Railroad behemoth Union Pacific (UNP 0.99%) demonstrated convincingly on Wednesday that its interpretation of precision scheduled railroading (PSR) has provided a lasting boost to its efficiency and its bottom line.
The rail giant released its fourth-quarter 2020 financial scorecard before the markets opened, and though UNP stock closed the day down 4.7%, investors in for the long haul should be more than pleased with the company's results and rail-operating metrics over the last three months.
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Steadying volumes and a pricing power
As it has since the beginning of the COVID-19 pandemic, Union Pacific struggled with volume this quarter, but it did manage a positive comparison over the last three months. Volume, as measured by revenue carloads, increased by 3% year over year, to 2.1 million carloads. Intermodal shipments, the company's largest freight type, improved in volume by 12%, offsetting declines in coal, metals, and energy shipments.
The railroad capitalized on the higher traffic by instituting advantageous pricing. Yet total freight revenue still declined by 1% year over year, to $4.8 billion, due to a drop in fuel surcharge revenue and what management described as a "less favorable business mix."
Net income dipped 2% against the fourth quarter of 2019, to $1.38 billion. Although the organization operated more efficiently versus the prior year, it took a non-cash impairment charge of $278 million on its Brazos Yard (a hump yard, or type of freight-sorting facility) in Hearne, Texas. This weighed on net income and produced the negative 2% comparison with the prior-year quarter.
The write-down on the Brazos Yard equaled roughly half of its project value of $550 million, which management had described last year as the largest capital investment in the company's history.
A breakout operating ratio performance
The Brazos Yard restructuring is related to the company's implementation of PSR principles over the last several quarters. While the Brazos facility is meant to increase network fluidity, its function has in part been made obsolete by other gains the company has achieved in network efficiency through its PSR program.
As I discussed in the fall, Union Pacific has enjoyed a significant opportunity to conduct its PSR experiment during a period of weak rail volumes. The result has been a sustained reduction in its operating ratio (OR), a measure of rail productivity (found by dividing total expenses by total revenue during any given period). After adjusting for the Brazos Yard impairment charge, Union Pacific's fourth-quarter OR hit an all-time company low of 58.5%, a mark roughly two percentage points lower than the comparable prior-year quarter.
Key metrics demonstrate how the railroad is achieving record efficiency. Freight car velocity increased by 6% in the fourth quarter over the prior year, while average terminal dwell time decreased by 8%. Locomotive and workforce productivity (metrics that track miles per locomotive and per employee) improved by 14% and 11%, respectively. And Union Pacific's average train length jumped by 12% year over year, to roughly 9,150 feet.
Union Pacific continued to translate its profitability into solid cash flow during the fourth quarter. The freight transportation specialist has generated $5.6 billion in free cash flow over the last twelve months. It used all of this cash in conjunction with debt issuances to repurchase $3.7 billion worth of its own shares, issue $2.6 billion in dividend checks, and retire about $2 billion in existing debt.
As is customary for Union Pacific, management didn't issue detailed financial guidance in its year-end report. The company did indicate that the freight environment remains uncertain in the near term, courtesy of the COVID-19 pandemic. Nonetheless, management signaled further pricing power ahead in core freight categories in 2021 as well as confidence that the rail giant will increase its market share at the expense of rivals this year. All Union Pacific needs now to spur a hearty acceleration in earnings is a return to pre-COVID freight volumes.
