Trains, planes and automobiles: Mexico rail freight comes of age

MEXICO CITY Fri Jul 5, 2013 2:43pm EDT

1 of 6. A crane removes a container at Ferrovalle rail yard in Mexico City June 24, 2013. Slowly, like the trains that crawl past towering avenues of containers here at the country's largest rail hub, Mexico's freight business has transformed into a principal artery for the top export industries of Latin America's second-largest economy.

Credit: Reuters/Tomas Bravo

MEXICO CITY (Reuters) - Slowly, like the trains that crawl past towering avenues of containers here at the country's largest rail hub, Mexico's freight business has transformed into a principal artery for the top export industries of Latin America's second-largest economy.

A rail network that once shunted Mexico's mustachioed revolutionaries to battles across the country was gasping for air by the late 1990s as grinding inefficiency and rising costs forced the government into privatization.

But gradually, thanks to private investment, the North American Free Trade Agreement, a bulging wage differential with China and booming auto and manufacturing sectors, Mexico's freight sector has morphed into a top logistical thoroughfare, shuttling cars, fridge-freezers and grains across the border.

A planned government reform that seeks to allow foreign investment in the state-controlled oil sector, coupled with a federal commitment to spend over $20 billion on infrastructure this year alone, has helped raise expectations for the industry.

Mexican trains now haul about 14 percent of the nearly $500 billion worth of goods that cross the Mexico-U.S. border each year, up from 10 percent in 2009.

And with some saying total bilateral trade could double in the next five years, having already jumped 62 percent between 2009 and 2012, it's a trend that looks set to continue.

"We're very conscious of the boom that's coming," said Isaac Franklin, chief financial officer at Ferromex, a joint subsidiary of Mexican miner Grupo Mexico and U.S. railroad Union Pacific, and one of Mexico's three railway concession-holders.

Grupo Mexico will invest a record $536 million in its rail business this year, a 10 percent increase on the usual spending level, on infrastructure, maintenance and equipment.

For a map graphic, see: link.reuters.com/hem49t

Seven years ago, the Ferrovalle terminus, a 1,000-hectare (2,472-acre) expanse in the heart of Mexico City, where yellow-flowered cacti sprout from the tracks, handled 150,000 containers a year.

This year, Ferrovalle's director, Erich Wetzel, said he expected 400,000 containers. A recently launched app lets customers keep tabs on the exact location of their goods.

"Our growth is limited by the size of the area," Wetzel said. "We calculate that by 2017, we'll be near capacity here."

Rewind 16 years to when Mexico privatized its railways and it shipped less than 20 percent of its total cargo by rail.

Today, Mexico's network, which is fully integrated with the North American system, allowing customers to move products seamlessly from Monterrey to Montreal, has a 26 percent market share.

Within a decade, experts say, if the government's proposed reforms take effect and Mexico's small but fast-growing aerospace and high-tech engineering sectors gain momentum, market share could rise to 35 percent, just below U.S. levels.

TRAIN DUOPOLY

Controlled both by Kansas City Southern de Mexico and Grupo Mexico via its Ferromex and Ferrosur subsidiaries, Mexico's freight sector is piggybacking the growth of leading export industries such as cars and electronics.

Infrastructure y Transportes Mexico (ITM), which groups Ferromex and Ferrosur and makes up nearly a fifth of Grupo Mexico's total revenues, has 55 percent of the Mexican market, with Kansas City Southern de Mexico controlling the rest.

That has fueled rumors of an upcoming IPO for ITM, and a possible takeover of Kansas City Southern, which derives just under half its revenues from its Mexican operation.

"It's hard to give you a date," said Ferromex's Chief Executive Rogelio Velez, when asked if the spin-off could happen this year. "We're analyzing it and if the conditions are right, it could be in that time frame."

Kansas City's blossoming cross-border business has positioned it better than most U.S. railroads, whose heavy dependence on coal shipments has hurt them since early 2012 as demand for coal slumped, making it a prime takeover target.

"There are always rumors," said KCS de Mexico President Jose Zozaya. "We're just focused on ourselves."

While such a move may well make sense, said former World Bank railways adviser Lou Thompson, U.S. antitrust regulators could be an obstacle to any railroad bid.

"There's always a big fish that wants to swallow the smaller fish if they can," he said, pointing to Warren Buffet's $44 billion purchase of Burlington Northern Santa Fe, the United States' second-largest railroad, in 2009.

Mexican billionaire Carlos Slim sold Ferrosur to Grupo Mexico in 2011 and retains a 25 percent stake in ITM.

CARS DRIVE TRAIN BOOM

One thing that links both companies is their growing reliance on Mexico's surging auto sector.

With myriad free trade agreements, a cheap labor force and proximity to the lucrative U.S. market, car makers have rushed to open factories in Mexico, the world's No. 8 producer.

Auto, including parts, which made up just 4 percent of KCS De Mexico's cargo in 2011, rose to 16 percent last year. Ferromex's car business has doubled in the last five years, Velez said.

Both companies are now investing record amounts to serve the car industry, tailoring spending to attract business from three new assembly plants belonging to Nissan, Mazda and Honda, which are due to come online late this year, or early 2014.

Mexico's budding aerospace industry, which is located near the country's major car plants and growing quickly, provides an attractive new market for railroads to lure away from trucking.

Just over 60 percent of goods are trucked north across the U.S. border, down from around 70 percent in 2009.

While trucks offer more flexibility, one three-km (1.9-mile) train can take up to 300 trucks off the road, said Wetzel, making it a cheaper and greener option for the right product.

Tony Hatch, a transport consultant with ABH Consulting, said train costs can, in some instances, be 20 to 50 percent lower. Still, trains cannot deliver door to door, so trucks must be involved at some stage, eating into rail's cost advantage.

Trucks take an average of 133 minutes to cross the border, according to data compiled by the U.S.-based Wilson Center. Trains take less than an hour, said Zozaya.

"Border security folks like trains," said Christopher Wilson, an associate at the Wilson Center's Mexico Institute, and one of the authors of the Center's State of the Border Report. "They do some deeper level of inspection because they have an X-ray machine sitting by the side of the track."

SECURITY TRAINING

According to FreightWatch, a logistics security firm, Mexico has among the highest incidence of cargo theft in the world. Beset by organized crime, Mexico has been scarred by a drug war that has killed 70,000 people since 2006.

And although trains are generally less affected by security issues than trucks, they don't come out unscathed.

Ferromex spends 33 million pesos ($2.5 million) a month on staving off thefts and attacks, Velez said.

Wetzel said the Ministry of Communications and Transport, which regulates the industry, has begun looking into the possibility of creating a dedicated rail police force.

Part of the problem, which both companies have raised with the government, stems from the fact that trains must travel at 12 mph in urban areas.

In another headache, the southbound part of the business, which mainly involves hauling U.S. grains to Mexico and makes up about 30 percent of Ferromex's business, is sensitive to factors like last year's devastating U.S. drought.

Beyond Mexico's inhospitable terrain, one additional factor limits the growth of the sector. Only the government can mandate the opening of new routes, and as concession-holders, neither company can build new lines.

But looking out across Ferrovalle's sprawling installations while locomotives clunked past the endless stacks of pastel containers, Wetzel sounded confident.

"Railways are cash cows," he said. "If you don't pay me, I don't deliver."

(Reporting by Gabriel Stargardter; Editing by Simon Gardner and James Dalgleish)

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