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The Science of Hitting
The Science of Hitting
Articles (722) 

Union Pacific: Solid Results in a Tough Year

A look at the railroad's 2020 results

January 22, 2021 | About:

Union Pacific (NYSE:UNP) recently reported results for the fourth quarter of fiscal 2020.

Revenues in the quarter declined 1% year-over-year to $5.1 billion, with a 3% increase in volumes offset by business mix headwinds and lower fuel surcharges. For the full year, revenues fell 10% to $18.3 billion, primarily attributable to a 7% reduction in volumes. As shown below, even inclusive of the mid-single digit growth expected in 2021, carload volumes have declined over the past ten years.

Despite the significant headwind on volumes, Union Pacific once again reported an improvement in its operating ratio (OR), to a record 58.5% (adjusted for the impairment charge from a Texas rail yard). This reflects continued PSR-related improvements in operating efficiency and asset utilization, including gains in freight car velocity, terminal dwell, locomotive productivity, fuel consumption and train length (up 30% since the company began its PSR initiatives in late 2018).

The fact that the railroad continues to deliver these results in the face of material volume headwinds is impressive. Simply put, Unified Plan 2020 / Precision Scheduled Railroading (PSR) is working. In 2021, management expects that the OR will improve yet again – a cumulative improvement of roughly 1,500 basis points over the past decade.

As a result of the declining operating ratio (iwhich is the nverse of the operating margin), as well as the continued benefit from share repurchases, Union Pacific was able to report only a low-single digit decline in 2020 earnings per share despite the 7% decline in volumes and the 10% decline in revenues.

The company generated $8.5 billion in cash from operations in 2020, down marginally from 2019. Cash outflows consisted of $2.9 billion for capital expenditures (which exceeded depreciation expense by $700 million), $3.7 billion of share repurchases (compared to $5.8 billion in 2019) and $2.6 billion for dividends. As those numbers suggest, Union Pacific has continued to rely on debt issuance to support outsized capital returns. At year end, the company had more than $29 billion in debt, with the leverage ratio (debt / Ebitda) climbing to 2.9.

In the past, I had argued that Union Pacific's rising leverage ratio was concerning. It struck me as a short-term financing decision that would likely bite the company in the behind at some point in the future. However, I've changed my opinion over the past year. Given the ability of the business to consistently generate cash flows, even during periods like the financial crisis, as well as the cost of capital in today's low interest rate environment, I believe that management has a sound basis for pursuing this approach. While it still may put them in a position where they're unable to aggressively repurchase shares when the stock price comes under meaningful pressure, as we saw this year, I believe that a consistent strategy of running at 2.5 to 3.0 times leverage has its merits.

That said, it has a cost as well – by definition, they cannot be as opportunistic when things get ugly in the short-term. It would also be unwise to adopt a policy of continuous leverage increases far into the future.

Conclusion

I've followed Union Pacific closely for years. The fact that the stock has done so well over a period where business volumes have been unchanged for 10+ years is a great case study for investors. It shows you that value creation isn't solely dependent upon a single variable.

By my estimations, I think this business is likely to earn roughly $9 per share in 2021. Assuming all goes as planned, primarily as it relates to a continued improvement in the OR and share repurchases, I believe that Union Pacific could reach earnings of $13 to $14 per share in the next five years.

I don't currently own the stock. That said, given that I believe it trades at roughly 15 times earnings a few years into the future, that might change before too long. If Mr. Market decides to mark the price down by 15% to 20% in the near future, I will happily take a few shares off his hands.

Disclosure: None

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About the author:

The Science of Hitting
High-quality businesses for the long-term.

In the words of Charlie Munger, my approach is \"patience followed by pretty aggressive conduct.\" I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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Comments

rino.raguso
Rino.raguso - 1 month ago    Report SPAM

Good item

The Science of Hitting
The Science of Hitting - 1 month ago    Report SPAM

Thanks Rino!

Praveen Chawla
Praveen Chawla premium member - 1 month ago

Very impressive return on equity. Was lucky to buy this and CNI is 1999. Both are 10 baggers +. They make up for a lot of mistakes.

The Science of Hitting
The Science of Hitting - 1 month ago    Report SPAM

Praveen - Congrats on holding strong for the past 20 years. Well deserved returns!

bajjiblow
Bajjiblow - 3 weeks ago    Report SPAM

Alex,

Thanks for another good article !! EV disruption could be a headwind for rail roads. It might take a long time but i think they are in the path of disruption . Cost parity ( Hydrogen/electric powered trucks) and carbon neutral stance will eventually determine the speed of this disruption

The Science of Hitting
The Science of Hitting - 3 weeks ago    Report SPAM

Bajjiblow - I'd be curious to hear more of your thoughts on this. My current belief is that railroads remain a superior distribution method for much of the volumes that they move. Barring something big - which is admittedly possible - I think the risk of meaningful volume drawdowns is quite low in the medium-term. Thanks for the comment!

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