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Union Pacific Will Continue To Create Value

July 27, 2014 | About:
Faisal Humayun

Faisal Humayun

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Union Pacific Railroad is the principal operating company of Union Pacific Corporation (UNP). One of America's most recognized companies, Union Pacific Railroad connects 23 states in the western two-thirds of the country by rail, providing a critical link in the global supply chain. This article discusses the reasons to be bullish on Union Pacific after strong results in July 24, 2014.

Union Pacific has made a strong comeback after the financial crisis and the company’s fundamentals have improved significantly over the last five years. Union Pacific’s diluted earnings per share have increased from $3.74 in 2009 to $9.42 in 2013.

During the same period, the company’s dividend per share has surged to $2.96 from $1.08. Amidst an increase in dividends, the company’s operating cash flow has also increased to $6.8 billion in 2013 from $3.2 billion in 2009.

Union Pacific has also been successful in reducing the company’s debt to capital from 37% in 2009 to 31% in 2013. From a shareholder return perspective, the return on equity has surged to 21.4 in 2013 from 11.8 in 2009.

All these numbers show that Union Pacific has grown at a strong pace in the last four years and the company also has strong fundamentals. Guru Focus rates Union Pacific 7 out on 10 in terms of financial strength and this underscores my point on strong fundamentals.

The positive point is that Union Pacific is likely to grow at a strong pace in the coming quarters. For the first quarter of 2014, the company’s EPS increased by 17% to $2.38 from $2.03 in 1Q13. For the second quarter of 2014, the company’s EPS increased by 21% to $1.43 from $1.18 in 2Q13. The growth for both the quarters was driven by freight revenue increase coupled with volumes growth. This is also an indication of continued improvement in the US economic scenario.

Considering the full year outlook, Union Pacific expects the optimism to sustain and this is in line with analyst estimates of 16.8% earnings growth for 2014. Even for 2015, analysts estimate that earnings growth will be robust at 14.4%. Union Pacific is therefore set for strong growth over the next few quarters. Guru Focus rates Union Pacific 9 out of 10 in terms of profitability and growth and the above set of EPS and growth numbers also point to a high rating for the stock.

Another positive point on Union Pacific, which will impact the company’s margins in the coming years, is the investment in replacement infrastructure and productivity. For 2014, the company intends to incur an expense of $2.45 billion on replacement infrastructure and an investment of $1.2 billion on service growth and productivity. I believe that improved infrastructure and productivity will drive EBITDA margin higher over the next few years.

Shareholder value creation is likely to come in more than one way from Union Pacific. As the company is set for strong earnings growth, stock price appreciation is likely. Further, from 2007 until 2Q14, Union Pacific has repurchased $10.8 billion in shares with $1.5 billion of share repurchase coming in 1H14. This will be another major source of EPS boost and value creation.

Finally, strong increase in dividends is the third source of shareholder value creation. Union Pacific has increased its dividend payout by 32% to $0.91 per share in 1H14 as compared to $0.69 per share in 1H13. For the period 2013-17, Union Pacific plans almost 50% of the allocation of cash inflow towards dividends and share repurchase. Even if an annualized operating cash flow is considered for 2014, a likely OCF of $6.4 billion would mean that nearly $3.2 billion would be allocated towards cash returns in 2014. I expect annual cash returns over the next 3-4 years to be in the tune of $3 to $4 billion annually. Therefore, shareholder value creation avenues are in plenty and if the US economy continues to recover or remain resilient, the stock will appreciate along with higher dividends.

The risk factor is clearly the trend in the US economy. With the Fed tapering its QE program, the impact on the economy remains to be seen. To protect from downside related to this risk, investors need to buy this stock in a staggered manner so that prices can be averaged out in case the stock declines on relative economic gloom. I believe that the stock will provide handsome long-term returns even if this risk does come true in the near-term.

Union Pacific is a value creator and is likely to remain a value creator. Guru Focus ranks (Business Predictability Rank) Union Pacific as 5-star and I believe that this rank is reflective of the company being an investment worth considering.

About the author:

Faisal Humayun
Senior Research Analyst with experience in the field of equity research, credit research, financial modelling and economic research

Rating: 4.0/5 (1 vote)

Voters:

Comments

petershk
Petershk premium member - 1 month ago

Good article.

ive been thinking of picking it up but this saved me some research time.

Railroads are so undervalued by investors. You need to ask yourself what is going to replace them? No matter how many advances are made in digital tech, the trillions of atoms we consume have to be moved around and at $/unit weight railroads do well. Also the capital expense to compete should substantial advances is transportation come along would be massive... Never mind the various integration into other businesses.

my problem is I missed the boat a bit and I'm not sure it's cheap enough... But might be worth paying a bit of a premium.

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