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Falling Freight Demand Derails Union Pacific Corporation Earnings

By Joe Tenebruso – Oct 24, 2016 at 6:48AM

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Concerns are growing that the railroad's pricing power is eroding as volumes continue to decline.

Image Source: Union Pacific.

Union Pacific's (UNP 1.46%) third-quarter profit fell 13% as the railroad continues to struggle with declining demand for its freight-hauling services. Freight volumes, as measured by total revenue carloads, slumped 6% compared to the prior year period.

The decline was broad-based, with Union Pacific seeing lower freight revenue in nearly all its business segments, including coal (19%), industrial (13%), intermodal (9%), automotive (8%), and chemicals (1%). The only exception was Union Pacific's agricultural products segment, which rose 6% in the third quarter. In total, operating revenue declined 7% year over year to $5.2 billion.

Union Pacific was able to deliver core price gains of 1.5%, yet that's down significantly from 3.5% in Q3 2015. The railroad also continues to adjust its resources, with its active locomotive count and train, engine, and yard workforce -- while up sequentially -- down 9% and 14%, respectively, compared to the year ago quarter. Still, Union Pacific's operating ratio -- a key metric defined as operating expenses divided by operating revenues -- rose to 62.1% from 60.3% in the prior year period, as these price increases and expense reductions weren't enough to offset the decline in revenue.

All told, operating income fell 11% to $2 billion. Net income, which was impacted by higher interest expense, declined 13% to $1.1 billion. And earnings per share, helped somewhat by the $851 million in share repurchases Union Pacific conducted during the quarter, fell 9% to $1.36.

Looking ahead

The global trends that have dampened Union Pacific's business in recent quarters will likely continue to weigh on the railroad's results in the months ahead.

"The macroeconomic environment still has its challenges-an unstable global economy, the relatively strong U.S. dollar, and continued soft demand for consumer goods," said CEO Lance Fritz in a press release.

Still, Fritz remains confident that Union Pacific can weather the storm.

"Closing out 2016 and heading into next year, we are optimistic about the opportunities that lie ahead. In the coming months we will continue to do what Union Pacific does best-operate a safe, efficient, and productive network while providing an excellent customer experience and delivering solid shareholder returns."

Yet for Union Pacific to deliver market-beating returns, costs cuts and productivity improvements won't be enough. The railroad will need to prove that it still possesses pricing power and the ability to deliver rising profits, and that will be increasingly difficult to do if demand continues to weaken.

Stabilization in coal demand would help, and with natural gas prices rising in recent months, Union Pacific could get a reprieve in that regard. Additionally, strong global demand for U.S. grain is expected to bolster the railroad's agricultural products business. This could help to offset what will likely be further weakness in automotive , intermodal, and industrial products demand in the quarters ahead.

But until Union Pacific can return to positive growth in overall freight volumes, further core pricing gains -- and, even more so, a recovery in profits -- will be challenging for the railroad to deliver.

Joe Tenebruso has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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