Railroad companies like Union Pacific (NYSE: UNP) spend billions on building infrastructure, repairing and relaying tracks, and replacement of property and equipment. With lion's share of capital locked in illiquid assets, these companies need to be extra careful about how they manage their liabilities and obligations so that there are no disruptions in day-to-day operations. Here's a look at Union Pacific's liabilities to gauge if there are any risks that investors need to be aware of.

Liability structure in-line with peers
Deferred tax liabilities and debt are the two most important items on the liability side of a railroad company. Deferred tax liabilities arise from the treatment of depreciation -- railroad companies tend to depreciate their assets faster in the initial years as it lowers income and taxes thereon. The tax liability gets shifted to later years when depreciation levels out. The companies book this as deferred tax liability.

Also -- because of the capital intensive nature of the business -- railroad companies often tap debt as an alternate source of funds. So debt is significant.

Chart 1. Source: company 10Ks; chart by author  

At the end of 2014, Union Pacific had total debt of $11.5 billion with $462 million maturing in 2015 and the rest thereafter. It had deferred tax liabilities of $15.6 billion. In the last six years, the company's debt has remained in the range of 30% to 40% of total liabilities and deferred tax liabilities in the range of 45% to 50%. While debt could continue to remain at these levels, there's a possibility that deferred tax liabilities could come down in future.

President Obama has proposed to reduce corporate tax rate to 28% from the existing 35%. According to a March study, if this happens, Union Pacific could see its deferred tax liabilities decrease by $2.8 billion, resulting in a 13.1% increase in shareholders' equity. Rival BNSF could also witness a $3.4 billion cut in deferred tax liabilities and 7% increase in net worth.

The four major class 1 railroad companies have a similar liability structure with 75% to 85% of total liabilities represented by debt and deferred tax liabilities. BNSF has the lowest debt and highest deferred tax liabilities in the peer group.

Chart 2. Source: company 10Ks; chart by author 

Key metrics
Let's look at some of Union Pacific's key debt ratios to ascertain whether any risks are lurking. We have excluded BNSF from comparisons as it's privately owned and its ratios are not readily available. It suffices to say that because BNSF has the lowest debt among the four major class 1 railroad companies, its ratios would be more conservative than Union Pacific's.

Debt-equity ratio: It's calculated as total debt divided by shareholders equity. In 2014, this ratio increased for Union Pacific and stood at 52%, but it's nothing significantly different from the company's historical debt-equity ratio. Though analysts generally like to see this ratio at around 30% or lower, capital intensive industries such as railroads typically have higher debt-equity ratio. When compared with peers CSX and Norfolk Southern, Union Pacific's debt-equity ratio looks fairly conservative. 


Chart 3. Debt-equity ratio. Source: Morningstar; chart by author 

Interest coverage ratio: This is the amount of operating income a company generates compared with the interest payments. Union Pacific's interest coverage ratio was north of 15 in 2014. For any company, analysts like to see this ratio in high single digit or more. Union Pacific's interest coverage ratio is higher than CSX and Norfolk Southern. As such it can manage market slumps better and respond to market shocks or changes faster compared with peers. 

Chart 4. Interest coverage ratio. Source: Morningstar; chart by author 

Liquidity ratio: Current and quick ratios measure a company's ability to pay for day-to-day operating expenses. Both the ratios are calculated by dividing current assets by current liabilities. For quick ratio, inventory is excluded since it takes comparatively longer to convert into cash. The higher the ratios -- the stronger is the company's liquidity. Union Pacific's current ratio is above 1 that shows the company is meeting its near-term obligations without trouble. Though its quick ratio lags CSX and Norfolk Southern, it's still above the industry average which is less than 0.5. 

Chart 5. Quick ratio (left) and current ratio (right). Source: Morningstar; chart by author 

Last word
Union Pacific has a strong balance sheet. True to industry trends, the company's biggest liabilities are its debt and deferred tax. It has manageable debt and generates adequate profits to cover its interest payments. This leaves the company with some room to raise further debt should there be a need. Union Pacific has high deferred tax liabilities, but this has been the company's trend in the past and is in line with the industry. All in all, Union Pacific has it liabilities well under control and no obvious threats are visible.

ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.