3 Reasons Union Pacific Corporation's Stock Could Fall

What could derail Union Pacific's stock? Here are a few things to watch out for.

Sep 2, 2014 at 5:30PM

Unp Car

Source: Flickr/Loco Steve.

Over the past decade, the Class I railroad Union Pacific (NYSE:UNP) has been on a roll. Its stock outperformed the market in eight out of those 10 years, spurred by economic growth, an increase in oil-related traffic, and effective cost-cutting programs. Investors who held during that time period are undoubtedly patting themselves on the back.

For the rest of us, however, is it too late to get on board? What if the tailwinds propelling this railroad stock suddenly change course?

Before you go out and load up on shares of Union Pacific, here are three key risks you need to consider:

1. The rail industry lives and dies at the hand of regulators

The regulatory environment has been quite favorable for railroads in recent years. The Staggers Rail Act of 1980 dramatically changed the way major carriers conduct their operations, and the oligopoly it created has -- for the most part -- balanced the pricing concerns of customers with the high costs of running a railroad.

But that dynamic can change on a whim, especially as Class I railroads like Union Pacific rake in record profits and consistently earn returns that exceed their cost of capital. Union Pacific, in fact, barely crossed that threshold in 2010, after at least 50 years of missing the hurdle.

Now that higher returns are business as usual, it provides customers with leverage when protesting price increases. Powerful interests in the chemicals or manufacturing industry can point to certain routes where competition is limited or nonexistent and prompt lawmakers to re-evaluate the current structure.

On the whole, it is very difficult to gauge how lawmakers will respond to ongoing complaints. Chemical companies have suggested an idea that would allow them to quickly switch carriers if they found a better price. This proposal is called "competitive switching," and it's a solution that could result in higher costs for railroads. Obviously, the worst-case scenario would be if regulators put a cap on carriers' pricing power, which would dampen their profits even more.

Because regulation can have such a profound effect on rail, this storyline is one that investors need to become familiar with. Bureaucratic regulators, as you may know, can be highly unpredictable, and every aspect of the rail industry can be touched by their actions.

What happens, for instance, if developing economies follow in the U.S.' footsteps and de-emphasize the use of coal for electrical generation? In some ways, it might be in their best interest, economically speaking, but it would have dire consequences for railroads that depend on America's coal exports.

2. Safety concerns could affect oil transport

Oil Transport

Source: Flickr/Roy Luck.

The ongoing American energy revolution has been a boon for railroads, but along with it came increased risk for carriers.

The growth of fracking and horizontal drilling has led to a dramatic increase in energy-related shipments. In 2009, only 3% of rail carloads were hauling petroleum or petroleum products across America. Today, roughly half of all carloads are carrying goods for the oil and gas industry.

Consequently, railroads have found that transporting a highly flammable liquid is much different than moving grain or household products. In April, three crude oil cars on a CSX train bust into flames and spilled some of their contents into the James River. No one was injured in the accident, but it was the latest in a series of mishaps that have caused the oil and rail industries to re-evaluate their safety standards.

In a best-case scenario for railroads, carriers will work quickly with manufacturers to build more robust railcars for transporting crude oil. This would add new expenses but avoid a stoppage in terms of traffic.

Of course, any future accidents could lead regulators to press the brakes on this area of the business altogether, an outcome that would not bode well for Union Pacific. The company does not disclose the portion of its revenue that comes from oil, but this commodity gets lumped in with the chemicals business, which generates 17% of sales. 

3. Unpredictable weather is likely to cause more scheduling chaos

In Union Pacific's midyear presentation to investors, management made the following crystal clear about its 2014 outlook: "Weather will be a factor."

Without context you might find that statement unnecessary. Isn't weather always a factor? While this is true, more and more companies are recognizing that the increasing unpredictability of weather patterns poses challenges for their businesses. Railroads are no exception.

And railroads, in particular, loathe unpredictability.

Just as you probably hate waiting on trains at the station, their customers resent late arrivals. Their schedulers can't stand delays on the track. And, of course, the tracks themselves can't do much to offset the effects of unpredictable and sometimes disastrous weather patterns. Flooding, for example, severed a number of key corridors for Union Pacific this summer, including an important artery referred to as the East-West mainline.

These types of disruptions can have a severe impact on a railroads' performance. There is a domino-like effect when one line experiences a delay, which can then ripple across the entire network.

If the climate in a certain region changes over time, that can present both risk and opportunity for an industry. That's true for rail as well. But if unpredictable patterns and increasingly severe storms become the new normal, there's really no upside for a logistics-oriented business. Instead, it just makes a typically steady and reliable business a whole lot more volatile. And that poses additional risk for investors.

The takeaway for investors

Railroads like Union Pacific might seem invincible right now after an incredible 10-year run. But investors should not lose sight of the fact that the industry requires heavy reinvestment, thereby creating only a sliver of wiggle room in which to generate returns beyond their cost of capital.

Should pricing power decrease, oil volumes slacken, or volatile weather cause disruptions, Union Pacific's market-beating track record could come to an end.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Isaac Pino, CPA, has no position in any stocks mentioned. The Motley Fool owns shares of CSX. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers