Where Is the Economy Headed? Union Pacific Corp. May Have the Answer

A record first quarter may be a sign of good times to come for the economy and Union Pacific investors.

Apr 25, 2014 at 8:05AM

America's largest, publicly traded railway, Union Pacific (NYSE:UNP) recently released its first-quarter results. And by many measures, it was a record performance.

For the first quarter, operating revenues increased 7% while operating income improved 14%. And net income of $1.1 billion, or $2.38 per diluted share, was an improvement of 17% from the same period a year earlier. All first quarter records for Union Pacific.

Arguable America's most important railroad, connecting 23 states in the western two-thirds of the U.S., its results are an important leading indicator on the health of the broader economy. Here are three important takeaways from Union Pacific's latest earnings release, and what it means to investors and for the direction of the U.S. economy.

A record grain crop
During the first three months of 2014, Union Pacific transported 13% additional carloads of agricultural products and generated 16% more revenue. These impressive results were due to a nearly 40% increase in grain movements, from 65,000 carloads to 90,000 carloads.

It's very likely that Union Pacific will continue to enjoy a strong market for the transportation of grain for the balance of 2014, and maybe much longer. Last year, Western Canadian farmers harvested a record 80 million tonnes of grain and oilseed. And in the U.S., the yield was well above its five-year average. But much of that crop is only now starting to make it to market due to a lack of rail transport. In fact, the Canadian government recently introduced legislation requiring Canadian railroads move, at a minimum, one million tonnes of grain each week.

With new farming technologies, and more sustainable farming practices, there is little doubt within the agricultural sector that farmers' yields will continue to increase -- providing a boost to their incomes, and the railroads they depend upon to get their product to market.

A recovery in coal, growth in sand
Due to an usually cold winter, and low inventory levels at power companies, Union Pacific's coal carloads and revenue increased by 7% and 3% respectively during the quarter. This is a reversal of the fortunes experienced during the past few years. Coal has accounted for a declining percentage of Union Pacific's revenue over the past three years.

Though some analysts are forecasting a recovery in thermal coal as power producers switch back to coal due to increased natural gas prices, it's too early to tell whether Union Pacific will enjoy a full year of coal growth on the back of one solid quarter. However, Union Pacific does have an effective hedge against declining coal revenue -- increased silica sand revenue.

Union Pacific transported 10% more industrial products during the first quarter, driven primarily by silica sand used for fracking -- the process used to extract crude oil and natural gas from shale rock. The frac sand is necessary to keep cracks open in the shale after water and chemicals under high pressure fracture the rock, and allow the resources to be released.

According to the Freedonia Group ,, a U.S. market researcher, demand for frac sand in Canada and the United States grew 34.3% between 2007 and 2012, and is expected to increase 11.9% annually until 2017. Continued demand for silica sand will help offset some of the weakness in coal revenue, and be a boost to earnings if it maintains the momentum demonstrated in the first quarter. 

Impressive operating ratio
A railroad's operating ratio, its operating expenses as a percentage of revenue, is the ultimate indicator of efficiency and management effectiveness. A low operating ratio means more revenue flows to the bottom line as profit, and gives the company added flexibility to lower prices and take market share from competitors.

Despite a challenging winter, Union Pacific delivered a first quarter operating ratio of 67.1%, an impressive 2% point improvement from a year earlier, and a record for the quarter. It has confirmed the commitment to achieve a full-year operating ratio below 65% before 2017. To put things in perspective, Canadian National (NYSE:CNI) achieved an industry best operating ratio of 63.4% in 2013.

Foolish bottom line
A record quarter for the nation's largest railway, and arguable one of its most important transportation companies, is a positive sign for the health of the U.S. economy and Union Pacific investors. 

With its stock trading at a premium, both in terms of trailing and forward price-to-earnings, and offering a lower dividend yield than its peers, Union Pacific may not provide investors the best opportunity for short-term gains. But investors convinced that the U.S. economy is on the road to recovery, and see value in Union Pacific's outstanding franchise, which provides exclusive access to a number of markets, may want to take a ride on Union Pacific for the long run.

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Justin Lacey has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway. The Motley Fool owns shares of Canadian National Railway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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