Will These 3 Risks Stall Union Pacific's Growth?

Union Pacific has fantastic growth prospects -- but investors should consider these risks as well.

ICRA Online
Eshna Basu
May 20, 2015 at 1:07PM

In the past decade, Union Pacific's (NYSE: UNP) share prices have skyrocketed by more than 600%, outperforming peers and the industry as a whole. But the company is not without its share of risks and challenges. Weather disruptions and strict adherence to regulations have always remained generic risks and have hit Union Pacific as well. But here are some other risks that could cause Union Pacific's share prices to fall.

Source: The Motley Fool

Labor disputes at the ports
The growing importance of the intermodal business has made it critical for ports to operate smoothly and undisrupted as that is where the containers are loaded and unloaded. Intermodal generates nearly 40% of Union Pacific's business traffic and one-fifth of total revenue, with the ports of Los Angeles and Long Beach functioning as the hubs. Labor disputes at these ports pose significant risk.

In February, a long-drawn conflict between port authorities and labor unions at the ports of Los Angeles and Long Beach was settled (though not very amicably) through a five-year agreement. Due to this conflict, volumes had dropped 29% at the Los Angeles port and 19% at Long Beach in January.

The West Coast port obstruction has hit Union Pacific's international intermodal volume by 12% in the first quarter ended March 2015.  There's again news of unrest at these two ports with West Coast port truckers striking against four ground-shipment companies. Union Pacific being a dominant player of the West Coast could suffer the most.

Slowing coal demand
Strict emission norms in the U.S. and elsewhere have taken a toll on the demand for coal. By 2030, the U.S. government wants to cut the emission level by 30% from the 2005 level. This would mean using less coal and more natural gas. China, the world's largest importer of coal, is also reducing coal consumption to bring down the level of carbon emissions, which is hurting U.S. exports.

Coal shipments make up a significant portion of railroad industries' revenue and hence lower demand for the same could be concerning. Union Pacific and BNSF dominate over 60% of the North American coal carloads. Though Union Pacific has been reducing its coal exposure over the past few years, it still accounts for 18% of the company's total revenue.

Source: 10-Ks. Chart by author.

Again, the recent slide in gas prices is significantly affecting coal usage. The US Energy Information Administration has predicted that in April and May demand for natural gas for generating power could increase to a level that could almost match coal. .

Union Pacific's already feeling the heat as its coal revenue in the first quarter dropped 5% to $915 million and volumes fell 7%.

Low oil prices
Crude oil prices have halved in the past few months. This means low fuel costs and better operating ratios for railroad companies. But on the flip side, low crude oil prices could mean some of the upstream companies engaged in surface drilling activities go out of business. This could reduce crude and frac sand carloads for railroad companies, and also put the brakes on shipments of pipes and chemicals needed to haul oil and gas out.

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Union Pacific management sounded worried about this in the first quarter earnings call. Management admits that uncertain crude oil prices are hurting volumes in its Chemical segment.

Bloomberg data shows that in 2014, the company had a petroleum carload market share of around 12%, which is much lower than the 43% for BNSF. If crude prices remain depressed for a long time, the damage to Union Pacific will be that much less, but is nevertheless worrying.

In the first quarter, the company's crude oil shipments were down 38%. Union Pacific's executive vice-president, marketing & sales, Eric Butler said at the first quarter earnings call, "...we expect that crude oil prices will remain a significant head wind for crude by rail shipments for the rest of the year."

To conclude
It is important for investors to be aware of the pitfalls a company faces or may face in the future. This saves one from any unpleasant surprises. Labor disputes and sluggish coal demand were the main reasons why the company missed analyst estimates (first time since 2011) in its first quarter. Though oil isn't impacting the top and bottom lines significantly as of now, it remains a nagging issue. Investors should keep an eye on these in the coming days.