Should You Buy Union Pacific Post Recent Upgrades?

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May 18, 2015
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Analysts at TD Securities have recently upgraded Union Pacific Corporation (UNP, Financial) from Hold to Buy. They have set price target for Union Pacific at $120, implying ~15% upside from the current levels. Earlier this month, Union Pacific featured in Morgan Stanley's list of the 10 largest U.S. stocks that are trading at a discount to the broader market and also expected to grow at an above-average rate. Stifel analysts have also recently upgraded the stock citing attractive valuations. The company looks undervalued as per Gurufocus' DCF calculator as well, which gives it 38% margin of safety. Here's a look at the company in detail.

Union Pacific Corporation is a Class I railroad operating in the U.S. The company has 31,974 route miles, linking Pacific Coast and Gulf Coast ports with the Midwest and eastern U.S. gateways and provides several corridors to key Mexican gateways. It serves the Western two-thirds of the country and maintains coordinated schedules with other rail carriers to move freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada, and Mexico. Export and import traffic moves through Gulf Coast and Pacific Coast ports and across the Mexican and Canadian borders. Union Pacific provides value to its roughly 10,000 customers by delivering products in a safe, reliable, fuel-efficient and environmentally responsible manner.

Union Pacific’s freight traffic consists of bulk, manifest, and premium business. Bulk traffic primarily consists of coal, grain, soda ash, ethanol, rock and crude oil shipped in unit trains – trains transporting a single commodity from one source to one destination. Manifest traffic includes individual carload or less than train-load business involving commodities such as lumber, steel, paper, food and chemicals. The transportation of finished vehicles, auto parts, intermodal containers and truck trailers are included as part of the company’s premium business. In 2014, Union Pacific generated freight revenues totaling $22.6 billion.

In terms of competition, Burlington Northern Santa Fe railroad is the primary competitor of Union Pacific. Other competitors include motor carriers, ship and barge operators, and pipelines. In addition to price competition, the company also faces competition with respect to transit times, quality and reliability of service from motor carriers and other railroads. Motor carriers in particular can have an advantage over railroads with respect to transit times and timeliness of service. However, railroads are much more fuel-efficient than trucks and they also reduce the impact of transporting goods on the environment and public infrastructure. The company has been making efforts to convert certain truck traffic to rail.

Union Pacific has seen a good growth in its revenues and profitability over the last five years. In the last five years, the company’s revenues have risen by more than 50% while its EPS has more than doubled. The company has also done a good job in terms of returning cash to the shareholders through dividends and buybacks. The company has increased its annual dividend to $1.91 in FY2014 versus $0.655 in FY2010. The company has also bought back ~$9.6 billion of its shares over the last five years.

Going forward, analysts are expecting the company’s EPS to further increase to $6.47 in the current year and $7.33 next year. Its revenues are expected to increase 2.50% in the current year and 6.60% next year.

The company’s stock price has corrected of late as many railroad companies were affected due to lighter shipment of coal, adverse mix and weather-related challenges. I believe this correction offers a buying opportunity as once the weather-related challenges are over volume will again rebound from Q2 onwards.

Union Pacific is trading at a forward PE of 14.80 and has a dividend yield of 2%. According to GuruFocus’ DCF Calculator, the company has a business predictability rating of 4.5 stars and a margin of safety of 38%.

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Out of 30 analysts covering the company, 23 have buy or strong buy ratings while seven have hold ratings. I believe the stock is a good buy at current levels given attractive valuations, good growth prospects and history of returning cash to the shareholders through dividends and buy backs.