Union Pacific is the largest freight railroad company in North America, operating primarily in the 23 states west of the Mississippi River. The company’s nearly 32,000 route miles link the Pacific Coast and Gulf Coast ports with the Midwest and eastern U.S. gateways, and it offers several corridors to key Mexican gateways. After decades of real rate decreases, a “rail renaissance” began around 2004 when the regulatory backdrop on pricing became more rail-friendly, service levels improved, and rising fuel prices helped rails compete with trucking. Since then, Union Pacific’s revenues have grown approximately 7% per year, and its operating margin has increased from the low-teens range to the low 30% range. We believe that these positive trends will continue, albeit at a slower pace, due to pricing power that exceeds inflation and moderate volume growth from an improving economy and a recovery in below-trend categories like housing, construction and agriculture. Moreover, the company’s profit margin can still improve further, and we expect Union Pacific to return the vast majority of its free cash flow to shareholders via share repurchases and dividends. We consider the stock to be attractively priced at only 12x our estimate of “normalized” earnings in 2015.
From Bill Nygren (Trades, Portfolio)'s fourth quarter 2013 commentary.