How Union Pacific Is Overcoming Supply Chain Challenges

Like many transportation companies, Union Pacific (UNP 0.25%) is coping with supply chain challenges, including in the automotive and intermodal segments, or cargo that goes directly from ships to trains. However, the company has also discovered that it has pricing power at a time when shipping channels are constrained.

In this episode of "Beat and Raise" recorded on Jan. 21, Fool.com contributors Lou Whiteman and Brian Withers discuss Union Pacific's strong fourth quarter and how the company is adapting to the global supply chain challenges. 

Brian Withers: Let's talk about Union Pacific's quarter.

Lou Whiteman: We talked trends? Let me show you this and then we can talk about it for a second. Union Pacific, we know this is the big railroad out west. Can you see it on the screen now?

Brian Withers: I am. It looks awesome.

Lou Whiteman: They had a good quarter. You can see revenue $5.73 billion beat the $5.62 consensus, so that's a solid beat. Earnings of $2.66 per share. Consensus was $2.61.

Brian Withers: Wait a minute. I guess just got to say there. There's a railroad that's growing double-digits both the top and the bottom line and is wildly profitable?

Lou Whiteman: But wait, hold on a second because yes. You've got to remember that volumes were down at the end of last year. The year-over-year comparisons are a little weird. Nice year-over-year jump at 12 percent earnings, it should be noted that fourth-quarter of 2020 had a lot of charges though. So that almost a half-billion dollars in charges I think.

Brian Withers: That one was a layup this year.

Lou Whiteman: But no. This is a solid company that did really well. Outlook they don't give any real firm guidance, but they said volume growth is to be expected, and pricing gains in excess of inflation. A lot of what you saw from Union Pacific is what you already knew was out there from all of the port and shipping talk. Right now these guys have pricing power, because the railroads are about the only 24/7 part of the supply chain. They can take maybe not all of the capacity of the rest of the system get to them, but they certainly can handle whatever comes their way and they're getting really good pricing for it.

If you look into the highlights, you will see that 4 percent volume decline. What happened? Volume declines primarily in automotive and intermodal. Again, these are things that you already knew were out there from other stories. Automotive is down because of the lack of chips, is simply fewer cars being shipped. Intermodal, those are the huge bodies that can go straight off a shift onto a train, onto a truck. The clogged ports are just basically screwing up intermodal volumes. Those are macro issues as we know. But that volume decline was offset by pricing power and the fuel surcharge. Fuel surcharge is important because, if you look their operating ratio, this is basically a dirty quick expenses as a percentage of revenue. It's kind of how efficient they are. That's better, that's 57 percent down from 60 percent, but it did fall about a 100 basis shorts short of expectations. That's where we see fuel coming in. Which was another big issue that we all knew was out there, somewhat offset by fuel surcharge. They're doing pretty well.

If you have concerns I would say cost, because we do have expenses up 15 percent year-over-year, mostly fuel. 60 percent of the over was fuel. But there were some labor costs there. I mean, they are not immune to what we're seeing. I mean, it's not as bad as the truckers, but there are labor costs concerns. Secondly, we look at something called freight velocity, and that's basically a measure of how quickly cars are moving through the system. That's way down from two years ago. Some of that is COVID. A lot of it is just impacted by crew availability. We're still a work in progress. If you look out, this is a story I think that looks better in the second half of 2022 than the first.

Pricing power is here to stay for the immediate future. We're going to see strong pricing throughout this year. They're going to get more of those fuel surcharges as we get renewals in the spring, which is what's going on now. I think some of the premium areas like autos, like intermodal should be strong in the second half as the chip story changes and we have hopefully more velocity through the ports. You can see it doesn't look well on that one-year chart, to coming short of the S&P 500. If you look at the three-year, I think you'd see the same, but if you look at five-year or 10-year, things look a lot better. This is a long-term story. This is right now I think the best railroad to own. It's going to be a few years before we got-Canadian Pacific is going have to do a really good job of integration before I change my mind from there.

Brian Withers: It looks like their operating ratio. They've been really focused on that and targeting downtime of what, a 55 percent range. Fuel's probably a little bit of a wildcard there, but they continue to get more and more efficient with the business that they run.

Lou Whiteman: They do and just not to interrupt you. But one interesting thing here is that this is something that has been going through the railroads, where precision scheduling with railroads, it started in Canada and has come down where they are trying to do more with less. Trying to run it more as a schedule instead of as you need it. COVID and what's going on now has really challenged that. I'm less certain. I think we're going to see some of these operating ratio pushes slow, because of the pricing power. There is more logic to run more trains and go back to the old system of just flooding the network when you have pricing power. I still think it's a long-term goal, but yeah, I think we're actually-I think we should be less focused on that than we were, just simply because of the rates they can get for running these trains right now.

Brian Withers: The other piece that I was really impressed with the company is they have been paying a dividend for a 122 years plus, and for the last 16 years it's been increasing.

Lou Whiteman: A 100 years?

Brian Withers: Yeah.

Lou Whiteman: I'll tell you, we've talked a lot about markets and chaos and all everything going on. I wouldn't want a portfolio full of railroads but a well-run railroad as a ballast in times like this. Markets like these are a reminder of the importance of diversification. You can find really well-run companies on the income or more conservative side of the ledger. I think this is a good example of one.