5 Things Union Pacific Corporation's Management Wants You to Know

A Union Pacific station in Salt Lake City, Utah. Source: Flickr/vxla.

Union Pacific (NYSE: UNP  ) announced a record quarter last month, and the market barely shrugged. For the largest American railroad, it was business as usual.

A month later, however, investors are clamoring for shares, propelling Union Pacific's stock to new all-time highs. A recent dividend hike is responsible for some of the enthusiasm, but it's possible that the railroad's strong results are just starting to sink in with investors. After all, there was a lot to like in Union Pacific's second quarter, and management provided plenty of reasons to be optimistic about the rest of 2014.

Below are five key quotes from the conference call.

In the second quarter, volume was up 8% compared to 2013 and solid demand across our franchise led to volume gains in five of our six business groups. We had strong gains in agricultural products, intermodal and industrial products, and we also saw strength in automotive and coal. In chemicals, declines in crude oil volume were mostly offset by gains in other commodities.
-- Executive VP Eric Butler

It's reassuring to see such balanced growth across the board for Union Pacific, which is one of the most well diversified North American carriers. All six freight categories -- industrial, agricultural, intermodal, coal, chemicals, and autos -- contribute more than 10% of revenue, but not one contributed more than 20% in the second quarter.

Oil shipments fell 24% because of a narrowing spread between spot prices of West Texas Intermediate (WTI) and Brent crude oil. Source: Flickr/Roy Luck.

This allows the company to shrug off weakness in a single area. Crude oil volumes, for example, fell 24% year over year but the total effect was a mere 1% decline in revenue from chemicals. For perspective, the chemicals segment makes up 16% of overall freight revenue for Union Pacific.

Food and refrigerated shipments were up 3% for the quarter. Import beer volume was up over 20%, partially offset by declines in rice exports and lower produce and frozen food shipments.
-- Butler

Crude oil filled fewer railcars this quarter, but another liquid commodity helped pick up the slack: imported beer.

Americans are increasingly thirsty for imported beer from Mexico, a trend that drove beer volume shipments 20% higher in Union Pacific's latest quarter. Source: Flickr/Jirka Matousek.

Apparently, Americans are ditching name-brand domestic beers and turning to Mexican "cerveza" in droves. This isn't just a seasonal phenomenon either, but part of an ongoing trend. In 2013, Mexican brews grew twice as fast as total imports -- 11.1% versus 5.3% -- according to research by Beverage Industry.

All the while, America's beer-soaked summer is playing right into the hands of Union Pacific, which boasts six southern border crossings. Only one other carrier, Kansas City Southern, has a single route between Texas and Mexico.

Union Pacific management considers this "Mexico franchise" to be a key differentiator as cross-border trade continues to grow.

Beyond the record-setting volume figures, management provided something every investor needs to consider when evaluating quarterly results: context.

We believe some portion of the strength in the second quarter can be attributed to cargo owners advancing shipments ahead of the July expiration of the ILWU contract. So it is possible that some of our traditional peak international demand has already moved.
-- Butler

Source: Union Pacific.

As pointed out in the quote above, Union Pacific's surprisingly impressive results were in part due to customers pulling shipments earlier into the year. This relates specifically to the intermodal category, which transports goods in standardized containers that are easily transferred to trucks or ships. It accounts for roughly 10% of freight revenue.

In this instance, Union Pacific's international intermodal growth of 12% was propelled by an expiring labor contract that incentivized shippers to increase rail deliveries ahead of the June 30 expiration date. Growth in this segment was thus three to four times higher than originally predicted. 

We increased our targeted 2014 capital spend back in May to around $4.1 billion. Roughly $2.4 billion of that is replacement capital, with most of that to renew our track infrastructure. We are on target for the year as roughly half of that program work is now complete. Spending for service growth and productivity will total around $1.2 billion.
-- President and COO Lance Fritz

Any railroad investor must come to grips with the fact that this is a hugely capital-intensive business. As laid out in the quote above, only $1.2 billion out of $4.1 billion -- or roughly 30% -- in capital expenditures can be dedicated to growth. The rest, of course, is committed to track repairs or upgrades like positive train control that enhance safety and stability.

Investments in routine maintenance don't provide much of a payback for shareholders, but improvements in a railroad's operating efficiency can enhance the bottom line. And, in that category, Union Pacific is among the cream of the crop in its industry...

Every time we look at productivity, core pricing, the opportunities to grow our business, the reinvestment that we're making in our infrastructure to support that growth at profitable levels, we are enthusiastic about our ability to do better on operating ratio.

-- CEO Jack Koraleski

The most important operational statistic in the railroad industry is the operating ratio. It measures operating expenses as a percentage of revenue, and it's where many of the Class I carriers have eked out greater profits during the last decade. Union Pacific, for example, has seen its OR decline steadily from 89.4% in 2004 to 64.1% at the end of 2013.

In the latest quarter, Union Pacific posted an eye-popping 63.5% operating ratio, which puts the railroad right up there with the 63% posted by industry-leader Canadian National. One analyst on the call was skeptical that the West Coast carrier could go much further with its cost-cutting initiatives, but CEO Jack Koraleski refuted that very notion. From his perspective, there's always room for improvement, even in a 150-year old business.

The takeaway for investors

Union Pacific's stock is up 240% over the past five years, but -- incredibly -- this railroad's showing no signs of slowing. Even when the American economy hits a speed bump, the West Coast carrier picks up steam from increased international trade, fracking, automotive sales, or -- in this case -- Americans' growing thirst for Mexican lagers.

By taking a closer look at the second quarter, it's easy to see that a balanced revenue mix goes a long way for this railroad.

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  • Report this Comment On August 29, 2014, at 10:27 AM, ScoopHoop wrote:

    I've been promoting rail stocks for years. I started buying UNP at a split adjusted $22 per share in 2009. I now own 1900 shares. I wrote several articles for the Fool about UNP until the Fool dropped me as a contributor. Now I'm with Seeking Alpha. But I was singing this tune long before you and the others at the Fool, I now have $55,000 in unrealized gains in UNP. I believe the stock is about 5% to 7% overvalued based on historic metrics. One of these metrics is the dividend yield, normally 2% but is 1.9% at current price. Argus Research recently raised its target price to 120 from 104. That is a 14.2% upside potential from a 105 stock price.

    Here's links to two of my articles.

    http://www.fool.com/investing/general/2013/11/02/is-it-too-l...

    http://seekingalpha.com/user/9857091/instablog

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