q3 against Q3. And yet the crew starts have dropped by 23%. 23% drop in crew starts. And when you look at the headcount, which is reflective of this, the head count in the US went down by 18% in transportation. And even in Mexico, where we — the rules are different, but you know we used attrition, the headcount actually went down by 8%.

So total between the US and Mexico, the headcount of transportation went down by 12% and that translated into a $13 million reduction compared to the previous year. If you go that — to that now with a steady state, because I’m using actually September numbers, which are — where the volumes are pretty much the same as they were last year. It’s like $52 million reduction in cost on an annual basis. So the team did that, you look at the locomotives, the locomotives are down by 15% in spite again the volume is only down by 4%. And that you can see it in the mechanical headcount for the shops, mechanical is down 8%. Again 18% in the US, the headcount reduction in mechanical and 2% in Mexico, where again we have limitations.

The train lengths, which is the technique that allowed us to do all this, went up by 16%, that’s the train consolidation and getting smarter about the way you do service design. And how you combine the traffic and where you do it, and I’ll expand on that on the next slide, which is Slide 11, where we see what room is available now for us to grow and to keep getting better like we are at 58.8% operating ratio, but we still have a lot, a lot of work ahead of us and a lot of opportunity.

The number one is, we are expanding a lot of time now on trip plan compliance. We are measuring the traffic of our customers and the connection times and how they are missing the connection from train to train when you go down from the US with intermodal traffic and connect in San Luis Potosi and then go on another train and then connect again in Escobedo. For some of our key intermodal customers we are monitoring that, and not only that, but we build the tool now, so that the field can react. So we don’t have to wait until the trip plan has failed. And say, well, we missed it, they can actually act and expedite the traffic. And that will help us grow the revenue because KCS is unique in its opportunity for growing the revenue.

And like Pat said it many, many times from the beginning of PSR last year, service begets growth and it’s very clear. We provide the service and we came in first in a shipper survey, KCS did on service. So it’s a testament of the work we are doing. Another big area is balancing, reducing the switching and balancing it. It’s a principle of PSR is –the same way as you have a principle of train lengths. The other big thing is on the car level, reduce the switching. Don’t switch too many times the same car. And try to do it in the smarter yards. So you don’t want — right now we have a yard like Monterrey. Monterrey has a lot of customers, hundreds of customers and the yard has a tight configuration.

At the same time there is Sanchez, which is on the north, closer to the border, it’s a very large yard where we have a lot of opportunity. So, something we started doing in the past two months is that, we’ve got Sanchez to build the blocks for the Monterrey customers, before the train even leaves Sanchez to go to Monterrey. So [indecipherable] to Monterrey, Monterrey has less switching to do. Otherwise the car that get switched in Monterrey get switched four times because the tracks are short, that the yard is filled, it’s packed, in which case it’s a captive network. So you have to switch many, many times. So, you reduce that.

We had a yard in the center of Mexico where we had some issue about two months ago. And actually we shutdown that yard and we distributed the work to San Luis Potosi in the South, Escobedo, Queretaro. These are yards in the South and one in the North, Nuevo Laredo. And the issues got resolved in that yard and we went back to it. But we learned a lot when we did this exercise. We know that we can do a lot of that blocking at origin and do the classification at origin and we’ll definitely think about that again as we move forward.

Last example of blocking traffic in the right places, we just are upgrading, actually at the end of this month the capacity of our trains in Victoria Salinas, which is a big intermodal terminal in the Monterrey area. And that will allow us to do blocking of traffic for our interchange railroads in the north, instead of doing it in Sanchez and that will free up capacity in Sanchez to do more work for Monterrey, that I described earlier. And actually more work for Nuevo Laredo, which is a very small yard, just before the bridge. And that’s not the place where you want to do classification and get trains to do a lot of work, because if you miss any time you miss — you miss the famous windows which are a limitation on the bridge, six hours to go north, six hours to go south and you keep flip-flopping was the windows. And if you miss the window by half an hour, like I explained on other earning calls, then you are waiting for six hours.

So we want to move away from that yard as much as possible, but not only that, we are working very hard on removing the windows completely altogether. And we are very, very close to it. Some breakthrough happened this week, and we believe that we are very, very close to eliminating these windows, in which case, if you have two northbound you’d let them go, there is a southbound you let it go. South and you keep flip-flopping without having to wait for static windows of six hours.

The other big thing that has to happen in parallel to all these efforts and we started it like Jeff mentioned is putting money in infrastructure where it is complementary and synergetic with what we are trying to do with these switching and blocking in the property yards and also continuing our strategy of increasing the train lengths and consolidating trains. So you invest in longer sidings. We have two sidings that we expedited this year in spite of the improvement in cash flow and the reduction in our capital envelope. We actually managed to squeeze in, two more siding extensions in very critical locations between Benjamin Mendez and Vanegas, where we have a lot of train needs of long trains. And we are doing improvements in our yards in Sanchez, our configuration, because it’s a big yard, important yard, making along the switching lead. So that, when you are switching it, unblocks the main line and we are doing the same thing in San Luis Potosi.

So, these things are all parallel, they are well sort out and they are all happening at the same time. And these things would allow us to grow — our train lengths, right now is 7,000 feet. And we’re happy about that, it went up by 16%. But this is very far from where we can be. If you look at the rest of the industry, we can go to 8,000 feet for train lengths. The same way as by the way for velocity, all these things are going to have velocity, we are at, we are at 14 — 15 miles per hour. And we will get the backup, I mean, we had the hurricanes that affected us obviously and we are beginning to go back to our normal speed, but even a 70-mile per hour, we still can go to 21 mile per hour, where the rest of the industry is.

So we have an opportunity there. And not the least opportunity is the fuel efficiency. Fuel efficiency, we are at 1.25 which is a great improvement from when we started PSR, when it was 1.45. Yet, the US portion of KCS is at 0.97. The Mexican portion is at 1.55. It’s a very, very — that’s gallons per KGTM. The higher the number, the worse you are. So we can bring that down and that average of 1.25 should be able to be driven down to something like maybe 1.1 or maybe lower and that would help, that would help us get to where we should be. So there is still a lot of opportunity and I can go on and — but I don’t want to take any more time.

I think at this point, I would like to turn it to, Mike Naatz. Mike?

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

Hey, thank you, Sameh, and good morning all. I’ll go ahead and begin my comments on Page 13. Overall, third quarter revenue was down 12% year-over-year and a 4% decline in volumes. As you heard Pat say, we experienced a strong sequential volume recovery. The third quarter volumes rising 30% from the second quarter levels. We experienced a very nice close to the quarter with September volume rising 2% year-over-year.

Looking at the performance by business units, you may observed that quarter-to-date revenue declines generally outpaced the volume declines. This can be explained, at least in part by the RPU reconciliation in the upper right portion of the slide. You’ll see that lower fuel prices and FX together accounted for the preponderance of the decline in our revenue per unit. As you know we have offsetting cost benefits that go along with the declining peso and declining fuel costs.

If we were to hold the FX and fuel price constant, revenues would have been down about 7% year-over-year. Business volume mix including disproportionate growth in our domestic and franchise cross-border intermodal business, for example, contributed to lower RPU as well. Similarly, mix also contributed to a shorter length of haul in some segments and was another contributor to the decline in RPU. It’s important to note that the decline in revenue per unit does not imply repricing nor lower profitability, and our results clearly indicate that.

Returning to the business unit chart, a few brief highlights by business unit. Chemical and petroleum volumes increased 5% driven by strong growth in our refined products business, which was partially offset by lower LPG volumes, which experienced a shift in sourcing patterns. In industrial and consumer segments, our volumes fall 9% driven largely by weakness in our metals business.

We continue to see lower demand for drilling pipe, of course, due to the oil market collapse and for metals products, which are used in infrastructure projects. The good news is, that sequential volumes were up 8% in this area, and we’re looking for continued improvement. Ag & Min revenue was down 6% and a 3% decline in carloads, sequential volumes were up 11% here. While grain volumes were flat year-over-year, ores and mineral volumes were down, driven by weather related infrastructure delays. The energy business unit carloads were down 20%, which resulted in a 28% decline in revenue.

I think you’re all familiar with this story, frac sand and crude oil and coal were all down due to weak demand, and in the case of coal, lower natural gas prices. Intermodal carloads were up 2% with cross-border franchise and domestic markets both seeing at near 20% year-over-year growth in volume. This was driven by inventory replenishment, e-commerce demand and tightening truck capacity. Unfortunately due to the weaker peso and strong trucking port competition, these gains were largely offset by our lower lateral intermodal volumes.

And lastly, our automotive volumes were down 18%. We did see a strong sequential recovery as the plants continue to ramp up during the quarter. The improvement continued through the quarter and September volumes were only off 9% year-over-year. Healthy US demand and low finished vehicle inventories across many of the OEMs provide us with some optimism looking forward. Similar to the second quarter, core and contract pricing held up well, as we continue to execute with disciplined pricing strategies.

Turning to Page 14, you’ll get a better visual representation of our recovery. Overall, total daily carloads ended the quarter, up 60%, as my colleagues mentioned from second quarter lows and were above pre-COVID levels. This improvement was led by key strategic growth segments which had performed well since bottoming out in the second quarter. And these segments are actually growing on a year-over-year basis, highlighting our unique market position. Specifically, our cross-border franchise volumes were up 10%, demonstrating the unique role that we play in facilitating trade between the US and Mexico. The Mexico energy related business rebounded with revenues rising 17% and a 34% increase in volumes. You think about it, this is really quite impressive when you consider refined product demand remain soft, as a result of the COVID-19 situation. And we’ve already discussed the automotive and intermodal business.

So, looking at Page 15, I wanted to provide you with a bit more detail on our growing cross-border refined products business. Year-over-year, third quarter revenues were up an impressive 55%, and a 61% increase in carloads, again considering the COVID-driven weakness in fuel demand which is particularly noteworthy. On unit trains, as you can see in the map, I’m sorry — our unit train business remain strong and we’ve seen excellent growth in our manifest business.

Now as you can see in the map, we are uniquely positioned to move refined product from the Gulf Coast in the Mexico and we look forward to growing this opportunity along with our customers. In summary, the recovery has been remarkable, albeit a bit uneven, while certain business segments such as crude remain under pressure, and the COVID resurgence is a risk, we do have good reason to be optimistic. Based upon customer feedback and low inventories across many of the business segments, we expect the economy will continue with steady sequential recovery.

US trucking demand has been improving and we’re seeing tightening capacity and improved pricing. The Port Arthur DRUbit project continues on schedule and is expected to be operational in the second half of 2021. We continue to believe our nearshoring opportunities will promise in the long-run in both the US and Mexico. And we absolutely value our customers and look forward to working with them as the economic conditions continue to improve and the supply chain continues to change.

And with that, that concludes my comments. I’ll turn things over to our CFO, Mike Upchurch. Mike?

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

Thanks. Thanks, Mike and good morning everyone. I’m going to start my comments on Slide 17. Compared to 2Q, we saw an improving demand environment. And combined with our structural improvements to our operating costs, help deliver, I think, terrific financial performance in the third quarter and positions the Company incredibly well for improved profitability, as we expect continued volume improvement in the 4Q and in the 2021. Although, third quarter revenues and carloads dropped 12% and 4% respectively, the permanent improvements to our cost structure helped KCS post a record operating ratio of 58.8%, a 190 basis point improvement over Q3 of 2019.

An increase in quarterly volume of nearly 30% led to sequential incremental margins above 70%, strong evidence, our cost actions are contributing to a greatly improved operating ratio and ever increasing cash flows. Reported EPS was $2.01, adjusted EPS of $1.96, which was up 1% over prior year. Our reported and adjusted earnings per share includes a $0.20 benefit from new tax regulations issued in July that provide an exemption to certain aspects of the GILTI tax. Based on these final regs, we are lowering our adjusted effective tax rate guidance for 2020 from 29% to 26%, which includes a retroactive adjustment of $18.7 million. As a result of the new regulations, we are also lowering our adjusted tax rate guidance going forward to 28%.

On Slide 19 or 18, adjusted operating expenses declined 15% quarter-over-quarter, I think, terrific cost management by everyone on the team. Expense reductions were achieved across all operating expense categories, other than depreciation. And again I think evidence of really strong cost management. Our compensation expense declined by $18 million, as a result of reduced headcount and the benefit of fewer hours worked, that is mainly attributable to fewer train starts from our PSR train consolidation efforts that Sameh discussed.

Fuel expense declined $32 million, from price declines, lower fuel consumption and fuel efficiency improvements. And I’ll cover comp and benefits in fuel in a bit more detail on the next slide. We also saw repairs and maintenance expense declined $5 million, as reduced mechanical expenses benefited primarily from a reduction in our active locomotive and freight car fleet. Finally, peso depreciation during the quarter, drove $11 million in year-over-year opex benefits. Offsetting these reductions is approximately $4 million of higher expenses driven by COVID-19 impacts.

During the quarter, we incurred approximately $2 million in incremental compensation expense due to COVID-19, requiring employees to be off from work either due to illness or quarantine protocols. Additionally, we incurred another $2 million in cleaning, sanitizing and other health-related expenses, to keep our employees safe during this pandemic. Finally, we remain solidly on track to deliver the previously announced 2020 PSR savings of $95 million.

Moving to Slide 19. Let me cover comp and benefits in a little bit more detail along with fuel. Overall, we saw comp and benefits expense declined 13% driven by an $18 million reduction from lower headcount and work hours, as I mentioned on the prior slide. Our quarterly average headcount was down 9%, driven primarily by the furlough actions in the US and the voluntary separation program. We also experienced a 19% decline in transportation, compensation and benefits expense at KCSM from lower work hours, the result of reduced crew starts and train starts that Sameh discussed.

This reduction to comp and benefits from lower headcount and work hours is an excellent example of how PSR actions, that we have taken during the second and third quarters have benefited our cost structure and we expect to retain those benefits going forward. These reductions were partially offset by wage inflation of $4 million.

Moving to fuel. Fuel expense declined 42% in Q3 as reductions to fuel price drove $18 million in savings, while lower consumption drove $10 million in savings. Most importantly, we also achieved a $4 million benefit from improvements to fuel efficiency, as a result of running longer and more fuel efficient trains. Both compensation and benefits in fuel are excellent examples of how variable costs have scaled down quickly and meaningfully with volumes during this downturn. And as Sameh indicated, we plan to keep many of these efficiencies and cost savings as volumes return.

Finally, moving to Slide 20, I want to discuss our capital allocation highlights. Our year-to-date free cash flow was up 28%, excluding $78 million locomotive lease buyout, we executed back in January, our free cash flow would have increased 52%. And as Pat noted, we have increased our full year 2020 free cash flow outlook from $500 million to $550 million, a nearly 30% increase over 2019. Our year-to-date capex is down 38% driven primarily by the $139 million of locomotive purchases that we experienced in 2019. And we remain on track to spend $425 million or less on capital this year.

Finally, year-to-date shareholder returns are up 50% year-over-year, led by a 70% increase in share repurchases. As noted on the second quarter earnings call, we did resume share repurchases beginning in 2Q as we felt more and more comfortable, that volumes were sustainably improving after having bottomed in April and early May. Additionally, this morning we announced a new $500 million accelerated stock repurchase program, utilizing proceeds from our April ’20 debt offering. With the $500 million ASR, we expect to have consumed $1.4 billion of our $2 billion stock repurchase authorization, approved by our Board of Directors, less than a year ago in November 2019.

With additional visibility to the recovery from the pandemic and confidence in our ability to continue delivering superior revenue growth, margin improvement and increasing free cash flow, we also plan to reassess our capital structure and shareholder allocation goals with our Board before the end of the year.

And with that, I’ll turn it back to Pat for some closing comments.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. Thanks, Mike. Just a couple of quick comments. I think the most impactful slide in the presentation, you just saw was Mike Naatz’s Slide 14, if you, and of course, I know everyone on the call is aware of this. Second quarter volumes down 20%, third quarter up 30%. By the end of the quarter, we were running 60% above the trough on a daily basis. That’s really just a remarkable story and a remarkable roller coaster. The challenge of course was to, as we were coming out of the depth and as we were seeing recovery and business coming back was to balance the — bringing back resources, bringing back — introducing service, meeting our customer demand. But being very thoughtful about maintaining the operating efficiency and the cost efficiency, that our PSR efforts over the last year and a half have created.

I think we did an outstanding job, balancing that in the face of uncertainty as to exactly how this recovery was going to play out. Did we execute flawlessly from a customer service standpoint? No. But again I think our — our results were improving over the course of the quarter. And as Sameh mentioned compared to data that we have about other rails and rail service in general, feel pretty good about that. But we are very focused on customer service and service metrics as we now operate from this new level going forward, we are extremely focused as an executive team and all throughout the company, in making sure that we are meeting our customers expectations.

A final comment, I know a lot of employees on this call and I just want to reiterate the comments that I made in the press release about the performance this quarter and really over the last two quarters of the amazing resiliency and the tremendous discipline and focus of our employees throughout the Company, just for the efforts that they put in — in addition to the roller coaster of volume and the rapidly changing business conditions, thriving a couple of hurricanes and it was truly remarkable what our employees were able to accomplish. We are so proud of what our workforce has produced here and feel that we are in great shape going forward with the talent that we have on the team.

Before I turn it over and open up the mic to questions and answers, just a little friendly guidance on questions. We will — we will not entertain questions about M&A, I know there is still probably some unresolved questions about that. We have not commented on any of the rumors that are in the market and we don’t intend to, so you might want to just save your questions for something that we will respond to.

And then finally, on guidance we’ve updated some areas of guidance, but we are not in a position today to give any guidance on volume and revenue, as we get through the year and we tighten our forecasting and our budgets for 2021 and beyond, we may be in a position to provide some additional clarity in January.

So with that, I will be happy to answer or open the call for questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Allison Landry of Credit Suisse. Please go ahead.

Allison Landry — Credit Suisse — Analyst

Good morning, thanks. So, just given the dramatic change in volume throughout the quarter, could you give us a sense for how the OR trended maybe during each of the month? And specifically where you shook out in September? I guess, what I’m trying to understand is, there is some upside to the Q4 and full year OR guide to the extent that current volume trends holds? Thank you.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Yeah, good question, Allison. Definitely, we saw an improvement throughout the quarter, volume in September was up 2%. With volume increases, you get that added benefit of incremental margins on that volume. And so I would tell you generally we trended better throughout the quarter.

Allison Landry — Credit Suisse — Analyst

Okay, great. Thank you.

Operator

The next question comes from Chris Wetherbee of Citigroup. Please go ahead.

Chris Wetherbee — Citigroup — Analyst

Hey, thanks, good morning. I know you guys don’t want to address anything from an M&A perspective, but I think there is maybe a topic around longer term OR that can help us kind of think about how you view the potential of the business, which would be helpful. Obviously year-to-date, you’ve had a couple of very good quarters and a challenging one in the context of COVID in 2Q, you’re running in sort of the higher 50s now, so what is the longer-term opportunity of the business, if you can kind of see where you are today, volumes have not fully recovered but potentially are on good track to do that.

Where can the OR go? And if you’re not comfortable given that today, sort of when should we expect you to kind of lay out sort of that longer-term plan to give us a sense of what you guys think you can do?

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

Yeah, Chris, this is Mike. I’ll take that one. The year if you look at it, 59.7% in 1Q, 65.2%, I think it was in 2Q, and now 58.8%, you just kind of wonder what could the year have been without the pandemic. Clearly, but below 60%, which was our guidance for 2021 when we started the year in January. So we’re trending certainly well below that number here in the third quarter. And have a very, very constructive outlook on our ability to continue to manage cost down and now that we’re beginning to see a volume environment that is actually showing growth, the incremental margins in the quarter when you look sequentially, we’re over 70%.

And we think that model is going to be alive and well with volume growth. And so while there is still little bit of uncertainty in the macro, we do believe volumes are getting better and better and it will be nice to begin seeing some consistent growth. We’re going to stop short of giving you an OR number for 2021. We’ll do that in January as we’ve typically done by issuing a full set of guidance.

Chris Wetherbee — Citigroup — Analyst

Okay. But just one piece of clarification on that, when you think about maybe longer term and just 2021, I think there is sort of a view of potentially good improvement from here. Is that something we can also expect in January? Or is that something that we have to wait a little longer for?

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

Yeah, no, I think, will give some longer term outlooks, just like we did in January of this year. And remember we have said for a long time, we don’t see any reason why we can’t have the best operating ratio in the industry. Obviously, everybody else is not standing still either, but that’s certainly our position.

Chris Wetherbee — Citigroup — Analyst

Okay, understood. Thank you.

Operator

The next question comes from Jon Chappell of Evercore ISI. Please go ahead.

Jonathan Chappell — Evercore ISI — Analyst

Thank you. Good morning. Maybe a little bit of change of tone, as it relates to autos, I think, in one of the conferences in September, there were some cautious tones about the medium term outlook for automotive. Just given, things like work from home and unemployment. But Mike Naatz was pretty optimistic and we’ve seen some favorable start numbers, as well as some depleted inventory. So just wondering how you’re thinking about auto for the next six to nine months or so, as maybe we get to a normalized inventory situation.

What are your customers telling you? But also, how do you feel about your customers and Mexico’s ability to produce given all the COVID situations and the ramp-up, back to kind of normalize and what that means for the cross-border?

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

This is Mike Naatz, I’ll go ahead and take that one. Yeah, generally speaking, we’ve been pleasantly surprised with the recovery on the auto business. There is certainly some segments of the economy in some aspects that unemployment that remain. But vehicle sales have remained strong and the inventory levels remained low. And that’s why I said, we are optimistic. We are getting some mixed signals, but generally believe that auto levels should get back to more historical levels by the end of 2021.

And with respect to Mexico’s ability to produce the vehicles down there, I can’t speak directly for the OEMs of course, but I believe that they’ve been taking the necessary precautions to make sure that those plants continue to operate as smoothly and efficiently as possible. And we’ve generally seen that. We are not aware of any specific plant shutdowns that have resulted is — from COVID here recently and we are optimistic that that’s going to continue as well.

Jonathan Chappell — Evercore ISI — Analyst

Okay, great. Thank you, Mike.

Operator

The next question comes from Justin Long of Stephens. Please go ahead.

Justin Long — Stephens — Analyst

Thanks and good morning. Hey, just wanted to follow up on some of the service commentary. Obviously we’ve seen a substantial improvement there. I wanted to ask about how that’s impacted truck to rail conversions in the network. Is there any way you can help us think through that tailwind that you’re seeing today to volumes? And going forward, is there a framework that you have in mind for conversions and how that could contribute to volume growth going forward? Whether that’s 100 basis points or 300 basis points, would love to just get your high level thoughts on that.

Patrick J. Ottensmeyer — President and Chief Executive Officer

I think we’re probably going to fall short of giving specific guidance, as specific as you just suggested. But I’ll ask Mike Naatz to comment generally about the — the trends and capacity issues you’re seeing in intermodal.

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

Well, I’ll sort of refer to an example that we’ve used in the past. And we believe that we have a nice opportunity to convert cross-border truckload business over to rail. We currently have 1% or less of the truckload volumes that are moving across Laredo or moving on a rail. So we think we should be able to ease into that. So as long as service performance is acceptable to the marketplace, we see a lot of upside there. And clearly, we’re seeing that in our domestic and cross-border intermodal volumes here in recent months. So we remain bullish on that front.

Justin Long — Stephens — Analyst

Okay. Thank you.

Operator

The next question comes from Amit Mehrotra of Deutsche Bank. Please go ahead.

Amit Mehrotra — Deutsche Bank — Analyst

Thanks, operator. Hi, everybody. Congrats on the quarter. Mike Upchurch, I just wanted to follow up on the sequential margin question. If I think about the operating cadence of the business, 3Q to 4Q revenue will be up probably nicely, let’s call it 10%, it seems like a reasonable estimate as you look in 3Q to 4Q. The implied kind of sequential incremental margins to get to kind of a low 60s OR is only like 40% on that revenue growth number. So I just want you to address it’s kind of a wonky question. But I think it’s important in terms of trying to think about the operating momentum that you have seems to be improving as you go on. So why should incremental step down sequentially?

And then — just for my second part of my first question, the capex is 17% of revenue. You guys decided to give it out all the way to 2022, I mean that would in case you would be — basically be the most capital-intensive rail in the industry — sorry, the most capital in terms of US rail in the industry. With all the stuff that you’re doing that effectively creates capacity from a PSR perspective, why isn’t there a lower capex number as we look out to ’21, ’22, if you can address those two questions? Thank you.

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

Yeah, well, I’m not going to take the bait on your revenue number there. But I would just say, I think the 2Q to 3Q performance speaks for itself. And we have strong conviction that incremental margins are going to continue to stay very strong. What we don’t know is the volume environment. But right now, we’ve got a constructive outlook on that. And we think we’ll see a little bit of growth from 3Q into 4Q, just like we’ve seen throughout the third quarter.

On the capex question that you asked, 17% is kind of our target going forward. We have clearly significantly outgrown the industry in volume, you don’t do that without some incremental capex investments to improve your capacity. Sameh talked about a number of projects to improve the fluidity on the network in terms of yard expansions and siding expansions, to be able to run longer trains. And we think that has a just a terrific payback, expanding train length and we do need to make some investments to do that with siding extensions, and that’s the plan for ’21 and ’22.

Amit Mehrotra — Deutsche Bank — Analyst

Okay, all right. I’ll leave it there. Thank you.

Operator

The next question comes from Ravi Shanker of Morgan Stanley. Please go ahead.

Ravi Shanker — Morgan Stanley — Analyst

Thanks. Good morning everyone. So maybe this question a little bit unfair, but probably kind of this shows the high bar you guys have set yourself. I think by your own definition, you guys had a mixed operating quarter in 3Q, but there also were a couple of kind of unusual items like the hurricanes and such. I didn’t hear you quantify this, are you able to quantify kind of ex-COVID, if there were items that kind of hurt the results this quarter. And kind of what the metrics sort of look like and what the OR would look like without things like the hurricane and the strike and such?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Yeah, Ravi, I mean, listen, we had a rough quarter with hurricanes and we did incur some incremental expense. But we typically haven’t quantified that. It’s just part of doing business in the part of the country we operate in. And I think the only time that we have ever talked about in any kind of substantial incremental costs is related to hurricanes like Harvey in 2018 or Alex in 2010, that were $50 million to $75 million in costs. We did not have those kinds of costs, but understand that operating in that kind of an environment where you are moving equipment out of harm’s way and waiting for the storm to pass, and then having to deal with cleanup and ballast and all those other issues that come along with it. I think Sameh gave a pretty good description of all of that.

Yeah, there were some incremental costs and that’s not just physical damage, it’s trying to reposition equipment and your fluidity isn’t as good and it takes a little bit of time to recover. But we’re not going to talk about any kind of specific number there, just say it’s a few million of incremental cost in the quarter.

Ravi Shanker — Morgan Stanley — Analyst

Okay, fair enough. If I can just sneak in a quick follow-up of the incremental margin question, the previous one. If I can ask you in a different way, do — should we expect the incremental margins to be strong as now, as we are coming-off of the very bottom? Or do they get better as we go along, I know with volumes picking-up momentum or something. Do you expect the strongest incremental margins now are kind of 12 months to 18 months from now?

Patrick J. Ottensmeyer — President and Chief Executive Officer

We’re going to continue to try to improve our incremental margins every single quarter. And I think we’re going to leave it at that. We’ve given guidance here, we improved that guidance full year to the lower end of our 60% to 61% range. And we are going to stick with that commentary.

Ravi Shanker — Morgan Stanley — Analyst

Great. Thank you.

Operator

The next question comes from Tom Wadewitz of UBS. Please go ahead.

Tom Wadewitz — UBS — Analyst

Hi. Yeah, good morning. So I just wanted to see if you could offer some thoughts on what you might be most optimistic on for — if you look to like 2021, which segments would you think had the best potential for growth? You obviously talked a bit about refined products, it’s kind of hard to, I guess, it’s hard to know, like what are the catalysts from the current elevated level of refined products? Is that going to go more? Are there kind of other catalysts in other business segments. So kind of a 2021 frame and what you think of the kind of most powerful volume growth drivers?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Mike Naatz, you want to take that question?

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

I’m sorry Pat. Could you repeat the question please?

Tom Wadewitz — UBS — Analyst

Yeah, so the question was basically 2021, what do you think are the most powerful volume growth drivers? I know you spent some time on refined products, kind of where do you think you go from here? And also whether it’s intermodal or other segments, where do you have the most visibility to volume growth when you look at 2021?

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

I continue to believe that the cross-border business will remain good and that will be comprised of a variety of different components including the intermodal business and including continued recovery in auto. Grain will continue to be good moving across the border as well. We also expect that we’ll see some lift in manufacturing inputs as the economy would continue to improve, so that would include products in our Industrial & Consumer segment.

Tom Wadewitz — UBS — Analyst

Would you expect further growth in refined products from where we are?

Michael J. Naatz — Executive Vice President and Chief Marketing Officer

It all depends on how things go in terms of COVID and people returning back to work and the economy. But given the current trends, I would expect that that would continue to improve.

Tom Wadewitz — UBS — Analyst

Great. Thanks, Naatz.

Operator

The next question comes from Jason Seidl of Cowen. Please go ahead.

Jason Seidl — Cowen — Analyst

Thank you, operator. Pat, Mike and Sameh and team, good morning.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Good morning.

Jason Seidl — Cowen — Analyst

Wanted to talk a little bit, because I think the word roller coaster has been mentioned so many times, I think we’re at six slides right now. So when you’re thinking about a more normalized operating environment, sort of where should we see the benefits of that going forward especially on the cost side? So in other words, where did that roller coaster hit you guys the most on cost in 2020? And what types of improvement should we see in a more normalized operating environment?

Sameh Fahmy — Executive Vice President, Precision Scheduled Railroading

I can take that, Jason, like you saw, you saw the impact of that, not only of the roller coaster, but unfortunately being compounded by the hurricanes. You saw it in the dwell of — in the yards. And that is a number that that clearly will improve as time progresses. Now that we don’t have hurricanes and now that we stabilized, the volumes are improving, they continue to improve, but not in that same percentage that we saw, the abrupt sudden increase of 60%. So we should see an improvement in the dwell and an improvement in the velocity, which means a continued reduction in the assets or keeping the same assets to generate more revenue. A very good example that Pat has used also in the past is a car cycle on grain, okay?

The grain cycle was at the beginning of September definitely suffered, especially from the hurricanes. And then in the back end of September, it was incredible like the — we got to about 18-day car cycle. This is now from Kansas City, all the way to Mexico City and back, including the loading and unloading. This number used to be 29 days before PSR. It went down to 18, but we have now 1.6 cycles per months. And it used to be one cycle per month. And that generates revenue, at the same cost and increase revenue. And the revenue is this, like Mike touched on it, Mike Naatz.

The demanding for grain is substantial, like I think last month for one particular customer, we were very close to a record loads. And actually for October, the number that is targeted, that is forecasted is an all-time record. And we are quite confident that we’ll meet it. So to answer your question, Jason, once we read out, the hurdles that we went through in Q3, and we are removing them especially in the ORs and all that service design stuff that I talked about, classification. And while you do the classification, be smart.

While you do the switching and all that and improve your velocity, and that is going to translate into hopefully a higher revenue without increasing the cost, or if need be, then you can reduce your cost. So that’s where I think we are going to see, we’re going to see a big improvement.

Jason Seidl — Cowen — Analyst

Okay. Well, Sameh, obviously credit to your team for handling just a very difficult operating environment here in 2020 and producing results. If I can throw one more in, you guys mentioned train lengths and that you have plans to even increase them further as we look in 2021. You are above, I think your goals for 2020 already. What type of improvements, whether it be on a total foot basis or a percentage basis, should we expect in 2021?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Sameh, you want to take that…

Sameh Fahmy — Executive Vice President, Precision Scheduled Railroading

Do you want to take that, Pat? I mean, we are continuing, we are continuing to improve, like this morning as an example, both US and Mexico are at 7,300 train lengths. So we’re watching that like a hawk, okay. We’re not going to go backward. We’re going to keep going up. Now like Mike Upchurch said, we’ll provide some guidance, Jason, in January, and that will be on many things, OR, train lengths, probably train starts and velocity. I mean, a conservative way about train lengths would be at a minimum, an improvement — an additional improvement of 5%. And that is not, is not asking for a lot.

And as we — as we do more of these siding extensions, in order to allow more places, where long trains can meet — that is going to enable us to do more and more of longer trains. Without that, you have to hold trains for a long time at a location where we have the 10,000 feet or the 12,000 feet lengths until the other one passes-through and then you take the train out of the sidings. So it’s very critical that we deployed the siding extensions. And we have a big, big plan for siding extensions. I believe the total is something like 17 siding extensions, that are in the plan. And we’re going to finalize that at the end of this year, as to the pace of deploying them.

Jason Seidl — Cowen — Analyst

Okay. Well listen, I appreciate the color and it’s a great update and I appreciate the time as always, gentlemen.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Thank you, Jason. Operator, do we have another question? Did we lose the operator? Anyone who is out there, standby we’re trying to reach the operator to see what has happened.

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

Will do.

Operator

Excuse me. This is the conference operator. I just wanted to check, are you able to hear me?

Patrick J. Ottensmeyer — President and Chief Executive Officer

I’m able to hear you, yes. Do we have more questions in the queue?

Operator

Yes. The next question comes from Scott Group of Wolfe Research. Please go ahead with your question.

Scott Group — Wolfe Research — Analyst

All right. Thanks. Good morning guys.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Good morning, Scott.

Scott Group — Wolfe Research — Analyst

So for Mike — Mike Upchurch, you mentioned the capital structure and revisiting it, maybe can you just talk about, do you feel comfortable running the railroad at three times of leverage, would you go about three times of leverage? And then separately you took out the PSR savings slide, maybe just an update there, do you have an early look on ’21 for PSR savings? Is there more to go on the absolute savings or is it more just about operating leverage from here? Thank you.

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

Yeah, let me take those in reverse order. You will note on the slide that we discussed expenses we indicated, we are still on track for $95 million of PSR savings for 2020. And we are continuing on track with $150 million of annualized savings for 2021. So that is alive and well going into 2021. With respect to the capital structure, we’ve had a longstanding target of low-2s leverage ratio. I think at this point in time, given the interest rate environment and kind of the mix of equity and debt in our capital structure, we are going to have some conversations with our Board about potentially moving that. But I wouldn’t commit to anything until after we’ve had those discussions with our Board, which we do expect to occur here before the end of the year.

So just know, we’re looking at it. We understand it’s been a conservative management of the capital structure that was intentional. But given the operating cash flows that we’re generating in this business and the free cash flow, we feel just terrific about the prospects of the business and feel that some adjustment there upwards is probably warranted.

Scott Group — Wolfe Research — Analyst

Okay. Thank you guys.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Thanks, Scott.

Operator

The next question comes from Allison Poliniak of Wells Fargo. Please go ahead.

Allison Poliniak — Wells Fargo — Analyst

Hi, good morning. So just want to go back to the comments on trip plan compliance, relative to your customer service commentary. It sounds like you’re already taking steps on the cross-border traffic. Is there any way to give us some color on kind of where you are today, particularly with the cross-border relative to your goals? And how quickly can you think you can achieve that target, particularly in a normal environment here, any thoughts there?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Mike Naatz, do you want to answer that question?

Operator

Mr. Naatz, your line is open. Okay. It appears that we’ve lost Mr. Naatz.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. In Mike’s absence, I would like to go back, I think Mike may have misstated a number on the market share, the current market share and the opportunity we see for intermodal, in particular. And as we stated earlier, the cross-border intermodal continues to be a very solid growth area. And that is certainly one area where service and trip plan compliance is more — much more of a consideration in terms of growing — given the premium service sensitivity of that business. So we feel very good about our position in terms of the routing options that we have for our cross-border product.

The customer base that we have as you know we are a wholesaler in the intermodal space. So our customers are the big IMCs and we have service options, specifically meaning — interline service with all of the other Class 1 railroads that really give us an opportunity to serve any customer, regardless of their preference or commitment to IMC partners and rail partners. So, the focus is to continue to build out those trains, continue to improve our consistency and reliability. Those numbers are improving. And I think we have a pretty good visibility to — particularly as we have come through this, I’ll use the term once again, this roller coaster of declining and then rapidly recovering volumes to get to a — excuse me, a more — kind of more normal steady state and baseline to grow from this point.

Feel good about the commitment that our customers have made in terms of providing resources, specifically equipment, containers into this market, I think they all see the opportunity. And some of the things that we are doing at the border, specifically related to using technology, as Sameh mentioned, eliminating the windows at the bridge, some issues with international crews and then ultimately building the second bridge across the Laredo — Nuevo Laredo gateway, are all going to contribute to just over time, steadily increasing capacity and improving resiliency and consistency and reliability of service, which is really the key factor for those intermodal and automotive customers, as well as all other commodities. But no doubt that the consistency and reliability is of the utmost concern to the intermodal and automotive customers.

So I don’t know if all of that adds up to a good answer to your question. As far as the opportunity, we think we are in the 5% to 7% market share range today. So clearly there is a lot of opportunity for growth. If we do the things that I described earlier, add capacity, continue to work with our partners and improve consistency and reliability of the service. This is an opportunity, particularly in the intermodal space, where we could see market share and growth over a very long period of time.

Sameh Fahmy — Executive Vice President, Precision Scheduled Railroading

And maybe Pat to add, to add to this, like I mentioned, we monitor this every day. So, we do have numbers and you know right now, the trip plan compliance on that traffic is about 60%. And definitely we have room to improve. And we know — we know where the connections that get missed happened, like I said on — in my section, connecting trains from — at SLP, San Luis Potosi or at Escobedo. We understand where the connections can have issues and we are working on that. And the definition, by the way have trip plan compliance on this traffic is zero delays of hours, which is kind of nontypical.

Typically, you have — you have a little bit of latitude. If you — if the traffic makes it within two hours as an example, it is — it would be treated as a success. But in many other cases that we looked at with some specific customers, that is not even a two-hour margin. So 60% is not great, but it is quite decent considering what we have been through during this quarter. And now with our eyes also very focused on it, with our — between commercial and operation, and with a regular review every week, plus the review every morning call, these numbers will improve.

Operator

And the last question today will come from Ken Hoexter of Bank of America. Please go ahead, sir. Thank you.

Ken Hoexter — Bank of America — Analyst

Great. Thanks. Thanks for squeezing me in. Good morning. Maybe just a little bit on your thoughts about costs coming back on locomotives and employees as volumes ramp. And then just to clarify your comments on margins, do you see nothing structural in terms of given your more regional intermodal moves on a margin potential versus rails with longer haul, I just want to understand your thoughts on attaining that best-in-industry potential. Thanks.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Yeah. Ken, in terms of cost coming back on, I mean, I think any way we look at it, we just had terrific cost performance there, and maybe this will help a little bit. I think 3Q to 4Q, as we look at expenses, I mean a lot of it’s going to depend on volume, but we’re kind of looking at flat to slightly higher expenses across the Board. I think you may see a little bit flat to low single digit on the comp line item, just given some expectations around better volume growth. I think equipment and materials and other and purchase services are all going to be in the flattish kind of range, which I think creates a good uptick for incremental margins.

This is obviously a question everybody has got some interest in. So let me just go out there and say we had a 70% plus incremental margin, 2Q to 3Q. I think we can see something similar, 3Q to 4Q. We’ll see what the volume environment looks like. But I think, that’s pretty reasonable. In terms of longer-term, the structural points that you referenced, I mean, there is pluses and minuses there. Yeah, sure, we’ve got maybe some shorter haul but we make that up on our cross-border, which looks a lot more like the larger Class 1s, and given the kind of growth we are seeing in cross-border, that’s good for margins long term. That’s our sweet spot or crown jewel.

We obviously have better labor costs in Mexico that will continue to give us some favorability. And then some minor offsets going the other way around security costs and the concession fee that we pay to the government based on revenues. But net-net, there is nothing that I believe that would prevent us from having the best operating ratio in the industry.

Ken Hoexter — Bank of America — Analyst

Thanks for the time. Appreciate it, guys.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. Operator?

Operator

Thank you, sir. I’d like to turn the call back over to you for any closing remarks, sir.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay, well thanks. Apologize for some of the clunkiness here, but that’s an indication that we are taking distancing seriously here. So thank you all for your attention and we’ll look forward to update as they occur at conferences and getting back together in January for our fourth quarter and additional commentary about what we feel 2021 looks like. Thank you all very much.

Operator

[Operator Closing Remarks]