Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 1Q18 Earnings Update
Prev. Ed.: Mar 21, 2018: News update
Brokers’ Recommendations: Positive: 56.2% (9); Neutral: 43.8% (7 firms); Negative: 0.00% (0) Prev Ed: 8, 8, 0
Brokers’ Target Price: $142.15 (↑ $1.47 from last edition; 13 firms) Brokers’ Avg. Expected Return: 3.6%
Portfolio Manager Executive Summary
Union Pacific Corporation (UNP) is one of America’s leading railroad operators. It provides rail transportation services across 23 states in the country through Union Pacific Railroad Company.
Of the 16 firms covering the stock, nine assigned positive and seven assigned neutral ratings. Target prices range from $120.00 to $162.00, with the average being $142.15.
The outlook of the firms toward Union Pacific is dealt with in the following paragraphs:
Bullish: Buy or equivalent outlook (9/16 firms): These firms believe that Union Pacific continues to benefit from its large size and operational efficiency, which allows it to control costs. Firms are bullish about the low unit cost inflation at Union Pacific. Improvement in operating ratio also pleases the firms. Some firms are impressed by the improving coal scenario and believe that headwinds related to the commodity will be less severe going forward. The bullish firms expect volume growth on strong grain shipments and continued core pricing gains. The firms are also optimistic about domestic intermodal business. Moreover, efforts of the firms to reward shareholders through dividends and buybacks. Savings from the personnel reorganization should also drive the bottom line according to the firms. The amount of free cash flow expected to be generated by the company in 2018 due to the new tax law pleases the firms. Firms believe that pricing growth, which was weak in the fourth quarter of 2017, should pick up in 2018. However, declining automotive volumes due to sluggish vehicle production in the United States, concern the firms.
Cautious: Neutral or equivalent outlook (7/16 firms): These firms believe that the company should gain from its efforts to reward shareholders. Volume growth should also aid the company. However, some firms believe that operating costs may rise due to rail inflation and labor inflation. Additionally, some firms believe that the challenges in the intermodal and coal businesses might hurt the company’s performance. The company’s decision to withdraw its operating ratio guidance of around 60% in 2019 due to operational issues has disappointed firms. The below-par productivity savings generated by the company in 1Q18 has also disappointed the firms.
Feb 1, 2018
Sep 1, 2017
Overview
The firms have identified the following merits for investment decisions:
Key Positive Arguments / Key Negative Arguments· Strong Fundamentals: Union Pacific enjoys strong yields and pricing gains are expected over the next few years as a number of legacy contracts get renegotiated.
· Operating Ratio Improvement: Union Pacific should gain from the improvement in operating ratio (operating expenses as a percentage of revenues). The company expects the metric to improve in 2018 and reach around 55% in the long-term.
· Shareholder-friendly initiatives: The company’s efforts to reward shareholders through buybacks/dividend payouts also encourage the firms. Most firms believe that dividend growth will continue at Union Pacific driven by the company’s potential to generate earnings growth and free cash flow.
· New Tax law: Firms believe that changes to the tax code should benefit the company. / · High Costs: High operating expenses are expected to hurt the bottom- line going forward due to rail inflation and labor inflation.
· Competition: The company faces competition from other railroads, motor carriers and to a lesser extent, from ships, barges and pipelines.
· Sluggish automotive segment: The firms are concerned about the struggles of the company’s automotive division due to sluggish vehicle production in the United States.
Based in Omaha, NE, Union Pacific provides rail transportation services across 23 states in the U.S. through its principal operating company, Union Pacific Railroad Company. As the largest railroad in North America, Union Pacific connects the Pacific and Gulf Coast ports with the Midwest and eastern United States gateways. The company also connects with Canada's rail systems and is the only railroad serving the six major gateways to Mexico. The company offers transportation services for agricultural products, automotive, lumber, steel, paper, food, chemicals, coal, and industrial products, as well as for finished vehicles and intermodal containers. It also provides container and traffic services, primarily for shipper agents and consolidators, as well as for truckload carriers.
Further information on the company is available at its website: www.up.com.
Note: The company’s fiscal year coincides with the calendar year.
Feb 1, 2018
Long-Term Growth
The firms are impressed by the company’s efforts to control costs. Driven by improved efficiencies, the railroad operator has been able to reduce its operating ratio (operating expenses as a percentage of revenues) from the highs of nearly 90% in 2004 to below 65% currently.
The company, which focuses on its operating and productivity improvements to provide safe, efficient and high-quality service, expects operating ratio to decline to around 55% in the long term. Its G55
+ 0 initiative is aimed at the achievement of the above target. The company generated productivity savings of approximately $35 million in 1Q18. Given the poor performance, the company’s original guidance of 2018 productivity savings between $300 million and $350 million will be unachieved.
The company’s efforts to reward shareholders through buybacks/dividend payouts also encourage the firms. In February 2018, the company raised its quarterly dividend by 10% to 73 cents per share. This was the second hike in three months. Most firms believe that dividend growth will continue at Union Pacific driven by the company’s potential to generate earnings growth and free cash flow.
Some firms are impressed by the improving coal scenario and believe that headwinds related to the commodity will be less severe going forward. The rebound in energy prices from extremely low levels augurs well for the company’s coal and shale-related operations. Firms are also impressed by the company’s the company's efforts to promote safety and enhance productivity. To this end, its crossing incident rate has been improving constantly.
Additionally, strength in intermodal volume is expected to continue based on the ongoing domestic expansion and a pickup in activities in the international arena. According to the firms, tightening truck capacity should aid pricing in this segment. Moreover, Union Pacific expects the grain market to improve which could aid results.
The firms believe that the significant reduction in corporate tax rate, owing to the recent changes to the tax code, should aid the company immensely. The massive tax savings would result in the availability of more cash with the company. This, in turn, would lead to an uptick in dividend payments and increased investments on capital assets.
Declining automotive volumes due to sluggish vehicle production in the United States, however, concern the firms. Light vehicle sales of 16.9 million units down 2% year over year are projected for 2018.
Mar 21, 2018
2017
Target Price/Valuation
Provided below is a summary of target price and rating:
Rating DistributionPositive / 56.2%↑
Neutral / 43.8%↓
Negative / 0%
Maximum Target Price / $162.00
Minimum Target Price / $120.00
Avg. Target Price / $142.15↑
Firms with Target Price/Total no. of Firms / 13/16
Primary risks to the target price include economic downturns, regulatory uncertainty, pricing pressure, fluctuations in fuel prices.
Recent Events
1Q18 Earnings – Apr 26, 2018
The company’s earnings of $1.68 beat the Zacks Consensus Estimate of $1.65 per share. The bottom line expanded 27.3% on a year-over-year basis.
Operating income in the first quarter rose 8% year over year to $1,939 million. Adjusted operating ratio (defined as operating expenses as a percentage of revenues) came in at 64.6%, reflecting an increase of 0.6 points. During the quarter, the company bought back 9.3 million shares for $1.2 billion.
Union Pacific exited the quarter with cash and cash equivalents of $1,048 million compared with $1,275 million at the end of 2017. Debt (due after one year) came in at $15,697 million at the end of the quarter compared with $16,144 million at the end of 2017. Adjusted debt-to-capitalization ratio increased to 45.1% from 43.9% at 2017-end.
Revenue
Operating revenues of $5,475 million in 1Q18 surpassed the Zacks Consensus Estimate of $5,370.8 million. Moreover, revenues increased 6.7% year over year. Higher freight revenues boosted the top line. The bulk of revenues (93.6%) at Union Pacific was derived from freight in the reported quarter.
Freight revenues grew 7%, boosting the top line. The uptick was owing to volume growth and increased fuel surcharge revenues among other factors.
The segment details, per the company, are as follows:
Agricultural Products freight revenues were $1,098 million, flat year over year. Revenue carloads decreased 4%year over year. Average revenue per car however increased 5%.
Freight revenues at the Energy division were $1,173 million, up 15% year over year. Revenue carloads increased 6%year over year. Average revenue per car increased 8%.
Industrial freight revenues were $1,340 million, up 6% year over year. Revenue carloads increased 2%year over year. Average revenue per car increased 4%.
Freight revenues at the Premium division were $1,511 million, up 7% year over year. Revenue carloads increased 2%year over year. Average revenue per car increased 5%.
Other revenues improved 4% to $353 million in 1Q18.
Outlook
The company’s pricing strategy, new business avenues and improved network efficiency, backed by enhanced safety, reliability and productivity, are the key factors driving its performance. Further, the company is optimistic about growth trends across the majority of its product lines.
Meanwhile, the company continues to see opportunities in several segments in spite of uncertainties in some markets. The firms believe that strong asset utilization, diverse franchise, and reduction of service failure along with strength in some industrial products will likely drive the performance level of the company. An improving economy should also allow the company to deliver a solid performance. In agricultural products, the company sees favorable conditions in the overall crop scenario.
However, the firms are cautious about the sluggish automotive revenues. Uncertainty regarding the coal business also concerns some firms.
Margins
Operating income in 1Q18 rose 8% year over year to $1,939 million. Adjusted operating ratio (defined as operating expenses as a percentage of revenues) came in at 64.6%, reflecting an increase of 0.6 points. During 1Q18, the company bought back 9.3 million shares for $1.2 billion. Moreover, it returned $1.7 billion to its stockholders through dividends/buybacks in the quarter.
Outlook
The company believes that if economic growth remains stable, it could witness solid core pricing gains, which could surpass inflation growth, thus leading to margin expansion.
However, high operating expenses might hurt the bottom line going forward according to some firms. Labor inflation is expected to be below 2% for 2018. The company aims to achieve a long term operating ratio of around 55%. The company generated productivity savings of only $35 million in 1Q18. The lower-than-expected figure disappointed the firms. In view of this development, the company stated that its 2018 target of generating productivity savings between $300 million and $350 million will be unachieved. The company intends to provide additional details at its Investor Day on May 31.
Earnings per Share
The company’s 1Q18 earnings of $1.68 per share surpassed the Zacks Consensus Estimate by 3 cents. The bottom line expanded 27.3% on a year-over-year basis. Volumes increased 2% year over year, mainly due to the impressive volume growth at the Energy division. Volume growth in the low single-digit range is expected by the company in full-year 2018.
The company expects that its current-year effective tax rate between 24% and 25% in 2018. The massive tax savings induced by the Tax Cuts and Jobs Act should help the company generate significantly higher cash flows, according to most firms. Further details will be revealed by the company at its Investor Day.
Research Analyst / Maharathi BasuCopy Editor
Content Ed. / Self
Reason for Report / Earnings update