North American rail operator Union Pacific's (NYSE:UNP) fortunes are closely tied to activity in the U.S. economy. And as the economy opens back up at an extremely gradual pace, rail volumes are showing small signs of life. Roughly two-thirds of the way through the third quarter, the organization's Aug. 29 weekly traffic report reveals a 14% decline in carload volumes quarter to date against the same prior-year period, while intermodal volume has eked out a 5% gain, for a total volume decline of 6%. This marks a tangible improvement from the railroad's 20% volume slump in the second quarter of 2020, and its 12% dip in the first six months of the year.

Higher carload and intermodal activity should help stabilize faltering financials: In the second quarter of 2020, Union Pacific's total revenue fell 24% against Q2 2019 to $4.2 billion, while net income plunged 31% to $1.1 billion.

Though the rail giant will still generate positive net income in 2020, shareholders already understand that it's headed, along with the rest of the industry, for a lackluster year. Union Pacific stock has at least kept up with the performance of the broader market, generating a 6% year-to-date gain at the time of this writing, in line with a 5.7% improvement in the S&P 500 index.

However, the COVID-19 pandemic may be opening up a one-time opportunity for Union Pacific to have a lasting impact on future results.

A yellow freight train ascends a hill under blue skies in Colorado.

Image source: Getty Images.

Tinkering with rail assets during an unusual period

In its second-quarter report issued in late July, Union Pacific revealed a setback to recent progress in its operating ratio. The operating ratio is the most widely followed metric tracking railroad performance. It's derived by dividing total expenses during a period by total revenue; thus, a declining operating ratio denotes rising productivity.

Union Pacific's operating ratio rose by 140 basis points in the second quarter against the comparable quarter, to 61. This followed several periods of record productivity for the railroad -- its operating ratio hit an all-time quarterly record of 59% in the first quarter of 2020. The organization was making steady progress on efficiency through the implementation of its "Unified Plan 2020 initiative," which relies heavily on principles of precision scheduled railroading, or PSR, to beef up performance.

While productivity dipped slightly in the second quarter as rail volumes plunged, overall, lighter traffic this year is handing Union Pacific a unique opportunity as it works on programs like improving network fluidity, reducing hump yards (a type of sorting yard for rail cars), and reducing locomotives in service and staffing to optimal levels.

All of these initiatives and other PSR activities can be achieved under normal volume conditions. But they're often conducted in an environment in which a railroad is simultaneously solving bottleneck problems on various lines and at major terminals. A higher level of experimentation and fine-tuning can be processed during a period of light traffic. 

Indeed, some of this progress is already visible in the transportation giant's operational statistics. In the second quarter, terminal dwell time decreased 16% against the prior-year period, to 21.6 hours, while average train speed increased 10% to 26.9 miles per hour. Locomotive productivity rose 12% to 136 gross ton miles per horsepower day. And average train length, a telling measure of efficiency (longer is better), increased by 13% over Q2 2019 to 8,664 feet.

Union Pacific has been working on its Unified Plan 2020 since late 2018, so admittedly, better stats haven't arisen solely from a sudden change in rail conditions. Yet the confluence of so many positive results at double-digit rates or higher is undoubtedly also being spurred by the ability to conduct wider real-time PSR adjustments during the pandemic year.

While the beneficial effects of 2020 productivity enhancements will likely be masked until volume normalizes, Union Pacific is building durable advantages during a sequence of soft quarters. Rising efficiency under an improved volume picture, which should manifest at some point in 2021, will result in higher profits associated with every carload and intermodal shipment, and higher net income and free cash flow per share for investors.