After Union Pacific (UNP 1.92%) reported its second-quarter results, its management team shared some important information with investors during the subsequent conference call. Here are the key takeaways for long-term shareholders.
1. Union Pacific has pricing power.
A 4% core price increase was a positive contributor to freight revenue in the quarter ... Core pricing continued at levels that are above inflation and reflects the value proposition that we offer in the marketplace.
Railroads are a monopolistic industry, and while they compete with other modes of transportation, their nearly irreplaceable assets allow the major railroads to price their services in a way that helps to ensure an adequate return on investment.
2. Yet price increases have been unable to offset failing demand.
Union Pacific is reporting net income of $1.2 billion, or $1.38 per share for the second quarter of 2015. This is a 3% decrease in earnings per share compared to the second quarter of 2014. Solid core pricing gains were not enough to overcome a significant decrease in demand. Total volumes in the second quarter were down 6%, led by a sharp decline in coal. Industrial products and agricultural products also posted significant volume decreases.
With the railroads becoming more dependent upon commodities to fuel growth in recent years, they have also become increasingly exposed to downturns in the energy industry and in major commodity consumption markets such as China. As both of these areas have come under significant pressure in recent months, so too has Union Pacific's profits.
3. The sharp plunge in the price of crude oil is taking a toll.
We continue to expect crude oil prices and unfavorable spreads will remain a significant headwind for crude-by-rail shipments for the rest of the year. Lower crude oil prices will also continue to impact some of our industrial products markets.
Plunging crude oil prices have sharply reduced demand for crude-by-rail shipments, which fell 29% year over year in the second quarter. And the impact from falling oil prices reaches beyond just crude oil shipments; the reduction in drilling activity also led to a 28% decline in shipments of frac sand and a nearly 50% reduction in drilling-related metal shipments.
4. The downturn in coal demand also remains troublesome.
Coal revenue declined 31% in the second quarter on a 26% reduction in volume and 7% decrease in average revenue per car.
Demand for coal was negatively affected by mild weather and lower natural gas prices during the second quarter. But the bigger story is the long-term secular decline in coal demand related to the closing of coal-fired power plants as the U.S. turns increasingly to natural gas for its electricity production. This trend is likely to remain a drag on Union Pacific's results for the foreseeable future.
5. Management is "right-sizing" the company to get back on track.
As you recall, first quarter volumes were down 2%, and we began realigning our resources early in the year, storing locomotives and furloughing employees. These efforts continued throughout the second quarter. We've made meaningful progress right-sizing our resources to current volumes, and I'm encouraged to report that we've made these improvements while posting strong safety performance. But our work is not finished. We'll continue to become more agile with our network and our resources.
Union Pacific is attempting to offset declining volumes by reducing operational inefficiencies. By June, the company had reduced its train engine and yard workforce by 4% and active locomotive fleet by 5% compared to the end of the first quarter. The more progress Union Pacific makes in better aligning its resources with demand, the less it will suffer when demand is low, and the better positioned it will be to profit when volumes eventually rebound.