Kansas City Southern  (NYSE: KSU) Q1 2020 Earnings Call Transcript

Kansas City Southern  (KSU) Q1 2020 earnings call dated Apr. 17, 2020

Corporate Participants:

Ashley Thorne — Vice President of 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 of Precision Scheduled Railroading

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

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

Jose Guillermo Zozaya Delano — President of KCSM, General Manager and Executive Representative

Analysts:

Chris Wetherbee — Citigroup — Analyst

Tom Wadewitz — UBS — Analyst

Jason Seidl — Cowen and Company — Analyst

Allison Landry — Credit Suisse — Analyst

Jonathan Chappell — Evercore ISI — Analyst

Ken Hoexter — BofA Securities, Inc. — Analyst

Scott Group — Wolfe Research — Analyst

Justin Long — Stephens, Inc. — Analyst

Amit Malhotra — Deutsche Bank — Analyst

Ravi Shanker — Morgan Stanley — Analyst

Presentation:

Operator

Good morning and welcome to the Kansas City Southern First Quarter 2020 Earnings Conference Call. [Operator Instructions]

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

Ashley Thorne — Vice President of Investor Relations

Thank you, Drew. Good morning and thank you for joining Kansas City Southern’s first 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. Readers can usually identify these forward-looking statements by the use of such words as may, will, should, likely, plans, projects, expects, anticipates, believes or similar words. 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 31st, 2019 and in other reports filed by us with the Securities and Exchange Commission, including our quarterly report for the quarter ended March 31st, 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. In addition to disclosing financial results in accordance with US GAAP, the accompanying earnings release and presentation contains non-GAAP financial results. These non-GAAP measures should be viewed as a supplement to and not a substitute for our US GAAP measures of performance and liquidity and the financial results calculated in accordance with US GAAP and reconciliations from these results should be carefully evaluated. All reconciliations to the most directly comparable financial measures calculated and presented in accordance with US GAAP can be found on our website, and our full Safe Harbor statement can be found on page 2 of the earnings presentation.

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

Okay. Thank you, Ashley. Good morning, everyone. We are going to make the best out of this. We’re all together here. If you go to slide 4, you’ll see the list of presenters and others who are available. We’re all going to stick to the format that you’re familiar with and used to hear, even though we are all distanced. I will make the comment. Brian Hancock, who all of you know, is our EVP and Chief Innovation Officer, much of our business continuity infrastructure sets in Brian’s organization, so there may be a few more opportunities for him to provide guidance in terms of our COVID-19 strategy — response strategy, which I’ll talk about in a couple of minutes. And then obviously Jose Zozaya on the phone again if there are particular topics of interest related to Mexico and what’s going on in Mexico, but again I’ll cover some of those.

So moving on to slide 5, we had a great quarter. The first three bullet points we’re going to go through, all of this in much greater detail over the next several minutes, but revenue increased 8%; volumes, up 4%. I’ll talk about the adjusted operating ratio and EPS since the adjustments relate to restructuring items, but adjusted operating ratio for the quarter of 59.7%, 650 basis point improvement from last year, best operating ratio we have ever posted. And then adjusted diluted earnings per share of $1.96, an increase of 30% over last year, and again we’ll have much more detail on both of those over the next few minutes.

I do want to talk about our COVID-19 situation, the health profile of our Company, what we’re doing briefly to prevent the spread of the virus across our network. And from the very beginning when it became clear that we had a problem and needed to come up with an appropriate response, we’ve been very clear on two top priorities as we approach responding to this pandemic. The first is to protect the health and well-being of our employees and the second is to assure the continuity of our business operations. So our strategy, our response, our communication with our employees, with our customers, with others have all been focused on those two objectives.

Again, we’ll be happy to get into more detail, but I will talk a little bit about the health profile of the Company, both US and Mexico. One important comment that I’ll make here is, as we started to respond with distancing, facial protection, gloves, working from home, sanitary procedures, basically everything we did to respond to the COVID pandemic we did equally in the US and Mexico at the same time. I think that’s important, because there’s a lot of news, a lot of question about the Mexican health profile, the accuracy of data, other things that, again, would be happy to give our opinions of over the course of the call. But I will say that our — I think our effort, our response in treating US and Mexico the same and in doing everything across our network regardless of which side of the border has served us extremely well and resulted in some pretty outstanding health statistics. And I will say the best indicator that we have of what’s going on in Mexico would be the health profile of our own employee base.

Again, 3,500, maybe closer to 4,000 employees in Mexico across the entire country including dense population centers and I’ll say just to give you a quick overview as of this morning, we have a total of 272 employees in Mexico that are staying home for the health mandates and sanitary guidelines that have been issued by the government. 247 of those are quarantined due to chronic disease conditions, 24 of those are quarantined because of age and one because of pregnancy. None of them have reported COVID-19 confirmation, no confirmed cases of COVID-19. And really very few are quarantined because of symptoms. So again, most of the — our own experience in Mexico is due to the health conditions and the age of the — related to the quarantine, the sanitary guidelines that have been issued by the government and none because of symptoms or confirmed COVID diagnosis.

In Mexico, we have three additional people quarantined because of possible exposure. And in the US, we have 18 currently quarantined because of possible exposure, none because of symptoms or COVID diagnosis. So again, we’ll be happy to answer the questions, but that gives you a quick snapshot of the health profile of our Company across our entire network. And we’ve had no business interruptions as a result of labor shortages, crew shortages or unavailability of people that we need in those key locations.

So moving on. Again, as you know, railroads are classified as critical infrastructure in both US and Mexico. And I’d like to make a comment here, if you’ll indulge me for about 30 seconds about the dedication and commitment of our more than 7,000 employees across the US and Mexico. There’s been a lot of talk about the unsung heroes of this global pandemic; and, of course, at the top of the list of those that are responding with extraordinary encouraging commitment would be health-care workers. But railroad workers certainly need to be included on that list. Not only is our service deemed essential by government guidelines in both US and Mexico, but it will be absolutely critical to lead our economies out of the downturn that we are expecting and currently experiencing.

Our employees on both sides of the border and all railroaders in North America have shown extraordinary commitment, dedication and determination in the face of this global health pandemic and deserve the same recognition as other frontline heroes. So, for all of the KCS and KCS De Mexico railroaders who may be listening live or via replay, thank you. We are proud of you and greatly appreciate what you do every day to keep our company, our customers and our nation’s economies functioning at the highest possible level.

Again, moving onto the slide, we’ll talk quite a bit about the scaling of operations and cost in this rapidly changing environment and then we will reiterate our outlook for PSR initiatives and savings. And again, Sameh and others will talk about our PSR efforts, but I want to just again take a minute here to express a little bit more than just the numbers.

Our PSR infrastructure, and we’ve talked about this over the last four or five quarters, led by Sameh– as you all know, Sameh came onboard a little over a year ago and has assembled a cross-functional very wide and deep group of professionals across the company that have been driving our PSR initiatives and transformation for the last four quarters, –that has put us in just outstanding position to respond to this latest extraneous curve ball that we’ve been dealing with in the rapidly changing business environment. It has put us very much on our toes. Sameh has led this effort and created a great deal with enthusiasm and excitement across the entire organization. Again, a very cross-functional effort. The executive management team is deeply involved in this as well, but it has put us in really great position to take the progress that we have been making which on its own was outstanding, and really turbocharge it as we’re dealing with rapidly changing business conditions and environment that we’ve seen over the last four or five weeks.

So, we’ll talk more about that and be happy to take questions about that. But I just want to say that infrastructure in Sameh’s leadership of this cross-functional endeavor has put us in a really great shape as we have now shifted our focus and responded to a different challenge.

Moving on to Slide 6. Not surprisingly, I’m sure this will be a surprise to no one on the call, we are pulling back on most of our guidance that we had previously given. I think the best advice I’ve heard recently, as we’ve all been probably watching more CNBC, is from Jim Cramer, who said: “You would have to be an idiot to give guidance in this market.” So, we’re not idiots and we’re going to put the guidance on the shelf. For the most part, we will stick with our capital expenditure guidance and then we have some additional information that Mike Upchurch will go through later on free cash flow.

So with that, I will turn the presentation over to Jeff Songer.

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

Okay. Thank you, Pat, and good morning. Starting on Slide 8, I’ll open my comments today with a brief overview of our COVID-19-related efforts and expand a little bit on what Pat discussed. We have an extensive business continuity program in place. At the onset of the virus, we enacted several measures to ensure the safety of our employees and continuation of our operations.

Early on, we took steps to adhere to social distancing recommendations, such as separation of our network operating center and dispatching functions. We are currently operating out of five separate NOC facilities across the network. Ensuring the safety of our workers remains our top priority and we have implemented self-isolation protocols for anyone potentially exposed to the virus, who are showing symptoms of the virus.

Regular cleaning of facilities, sanitation of locomotive cabs, supplying face masks and temperature readings at major facilities are some of the specific actions we have taken to-date.

We believe our actions to follow relevant CDC recommendations has led to low incident rates and relatively low impacts to the operation in general. At this time, our workforce is stable, and we continue to monitor the situation daily.

Other industry related efforts include daily updates with the FRA and STB, as we are working to ensure strong communications across the entire rail network.

Regarding key operating metrics for the quarter, velocity of 15.9 miles an hour improved 26% year-over-year and 4% sequentially. Dwell of 19.8 hours improved 9% year-over-year and 1% sequentially. Cross-border performance continues to outperform with volumes up 12% year-over-year. Some of the new train consolidation opportunities we will discuss later will continue to support growth in this segment.

Turning to Slide 9, PSR metrics have shown significant year-over-year improvement across the board and we are tracking well to our 2020 goals. Noting the column on the far right, current month-to-date metrics are showing substantial improvement in most categories versus the Q1 average.

Our enhanced PSR infrastructure has allowed us to quickly adjust to recent changes to volumes and business patterns and have created opportunity, continued to drive efficiencies in the operation.

Car miles per day, velocity, and train length are showing significant gains over the past few weeks as our heightened focus and discipline have allowed further consolidation of trains, reduction in train starts, and scaling of expenses in line with changes in volume.

Sameh will provide more details on these specific actions as we see an opportunity in the current environment to accelerate these productivity improvements.

As Mike Upchurch will detail, these operational improvements are having direct impact to the bottom line; picking a couple of examples, improved velocity contributed to a $3 million reduction in car hire while gains in fuel efficiency led to a $5 million reduction in that category.

As we look forward to recovery, I want to acknowledge the resilience and extraordinary efforts of the operating team during these challenging times.

I will now turn the presentation over to Sameh.

Sameh Fahmy — Executive Vice President of Precision Scheduled Railroading

Thank you, Jeff, and good morning. So, on Slide 11, I would like to describe two stories that happened in this quarter, January, February, and then March, which is at the bottom of the slide. So, January, February, we kept going pretty much along the same strategy and the same pace that we have taken since the onset of PSR early last year.

So, our focus was very much on eliminating delays, eliminating mechanical failures, improving the velocity of the network, a great emphasis on service and allowing revenue to grow. And as a result of that, as Jeff mentioned, we have been increasing our velocity in a significant manner. We used to run in Mexico, this time last year at about 11 miles, but our — in January, February, we ran 16 miles per hour, and in a minute I’m going to describe what’s happening in March and April.

The equipment, obviously, comes out of this. I mean, the more fluidity you have in the network, the more equipment you can take out. So, we have taken out a lot of locomotives out of the fleet. We are down now by about 20% since the beginning of PSR, we’re at 1,046 locomotives. We started the year this year at 880. Around the end of February, we were down to about 825. So, we have taken out about 20% of all locomotives. We have taken out about 10% of the cars. A lot of focus on the car hire because they cost us money every day, that’s foreign cars and TTX cars that have come down by 13%, and a lot of focus also on returning leased cars because that obviously costs us money. So, grain harper cars, we are returning about 300 of them, while returning about 400 automotive cars.

We also have about 700 grain cars parked, stored, even though our grain volumes actually have increased and continue to increase in spite of Corona. So, a lot of equipment coming out, a lot of improvement. Fuel efficiency is another thing that comes out of fluidity and a better service design when you have longer and heavier trains and better horsepower-to-tonnage. So, we improved that by 6% and as I was saying, that happens when we get fluidity, is obviously crews. You can reduce recrews, reduce that heading, save on taxes and you get to a point where you can actually eliminate some of the crew bases, the crew change points, because a train can make it from one point to another without having to change crews, because you can — you can run the whole trip in less hours.

So that is having a big impact on our crews. And we also did a field trip in January to the Northern side of Mexico. We looked at Sanchez Yard and we looked at the border and we looked at the Saltillo area, which is a very industrial area and we’ve got a lot of nice new ideas that will definitely pursue even while we are going through this corona episode, we are continuing like the bridge, as an example, is a big area where we can improve drastically. The velocity on the bridge is like 2 miles per hour, because trains have to wait for windows of six hours, northbound and then six southbound. So if you miss the window, it’s like missing a ferry, you have to wait for the next one. So this is another area that we are focused on. That’s what happened in January, February, very much similar to what happened throughout the year, last year.

And then, the plant started shutting down in March and we got advice of that. And we tried to move as fast as quickly as possible to get ahead of it and take assets out and take cost out, and we are doing that on a daily basis. So we kind of pivoted from a customized PSR model that we had built for revenue and we started pivoting to the traditional old fashion part of PSR if you like of eliminating costs and eliminating trains and reducing train starts and the likes. That does not mean that we are neglecting the service. Actually the velocity went up to 18 miles per hour in Mexico. So again, it was 8 miles per hour in 2018. It went to about 11 to 14 throughout last year, now it’s running at 18 miles per hour. So actually fluidity has even improved, while we have been making a very significant effort to take out — to take out assets and to take out cost. So we took out the 179 trains either annulled or consolidated.

We saved 416 crews, store 50 additional locomotives and 2,500 cars. And the way we did this is that we empower the feed. We said we have no time here to do studies. We have no time to do models, we always had a hesitation as an example, about the size of our yards in Mexico, because they are small, would they be able to handle consolidation of trains. Because when you consolidate trains, you take cars from one train, give them to another train. So they have to wait a certain time. It’s like time between two flights, when you make a connection. You don’t want to hold them too long. And you don’t want to congest the yard.

So we always had a bit of hesitation on the train length throughout last year went up by 4, while since we started doing this intensive effort in April, the train length and I’ll show it in the slide in a second, went up by 6%. The tonnage on the train, went up by 16%. So we would have would have a train going from Lazaro on the Pacific moving north to Laredo in Texas and it used to go all the way. And now we take that traffic to a place called Queretaro which is in the middle of Mexico. And then it piggybacks on another train in Queretaro that actually is going north.

And the team is energized, they actually — the Head of our operation in Mexico is calling it now a religious experience, which is kind of interesting David Eaton, and he has a team, a fantastic team Erwin Bernal, Jesus Baltazar, Fidel Ortega, Jerry Leal to name a few. These guys are doing an awesome job and they are taking the cost out extremely fast and obviously a lot of emphasis on the car hire, we want to take that out, we also are seeing obviously a lot less locomotives like we decided we’re going to take 50 locomotives out in addition to everything we have planned and we did not study it, we did not analyze it, we said, that’s the way, by the way, the legend of this industry, Hunter Harrison used to do it. You take the assets out and then make it work, and it did work.

So 50 additional locomotives went out. So now we’re down to 770 locomotives, when we started our journey with PSR at 1,046 and it is humming. Now that means a lot less work for the locomotive shops and we have a choice, either we lay people off, which is going to handicap us when the recovery starts, which is very important for us or we channel them to other work and that other work is to catch up on the backlog of overhauls.

We have a lot of locomotives that should have been overhauled over the years that are behind. So now is the time to do this work, the same way as for the engineering track, work, the maintenance people who are doing repairs, they have some unproductive time, some extra time, now we put them to do some of the capital programs and we are pushing out the contractors and saving money. So a lot of that is happening, it’s happening very, very fast and we are seeing the numbers. We looked at the numbers last night actually, the pacing for the month of April and we are seeing — we are seeing the money immediately beginning to be taken out. Fuel efficiency, as an example has gone up by 7% in Mexico, that’s over and above the 6% I was talking about at the top of the slide. That’s just from this consolidation work, but by the way, fuel cost is going down, because the price is down and the volumes are down too.

Last point on this slide, which is very important is that we want to learn from what we are doing. We’re not just doing this to cut cost, to compensate for reduced revenue. We keep telling our field guys every morning on the morning call you have to write down every single learning here, you have to see where you are consolidating trains, we want the stuff to stick after this thing is over. We don’t want to go back to all the train starts that we used to have before even when the volumes come back. And now we are focusing on what yards, are we doing a lot of consolidations in, where you are a bit cramped and what can we do about these yards, because now it’s going to be changes with focused capital based on live experience, not based on design and modeling and simulations, okay? So we are already working on that and obviously on siding that can be extended to accommodate long trains permits.

The last two slides, I’ll go very fast on those. I have already taken a lot of time. This is just an illustration of how, on the left side on page 12 — slide 12, you see that the train starts used to run at about 100 train starts per day. Then the first week of April they went down to 79, then the second week of April they went down to 66 and we are beginning actually to go down even more than that, like in the 50s. And you have to keep in mind that every train start is $2 million a year. So every one that we can take out is going to be — to stick and can carry us. Now, some of these train starts obviously would have to come back once the volumes come back. You see it also in the train lengths, the lengths is going up in an obvious manner.

And if I go now to my last slide, which is on page 13, now this one shows the whole span of PSR since pretty much its beginning around April 2019. And you see that we have been improving train lengths gradually, but that was not really our emphasis. Our emphasis was on velocity and service and fluidity of which we have achieved and took a lot of equipment out as a result of that. Now we are focusing on train lengths. And the graph at the bottom is focused on train tonnage.

And you see the significant demarcation on the right side of each slide where you see the yellow lines, which is the train starts dropping like a rock while the train lengths on the top graph and the train tonnage on the bottom graph beginning to really spike north. And this is goodness, because you get fuel efficiency with that, the longer and heavier the train you got fuel efficiency. You get reduction in crews obviously. And even though we may not be able to lay people off, because of some labor agreements, well, if you don’t call them, you don’t pay them. And the example — not the example, the numbers that I gave, 416 crews have been safe so far in Mexico. That’s about 1,000 people, because a crew can be two people or three people, in some cases actually four people, break the rule in Mexico.

You save that money, and again last night, we looked at the numbers and there is a good reduction, actually crew starts went down by 38% in Mexico, while GTMs and carloads went down by about 24%, 25%. And that’s the difference, that’s the productivity and the breakthrough that is mentioned at the top of the slide, is that now we are finding things that would have taken us a year or two to find through design and other things. We are doing it live and we’re learning from what we are doing. And then once the dust settles here, a lot of this was sick.

Okay. So, at this point, I will turn it to Mike Naatz. Thank you.

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

Thank you, Sameh, and good morning, everybody. I’ll begin my comments on Page 15. Despite seeing some COVID-19 impacts, which occurred in the latter portion of March, we had a very nice quarter. Year-over-year revenue grew at 8% and a 4% increase in volume. Revenue growth was led by the usual suspects. Our cross-border franchise business experienced strong revenue growth of about 13% and a 12% increase in volume. This was driven by strength in our Mexico Energy Reform business, which experienced a 43% revenue increase and a similar increase in volume. Our total cross-border business now represents approximately 53% of our total revenue.

We also benefited from easy year-over-year comps due to the 2019 teacher strike, as well as an increase in fuel surcharge revenue. Our core pricing and renewals were in line with our expectations and were similar to levels reported in the prior quarter.

It is somewhat challenging to discuss revenue drivers for the quarter without getting into the impacts of the current economic environment. Nonetheless, I will address current quarter performance first and we’ll conclude with some thoughts on the current situation.

Again, we did see some limited impacts from the COVID-19 situation in the first quarter. Our Chemical & Petroleum revenue was up 18%, and a 14% increase in volume. Energy Reform and Plastic segments were the primary contributors to growth in this business unit.

The Metal segment was the primary driver of growth in our Industrial & Consumer business unit, recording a 6% increase in revenue and a 4% increase in carloads.

Our Ag & Min business unit also had a great quarter, seeing revenue growth of 9%. Our Food Products business benefited from a shift in sourcing patterns and the cross-border franchise Grain business continues to take advantage of our improved service levels.

Our energy revenues and volumes did deteriorate, driven largely by weakness in utility coal resulting from warm weather and low natural gas prices.

Interestingly enough, our crude revenue was strong early in the quarter and was partially offsetting the coal declines. Unfortunately, crude oil prices tumbled in March and resulted in a sharp decline in our crude traffic.

Turning to our Intermodal business, our cross-border franchise revenue grew 22%, benefiting from improved service and positive pricing. Despite some impacts from COVID-19, our Lazaro revenue saw a strong uptick, growing 16% and relatively easy comps, again due to the 2019 teacher strike and changes to the application of fuel surcharges.

Automotive revenues were 6% lower year-over-year and a 12% reduction in volumes. The quarter started a bit soft with volumes as a result of lower production and model changeovers, and of course, we did see COVID-19 related shutdowns across most of our major OEMs in the second half of March.

I’d like to turn to Page 16, please. You’re looking at a slide that endeavors to communicate how each of our business units has been and currently continues to be impacted by the economic downturn. However, before I get into those specifics, I’d like to comment on our April month-to-date volume performance.

While we are experiencing a 21% or so month-to-date decline in April volumes, I would like to remind the group that we have a timing difference with where the Easter holiday falls in the month between 2019 and 2020. This year, the lower Easter volumes are already behind us, whereas last year, Easter occurred later in the month. And when Easter falls earlier, Mexico volumes are disproportionately impacted as industry in Mexico tends to take a longer break for the holiday. Of course, the Easter comps will reconcile themselves by month end.

All right, going back to the slide, I believe that this information will be intuitive to many of you. On one end of the spectrum we have business units such as Ag/Min that have not been materially impacted by the COVID-19 situation. Of course, this isn’t to say that we have not seen changes in the business unit, but the chickens are still eating and cookies are still being made. However, low fuel low fuel demand has impacted the ethanol market and that corn will have to find another home in the marketplace.

On the other end of the spectrum, you have the Auto business. Of course, plants across North America are closed and automobiles are not being produced. Looking at the AAR data for week 15, motor vehicles and parts traffic was down almost 90% year-over-year. Of course, these temporary plant closures effect other industries including steel and plastics and the Intermodal Auto Parts business has certainly been impacted.

In the middle of the continuum, you have a variety of impact, some positive like chemicals that go into cleaning products and some negative like building products. And as a reminder, those business units on the top half of this continuum comprised approximately 70% of our revenue portfolio. In addition to this information, falling fuel prices and a deteriorating peso are likely to create topline revenues that will be impacted, and these declines would be offset with lower expenses.

Not surprisingly, given the circumstances, we have received some request for accommodation from our customers. Our pricing strategy to achieve inflation plus pricing remains the same. We will work — we will focus on yield optimization through operational improvements and service design, and we will continue to work with our customers to develop win-win solutions where we can share the benefits.

We are pursuing these strategies with a renewed focus in the current environment, continue working with our customers to achieve mutually desirable outcomes.

As Pat indicated earlier, it is very difficult to forecast what may happen in the near future and we are certainly not in a position to provide guidance. However, the economy was healthy going into the crisis, the government has since produced meaningful stimulus packages. Inventories have fallen in some sectors and we are optimistic about the recovery.

To that end, we will continue to stay in close communication with our customers so that we are prepared to efficiently handle volumes as they return. As Sameh noted earlier, our focus is on quickly reducing costs while staying prepared for volumes to return. This will certainly allow us to take advantage of our unique growth opportunities in the future.

Thank you for your time. And with that, I’ll turn things over to our CFO, Mike Upchurch.

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

Thanks, Mike, and good morning everyone. I’m going to start my comments on Slide 18. The first quarter results highlighted on this slide is already been covered. So, I’ll just once again reiterate the combination of record first quarter revenues and strong cost controls led to outstanding financial performance. 8% revenue growth and a 2% decline in adjusted expenses combined for 29% growth in adjusted operating income and over 100% incremental margins.

Our adjusted operating ratio of 59.7% improved 650 basis points over first quarter 2019 and is the first sub-60 OR posted by KCS in any quarter. Reported EPS was $1.58, adjusted EPS was $1.96, up 30% over prior year. Our reported earnings per share includes a negative $0.33 impact from the net of FX hedge losses and the offsetting benefit that we see in income taxes.

Please refer to slides 28 and 29 in the Appendix for a reconciliation of reported to adjusted EPS and for details on our net hedge loss.

Our reported earnings per share includes a $6 million charge or $0.05 per share for true ups associated with our PSR restructuring actions and primarily relates to the completion of the purchase of leased locomotives we executed earlier in January of 2020.

Turning to Slide 19, I would like to remind everyone that Kansas City Southern’s PSR implementation is driving significant and sustainable improvement to our cost structure. We are reiterating our outlook for $125 million of savings for 2021, with $61 million of savings being incremental in 2020.

This outlook is unchanged from the update that we provided in January, despite the anticipated negative volume impact of COVID-19 relative to our original plans. And as Sameh indicated, we are aggressively reducing expenses on a real-time basis that we believe will offset any kind of reduction because of volume reductions.

Turning to slide 20, adjusted operating expenses decreased 2%. Our expense reductions were driven by strong cost management across the business. Lower headcount and work hours and fuel price each drove a $6 million reduction. We also achieved a $5 million benefit to fuel efficiency, which more than offset a $4 million increase from fuel consumption. We carried 4% more GTMs in the first quarter of 2020 while reducing our gallons by 2%. Lease rents drove a $5 million expense savings year-over-year including the benefit from the locomotive lease buyout that I previously mentioned.

We also realized a $3 million benefit from car hire expense, primarily from continued reductions to cycle times, to that point our foreign car cycle time declined by 12% in the first quarter. Finally, the peso depreciation during the quarter drove $4 million in year-over-year opex benefit, partially offsetting these reductions to expense were higher estimated payouts for short-term and long-term incentive comp, we experienced a $4 million increase to wage inflation, $4 million increase to fuel consumption due to volume growth and derailments and casualties increased $4 million primarily from higher derailment activity.

Turning to slide 21, I’ll briefly discuss our capital allocation highlights. Our free cash flow in first quarter was up 14% despite a $78 million locomotive lease buyout we executed in January. Our capex was down 50%, driven primarily by $74 million of locomotive purchases in first quarter 2019. First quarter ’20 return to shareholders was up 170% driven mainly by increases in share repurchases. Most importantly, we have $700 million of liquidity between cash balances and an undrawn revolving credit facility of $600 million. Finally, we have no debt maturities due until 2023, so we think our balance sheet is in terrific shape.

Turning to slide 22. While you’ve already heard we can’t accurately forecast the impacts of COVID-19 on carload volumes and revenues due to these unprecedented events, and have accordingly withdrawn our guidance for volumes, revenues, OR and EPS. However, we do want to share with you a few scenarios that we are preparing for. Our first scenario assumes an approximate 15% decline in second quarter revenues coupled with approximate 10% and 5% year-over-year declines in the third and fourth quarters of this year respectively. Our second scenario assumes a more dramatic decline of nearly 30% in 2Q, which would approximate the worst quarter we saw in the great recession in 2009, and then followed by declines of 10% and 5% for third and fourth quarters.

These are merely planning assumptions and neither scenario represents our forecast for the remainder of the year. We just simply can’t accurately predict or control what happens with volumes and revenues at this point during the COVID-19 crisis. However, I would like to highlight our ability to rightsize our cost structure in a declining volume environment and how we plan to adjust downward our capital expenditures for the rest of the year. Approximately 60% of our cost structure is variable or semi-variable and approximately 40% more fixed in nature. For additional details on our cost structure please refer to the appendix.

As Sameh already discussed, we have moved aggressively to reduce variable cost by dramatically reducing and consolidating trains on our network. These actions should allow us to immediately rightsize crew and yard labor costs, fuel usage, fuel efficiency and car hire rents. Finally, we are strategically targeting reductions in growth capital to further improve our cash flow.

As Pat previously mentioned, we have already reduced our capital outlook to $450 million for 2020 and we have identified additional actions that could enable us to reduce this year’s capital by an incremental $50 million, down to $400 million for the full year. We will make final decisions on this incremental $50 million capital cut by June 30th prior to spending on any of those projects.

So again, while we can’t accurately anticipate volumes and revenues for the remainder of the year, I hope you agree we’ve already taken very aggressive actions to manage our expenses and we’ve reduced our capital spend. Aggressively managing what we can control is our goal right now. And based on the various planning scenarios we have prepared for, we are targeting at least $500 million of free cash flow in 2020, which would be more than 10% growth over 2019.

And finally, turning to slide 23, we understand that there is some uncertainty by analysts and investors as to whether we can scale our compensation and benefits in Mexico due to the more onerous furlough rules compared to our US operation. And while it is true that headcount in Mexico may not decline at the pace of volumes, approximately 75% of KCSM’s transportation union wages are variable and we fully expect to be able to scale down comp and benefits as crews and yard personnel are called to work less frequently. And to illustrate that point, we’ve produced a graph that shows while headcount in Mexico during the great recession in ’08 and ’09 did not scale down, we did in fact scaled down labor cost by approximately 50% from peak to trough, while experiencing a 19% volume decline. So there may be a very good lesson to be learned there.

And with that, I’ll turn the call back over to Pat.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. I think we’ve covered a lot, we’ve taken a little bit more time in the prepared comments. I’ll just make a couple of points to reinforce some of the key messages. Again, our prioritization will continue to be focusing on the health and well being of our employees and assuring the continuity of our business operations. And as we begin to see hopefully sooner rather than later a return to business and the reopening, so-called reopening of the economies, we will continue these practices to make sure that both of those objectives are accomplished.

I feel very good about the focus on rightsizing the resources. As I mentioned at the beginning, the PSR infrastructure that we’ve put in place with Sameh at the lead and the cross-functional nature of that exercise has put us in terrific shape. We are on our toes, we are responding daily to changing circumstances and what has been declining volumes over the last few weeks, but we are very focused on remaining to be prepared for a return of volume growth whenever that happens.

And I think with some of the recent news of the Federal government in the US beginning to talk more specifically about reopening the economy, things like new vaccine technology that seems to be very promising, large companies such as Boeing that are returning to work as soon as next week. It may hopefully be the case that reopening of the economy is sooner rather than later and we want to be prepared to help our customers recover and see volume growth as quickly as possible when that economy reopens.

So with that, we’re going to open the lines for question. I’m going to be — since we’re all distanced and separate, I’m going to be the quarterback here, so I will refer questions to my colleagues here as they come in. So go ahead and open the line for Q&A.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Chris Wetherbee of Citi. Please go ahead.

Chris Wetherbee — Citigroup — Analyst

Yes. Hey, thanks and good morning, everybody.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Good morning, Chris.

Chris Wetherbee — Citigroup — Analyst

Good morning. Maybe to start off, with Mike’s comments around free cash flow and maybe some of the scenario analysis that you’ve done, is it fair to assume that the $500 million of free cash flow you’re targeting in 2020 is a number that you feel good with under sort of multiple scenarios that you’re — both of those scenarios that you outlined in the prepared comments? And I guess maybe a follow-up, just if I could squeeze in; and this one question would be kind of related to Sameh in sort of thinking about PSR and the ability for the network to flex up coming out of this, and whether or not there will be sort of good opportunity for incremental leverage as volumes return to the networks? I know that’s two questions, but that’s sort of what I was asking?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Hey, Mike, you want to start with that one?

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

Sure. On the $500 million, the answer to your question is yes. We’ve looked at a variety of different scenarios. Very difficult to model exactly what ends up happening here, how quickly we come out of this crisis. But we feel very comfortable that we can achieve that level of free cash flow under those scenarios. If something else happens to occur here that changes those scenarios, we would certainly keep people posted. But we feel pretty good about the $500 million.

Patrick J. Ottensmeyer — President and Chief Executive Officer

And as for the second question, Chris, second part of your question, yes, I’ll have Sameh provide some comments here; but, yes, as he mentioned in his comments, we’re not only responding on a daily basis to changing volumes and changing circumstances, but trying to make sure we learn from what we’re seeing and respond as we come out of the recovery when we come out and business recovers that we learn from this. And as we grow and ramp things up, we do it perhaps a little more intelligently with the benefit of this experience.

So we’re keeping things close. We are — as we scale back looking at equipment and people, making sure that we keep them close, so that when the recovery occurs, we don’t short-sheet ourselves, but at the same time really paying attention in doing diagnostics on the things we are doing to recover, the way we are using our yards, the way we are handling trains and service to individual customers, so that we can be very well prepared when that recovery occurs. Sameh, I don’t know if you have anything to add to that question from Chris.

Sameh Fahmy — Executive Vice President of Precision Scheduled Railroading

Maybe I can give an example or two, Pat, to reinforce what we are talking about. And before I say that, by the way, Chris, I read your report last night and really nice, I think you mentioned in it that week 15 the velocity is 56% higher than it was week 15 of last year, year-over-year. So thank you for seeing that and we always read your report.

Now as to — I’ll just give some small examples. Like, you know, that train I was talking about, I didn’t elaborate, because I don’t want to take too much time. But that train from Lazaro going to Texas, it has been bothering us for a while even before Corona, okay, like it dropped off a lot of traffic in a place called Escobedo, which is in the middle of Mexico. And then from Escobedo all the way to San Luis Potosi, which is 250 miles it would carry very few cars, okay. Like, honestly, it’s even embarrassing, like on some days 5 cars, 8 cars. So here you have two locomotives with crews, sometimes maybe even a third locomotive; that’s a waste. Now, it had more work to do in San Luis Potosi and then a place called Victoria Salinas in Monterrey on its way north to hand off traffic to an interchange to another railroad.

Now, with all the pressure that we have now and the focus, we said, well, we’re going to take that train only to a place close to Escobedo which is called Queretaro and then we’ll let Queretaro carry whatever cars we have left and go on and do the work on behalf of this train in San Luis Potosi and Victoria Salinas, okay. So these are situations that were there before Corona and now it was all the focus and intensity that we have and also the risk taking and the empowerment of people in the field and I keep repeating that. Suddenly, these guys are doing things that we kept saying, well, I don’t know if the yard can handle it or not; well, Queretaro yard can handle it and it did, and it’s working.

On the mechanical side, we’re doing things also that are kind of unique that will carry on in the future. On the engineering track side, I mentioned a couple of things where we’re spotting unproductive time of maintenance people while at the same time we have contractors hired and paid working with a production gangs that work on the subdivision of these maintenance people. So while they are there that production program, well, we are not going to have the contractors, we are going to let our people complement the production gang and do the work. And these are efficiencies.

So a lot of these things are going to stick and the focus now on train starts and train lengths and train tonnage is going to be as important as the velocity, which has been the emphasis from day one. Now, there is something in between, which is called dwell. When you do consolidation sometimes, you can pay a bit of a price in dwell, you notice that in your report last night. And yes, that’s a bit from the consolidation, so and that’s why you have to put emphasis now on yards and understanding the yards.

So we have a yard call Vanegas, which is in the middle of the network north of San Luis Potosi, and you say — and we spent some time yesterday looking at that. What can we do fast, small things that cost in $1 million, $1.5 million, you know, some elongation of a track to accommodate long trains, maybe a better lead to do better switching and classification, stuff like that, a main line that runs in the middle of the yard that’s terrible, because the switching blocks trains and they have to sit outside the yard, where now maybe we can build a main line around the classification tracks, simple things that don’t cost much money, but now we know from experience, because it’s not simulation, it’s not modeling, it’s real-life. We see what the guys are doing every day and we say, okay, I’m going to focus on that now in the future and I’m going to carry that. And therefore, PSR has just taken a bit of a leap here and its scope has been expanded was real life information and in a very accelerated mode. I hope that answers your question, Chris.

Chris Wetherbee — Citigroup — Analyst

Yeah, that’s fantastic information. I appreciate the time, guys. Thank you.

Operator

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

Tom Wadewitz — UBS — Analyst

Yeah, good morning. And great execution in the quarter, very impressive results in the quarter, and it sounds like you’re off to a really good start in terms of responding to the decline in volumes.

I wanted to see if you could give a little more perspective on refined products into Mexico. I know that’s been a powerful growth driver for you and I think there are couple of moving parts that are kind of tough to get a clean read on. So I think, one would just be, how do you think about the market response. Would you expect the demand to fall pretty meaningfully for refined products in Mexico? And then, how do you think about the share performance within that? Do you have good visibility to your customers, taking share from Pemex and potential to offset what might be decline in market demand for refined products in Mexico? Thank you.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. Thanks, Tom. That’s a perfect question for Mike Naatz.

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

Thank you, Pat. I guess, in general, demand is really going to be the driver of refined product. I mean, consumption, whether it’s in the US or Mexico certainly with the stay-at-home or shelter-in-place orders you are seeing in both countries, demand for the product is falling. And of course, demand is falling at different levels depending on whether you’re looking at regular gasoline versus diesel. With respect to share, our customers are still telling us that they are proceeding with their plans, they’re viewing this current situation as temporary in nature. And so they’re expecting a rebound and they’re moving forward with their retail station openings. Does that answer your question okay?

Tom Wadewitz — UBS — Analyst

Well, so you put those together, do you expect your volumes in refined products to fall meaningfully or does the kind of share gain offset the decline in the market?

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

No, I expect given demand reductions of being upwards of 50% or more in some circumstances, I think demand will have a bigger bite in the near-term than will the share gains. So we will see probably some falling volumes in the near-term. Once the economy is reopened we expect that that’s going to rebound quickly.

Tom Wadewitz — UBS — Analyst

Yeah. Okay. That’s very helpful. Thank you.

Operator

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

Jason Seidl — Cowen and Company — Analyst

Thank you, operator; and Pat and team, thanks for taking the time. And I just want to express my admiration for the men and women across the KCS network who are helping keep the economies rolling here.

Wanted to ask Jose a question, you put that graph up there about Mexico and how you were able to basically offset the last downturn. How’s the Mexican government response been to COVID, can you compare and contrast that to North America? And do you expect sort of additional rules that might either hurt or help you in this effort to sort of keep the network running, specifically when you look at crew sizes they’re much bigger obviously in Mexico than they are here in the US. Could that be an opportunity for the Mexican government to cutback in terms of social distancing?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Hey, Jason, before I turn that to Jose, thank you for your recognition of the role and the contribution of the employees. And Jose maybe talk about the government response and then specifically on the crew cost, I might refer that — and the way we use our crews might refer that to Jeff, but go ahead, Jose. Jose, are you there?

Jose Guillermo Zozaya Delano — President of KCSM, General Manager and Executive Representative

Yes. Thank you, Jason, and thank you for your question. As you may know, the Mexican government, precisely the President on April 5, he going there presented his sanitary and economic recovery plan, which touched on two basic parts: sanitary, regarding the measurements that the government is taking to fight the pandemic that is now all over the world; and economic, how he will support the economic of the country, the finance of the country to go ahead and cross this pandemic. There was not, according to the business sector, there was not enough efforts from the government started the care after they’ve seen this plan, but there were some agreements there regarding like DAT, devolution immediately or start to do the devolution immediately to support some of the companies — in some supports to the small and medium companies to fight this crisis.

It is still ongoing negotiation between the chambers and associations and the President and the Mexican government on how to fight for this crisis and there is special efforts being done by the CONCAMIN or the national industrial associations, which we are part of it and we play a very important role, also the CCE, which is the private sector organization and the other international chambers like the American Chambers. We do play an important role in all of the chambers and to those chambers we are participating in these efforts with the Mexican government.

There is still, like I said, ongoing negotiations on seeing what else the government is going to do. As you may know, the big part of the crisis in Mexico is expected for May 8 or 10, so there are planning on how to do to react and to support the Mexican economy. I don’t know if with that I have answered your that part of the question.

Jason Seidl — Cowen and Company — Analyst

No, that was largely answered. But I guess, when I’m looking at the crew sizes, is that something that your company would want to be reduced or is that something that you’re fine with existing regulations?

Jose Guillermo Zozaya Delano — President of KCSM, General Manager and Executive Representative

That’s something that Pat you may want to redirect.

Patrick J. Ottensmeyer — President and Chief Executive Officer

I’m sorry, Jason. Could you repeat that question? You’re talking about our desire to reduce…

Jason Seidl — Cowen and Company — Analyst

Yeah, your desire to potentially reduce the crew sizes in Mexico due to COVID-19.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Yeah, that hasn’t changed. We’re still engaged with the union for longer term solutions. And I refer to it as modernizing and updating some of our work rules in Mexico. Obviously, that’s been put on hold to some extent here as we get through this and make sure that we just again focus on the health and well-being of our employees, but still something that’s very much on our radar screen and a longer term strategy.

I’ll just make a couple of comments in addition to what Jose said about the government’s response and we’re close to what’s going on in Mexico. Jose has continued the dialog with government officials over these last few weeks and we have been very, very clear in our communications internally with our employees, with our customers. We are going to support all of the government initiatives regarding the sanitary procedures. And in many cases, we had — as I mentioned at the very beginning, because we started to do these things as a result of what we are seeing on the northern side of the border and we were doing them consistently across our entire network, we were starting to do some of these things even before they were part of the government guidelines.

But as far as economic stimulus you guys all kind of know what’s going on in Mexico. I think a lot of the dialog between the business chamber, the business community, private sector and the government continues to be active and hopefully healthy. Some of the specific incentives and stimuluses that Mexican government have really focused on are more to small and medium size enterprises.

And one comment here and I certainly don’t want to give you the impression that we think that our business in Mexico is going to be immune to what’s going on in Mexico however that plays out, but a large portion of our customer base in Mexico are US companies or multinational companies doing business in Mexico, producing products that are sold in other parts of the world. So they’re going to be — they’re going to have some tailwinds, for lack of a better word that’s coming to mind, for example, because of stimulus that’s happening in the US that’s going to help these companies and as the US market reopens, the economy reopens, Mexico is going to be a part of that.

So we’re going to be getting the benefit of some of those stimulus activities, even though they may not be coming from the Mexican government. And I think the positive momentum, and I don’t know if there are questions about the timing of the US MCA implementation, still believe that that could be July 1st, that provides certainly some very positive air cover as the markets reopen, as the economy reopens, that tension that might have existed previously between the US, Mexico and Canada has been removed.

Operator

The next question comes from Allison Landry of Credit Suisse. Please go ahead.

Allison Landry — Credit Suisse — Analyst

Thanks. Good morning, guys. So clearly you’ve been making some rapid progress on and even accelerating where you thought you’d be with train consolidation, given the drop in volumes. So I guess, first, is the roughly 10% delta between train starts and volumes that you’re seeing in April is something that you think you can hold going forward? And then does this level of productivity along with the increases in train lengths and weight suggest that maybe there is some upside to the $61 million cost savings target? Thank you.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Yeah, Allison, I’ll take that. Yeah, I do think we can hang on to that. And in terms of any incremental benefit to the $61 million, it’s tough sitting here understanding exactly what’s going to happen with our volumes between now and the end of the year, but we have a lot of confidence in the $61 million. I think all the examples Sameh gave you were great examples of how we’re stepping on the accelerator and getting more cost savings. So we feel very, very confident about the $61 million and we’ll continue to update everyone on the calls or at conference presentations.

Operator

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

Jonathan Chappell — Evercore ISI — Analyst

Thank you. Good morning, guys. My question is for Mike. Mike, on the capital return, so pretty generous with the buybacks in 1Q, which kind of makes sense given the volatility in the share price. But as we look into kind of the depths of the uncertainty here in 2Q and maybe in the 3Q, can you help us think about the two levers of capital return, is dividend kind of untouchable, the buyback, maybe you put a pause on that at least while we’re through the maximum period of uncertainty.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Yes. No, good question, Jon. Remember, the first quarter was positively impacted by the ASR that we announced back in November of 2019. So, that program was wrapped up in the first quarter and that’s why you saw sizable amount of buybacks taking place. You never say never in this business. But I would say the dividend is not something we have even thought about cutting. So, we feel very-very committed to that. And we’re just going to see what happens in the equity markets here. We have a lot of dry powder. We have the ability to continue to buy back shares based on our plan, and we will kind of evaluate market conditions. But a little bit of caution right now given the volatility, probably makes some sense here.

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

I think the one thing I’d add to that is just, no one knows how deep and how long this is going to be. We did have a touch point with our Board yesterday to update them on some of the forecast scenarios that we went — couple of them we went through with you all here today. And it’s just something that we’re going to be on our toes and just see how things play out, how quickly economies come back to normal and what that means in terms of our outlook for cash flows. But just have a lot of financial cushion right now and feel very good about our ability to manage through this.

Jonathan Chappell — Evercore ISI — Analyst

Great. Thanks, Pat. Thanks, Mike.

Operator

The next question comes from Ken Hoexter of Bank of America Merrill Lynch. Please go ahead.

Ken Hoexter — BofA Securities, Inc. — Analyst

Hey, good morning. Great job in the first quarter. Hope you’re well and safe, and this was great detail on Mexico and the PSR updates. But if I could just follow up on that; two things: one, Mike, you said in your prepared remarks, cross-border was now 53% of revenues. I just wanted to clarify that. And then secondly: Pat, how do you balance your thoughts on these scenarios and then cutting back employees and the fearful of kind of what you went through in the great recession where you kind of turned around and experienced that great growth and you want to be prepared for that. So, how do you prepare not to lose those employees, so you’re going through six whatever months of training for engineers, conductors, and that you’ve got the right set up for that bounce back while managing the cost in the downturn?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay, let me — maybe I’ll take that one first, the second half part of your question first and then Mike can address the other. At this moment, we’ve been managing through the way we’ve utilized the crews particularly in Mexico. Of course, we have different furlough rules in the US and Mexico. But we’ve had no big reductions in force, we’ve had no management layoffs or any of those other things at this point. Of course, we’re four months in or maybe four weeks, six weeks into this crisis, and then again just don’t have a lot of clarity on how long this is going to last, when economies are going to return to normal or reopen, and what that’s going to mean in terms of our resources.

We’re not going to make a bet on an economic outcome or forecast. What we’ve done, and Mike kind of gave you a couple of points on the spectrum here, is look at a range of outcomes and just be prepared for any possible outcome. When I listen to economists and other people who do this as a living, there are just so many different views out there as to how long this is going to last and how deep it’s going to go. It doesn’t sound crazy to me and I think to us, even in discussions with our Board, that we could have a noticeable recovery, possibly even a strong recovery before the end of the year. So, we want to be prepared for that and make sure that we’re ready and we have the adequate resources to respond when and if the economies recover.

So, that’s a vague answer to your question. But at this point we’re trying to be very responsive, be in our toes. Now, we’ve talked a lot about the PSR focus and what we’re doing on the field with train consolidation. The way we’re using our crews to produce the cost savings and continue the customer service, but to keep things close, so that if we do have a strong recovery relatively quickly, that we don’t miss that opportunity, and more importantly, the opportunity to play our role in getting our customers and the economies back on-track. And after that, the comprehensive answer, I forgot the first part of your question.

Ken Hoexter — BofA Securities, Inc. — Analyst

Mike, I think you just — I just want to clarify; he said cross-border was now 53% of revs in his prepared remarks. It just seems way higher than the normal mid-30%. So, did I catch the right number or was he speaking about something else?

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

Yes, Ken, that includes the, what we refer to as non-franchise, so it’s interconnected, predominantly with UP at the border. We’re still roughly 35%-ish on franchise, KCS to KCSM or KCSM to KCSR.

Operator

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

Scott Group — Wolfe Research — Analyst

Hey, thanks. Morning, guys.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Good morning, Scott.

Scott Group — Wolfe Research — Analyst

So, I understand that the Easter shifts point you guys were making earlier. But we’ve seen a much sharper drop so far in volumes in Mexico versus the US. Historically, that used to have margin implications. Maybe, Mike, can you comment on how we should be thinking about that shift and any potential margin implications right now? And then separately, if you can, maybe just some quick thoughts about sort of the net impact of fuel in this environment? Thank you.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. Yes, I think, Mike’s the comment was spot on. Our volumes, as what everybody’s volumes at this point in the month, would be negatively impacted by the fact that Easter has already occurred this year and it was, I believe, the 22nd, 233rd last year. So, that puts us in somewhat of a shutdown mode, Friday, Saturday, Sunday. In Mexico, I will tell you it goes much beyond just that three-day period. There’s really what’s referred to as Holy Week and many plants actually shut down for the entire week. So, you typically see a much bigger drop in Mexico as a result of Holy Week.

You’re right with respect to margins. I mean, if that were to play out, obviously, the margins are a bit better in Mexico. But I think you’ve got to let us get through the month of April. We think we’re going to see improvement in Mexico and certainly in our overall volumes from where we’re at right now.

Operator

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

Justin Long — Stephens, Inc. — Analyst

Thanks, and good morning. So, Mike, the commentary on the different revenue scenarios is helpful. But I was wondering if you could also address how you’re thinking about decremental margins as you model that outlook? Your commentary on the variable versus fixed cost structure, seems to suggest decremental is around 40% to 50%. Is that a good ballpark as we think about your ability to flex the business in this environment? And I know that can be impacted by mix, fairly significantly. So, maybe as you answer that question you could address the mix impact that you’re baking into those scenarios as well? Thank you.

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

Yes, I’ll give you an answer here that may not be entirely satisfying and try to wrap in the last part of Scott’s previous question around fuel. I think the challenge with us giving you any guidance on decremental margins is just some of the impact around fuel price and FX rate. And I think what we would encourage you to think about is the amount of variable or semi-variable expenses that we have and how we’re scaling those down right now. Again, I mean, fuel and FX can have a fairly significant impact on those margins particularly in a quarter.

In the first quarter, as an example, we did have a $6 million fuel lag benefit as a result of prices declining, and that adjustment will get onto customer bills until April, May. But we’re going to stay away from that, stick with our guidance around $500 million or more free cash flow. And hopefully, you’ve gotten the message here today that we have been very aggressive on the cost side, trying to take out expense.

Operator

Next question comes from Amit Malhotra of Deutsche Bank. Please go ahead.

Amit Malhotra — Deutsche Bank — Analyst

Thanks, everybody. I think, Pat, Mike, you talked about $125 million in kind of total profit improvement or savings to that number, and you talked about how you guys feel very confident in achieving that based on kind of the action that you’re taking, the run rate you’re at currently. And then you’ve also talked about, kind of, some opportunity beyond that. I was just hoping you can kind of help us with what that opportunity could be, based on a lot of the good work that you guys are doing. And the automotive business obviously gets a lot of attention and it goes 8%, 9% [Phonetic] of the revenue. Just given what’s happening in the US assembly plan for US production site, can you give us a little bit more color around how much of that business that you — how much of the finished inventory or parts that you’re producing in Mexico are actually going to just in time delivery for assembly plants? And how quickly can that business ramp up and what does that ramp up look like when production comes back?

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

Let me take the PSR portion of that. I mean, we’re going to stick with the $61 million for 2020 and the $125 million full year as we roll into 2021. And here’s the complexity that you have in trying to give you a little bit additional insight into this. As an example, fuel and equipment, depending on how volumes drop, there is clearly going to be a negative impact related to the $61 million. However, based on what Sameh explained, very-very well he explained this. As we consolidate trains, lengthen trains, make heavier trains, we would fully expect our fuel efficiency to improve and offset those kind of volume declines. And so, I think that’s a really good example. Likewise, on the equipment, I mean the volumes drop faster than what we think. The velocity improvements we’ve seen on our network are going to improve our foreign cycle time and move that equipment off of our network and therefore continue to reduce equipment costs.

So, I think we feel very confident around the $61 million. And as I mentioned earlier, we’ll continue to update everybody on our quarterly earnings calls.

Patrick J. Ottensmeyer — President and Chief Executive Officer

And as far as the second question about the auto supply chain, I’ll make a high-level comment and maybe Mike Naatz, if you have anything further to add. Yes, obviously, Mike covered this. We’re very-very close to our customers to make sure that we’re prepared. Auto is probably one of the best examples of where we really want to be prepared when our customers and the factories that we serve come back into production, that we have the resources, the equipment, the cars, the railcars, locomotives, etc.

So, we’re staying very close to our customers. I think the auto supply chain is probably one that’s getting more attention in the national media. So, everyone can sort of follow, how that’s going to play out, maybe a little bit better than we can. But that’s an industry that’s very much in the focal point now.

I will also say that the US and Mexico, including what appears to be dialog between the two presidents, very much in sync. And then, I think, Mexico has said that they will expect to– I’m not sure this is a credit phrase, but loosen the guidelines, so that the auto plants in Mexico will reopen on basically the same timeframe is auto plants in the rest of North America and the US.

Mike, I don’t know if you have anything to add to that, but that’s kind of how we are viewing the auto recovery.

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

Yes, I will add briefly. The automotive supply chains are very large and complex and there’s a lot of coordination that needs to occur. And so, an example of new communications that are in place to make sure that we’re prepared to start up properly, the OEMs, the railroads and the carpooling. Entity TTX have now established new weekly conference calls, so that we can properly prepare for the return of business. And of course, we’ll communicate what we know with providers, including steel manufacturers, plastic manufacturers, glass manufacturers and the like, so that we’re ready to go when those plants start up.

Operator

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

Ravi Shanker — Morgan Stanley — Analyst

Thanks. Morning, everyone. So, my one is going to be on Intermodal, If you could give us an update on the current competitive environment in the Intermodal business in Mexico given what fuel price have done? And also, maybe kind of given some of the changes to train schedules and such relating to PSR, how is the — maybe any potential share shift from a rail to truckers out of that?

Patrick J. Ottensmeyer — President and Chief Executive Officer

Mike Naatz, do you want to address that question?

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

Yes, sure. So, not unexpectedly, the Intermodal business is competing more heavily with the truck business. As you know, our lateral business, for example, is US dollar based. So, with the weakening peso, that provides trucking with an additional advantage there. So, we are seeing that pressure and we continue to see that pressure into the near future.

With respect to train consolidations, we’re doing our best to make sure that we satisfy the needs of our customers in terms of the frequency of service that we provide, but at the same time we are controlling costs. We believe that we’re striking a good balance there and we are in constant communication with our customers so that they can plan accordingly with any changes that we do decide to put in place.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Ottensmeyer, for any closing remarks.

Patrick J. Ottensmeyer — President and Chief Executive Officer

Okay. Thank you all. I know we’ve had a very long call here and hopefully we’ve answered most of the questions, has been consistent in some of our responses. There are still a lot of questions we don’t have good answers to. We are very pleased with the way we’re responding and we’ll do our best to keep everyone informed as we get new information and material information, whether it’s through conferences that Mike and Ashley and others will be attending, if there are any conferences scheduled, and other means. But thanks again for your attention and we appreciate your time here this morning and we’ll be in touch as we get more information and hopefully see economies reopen and business begin to recover. Thanks again.

Operator

[Operator Closing Remarks]