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Investment Overview for Union Pacific Corporation (NYSE:UNP)
Below are key drivers of Union Pacific's value that present opportunities for upside or downside to the current Trefis price estimate:
- Intermodal Freight Revenue per thousand revenue ton-miles:
We forecast Union Pacific's intermodal revenue per thousand revenue ton-miles to increase, reaching nearly $62 by the end of the Trefis forecast period from $51 in 2013 because of the strong pricing power that Union Pacific commands. There could be downside of nearly 5% to the Trefis price estimate if the company is unable to substantially reprice contracts and revenue per thousand revenue ton-miles declines to $45 by the end of the Trefis forecast period.
- Union Pacific EBITDA margin: We currently forecast Union Pacific's EBITDA margin to increase from 45% in 2013 to about 49% by the end of the Trefis forecast period. UNP aims to achieve a sub-65% operating ratio by 2017. The intermodal segment carries high incremental margins as train lengths are extended as the additional costs associated with adding containers to existing trains is low. We expect that this will allow for margin expansion given the future growth opportunities for the intermodal segment.
However if the margin stays relatively flat during our forecast horizon, it represents a downside of nearly 9% to the Trefis price estimate.
Energy Commodities Freight
- Energy Freight Revenue per thousand revenue ton-miles:
We currently forecast the energy commodities freight revenue per thousand revenue ton-miles to increase substantially, reaching $27 by the end of Trefis forecast period from $21 in 2013 because of the strong legacy contract repricing opportunities that lie ahead for Union Pacific.
However, should energy demand not increase to the extent that we expect, or new regulation inhibits the company's ability to effectively reprice contracts, revenue per thousand revenue ton-miles may remain about flat going forward. This would result in a downside of about 5% to the Trefis price estimate.
Union Pacific Corporation is the leading railroad network in the United States, engaged primarily in freight transportation. Union Pacific Railroad (UPRR), the largest class-1 railroad in United States, is the core subsidiary of Union Pacific Corporation. UPRR's route map covers most of the central and western United States, west of Chicago and New Orleans, covering nearly 23 states. Union Pacific competes with Burlington Northern Santa Fe Corporation (BNSF) which covers much of the same territory.
The company owned tracks are a major strength of Union Pacific. The company operates on 31,838 miles of track out of which 26,009 is owned and the remainder is pursuant to trackage rights or leases. Union Pacific operates on key north/south corridors and is the only railroad to serve all six major gateways to Mexico. UP also interchanges traffic with the Canadian rail systems.
Union Pacific Railroad Company’s business mix includes Agricultural Products, Automotive, Chemicals, Energy, Industrial Products and Intermodal. Although the company's primary role is transporting freight, it also runs a substantial commuter train operation in Chicago.
Union Pacific's earnings depend upon the volume of freight contracts it sells and the price of those contracts while its expenses primarily consist of labor, fuel costs, utilities costs and track maintenance. The largest of Union Pacific's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies and chemical manufacturers.
We believe the Intermodal Freight is the largest contributor to Union Pacific's value at around 19%.
High freight rates and incremental margins for Intermodal Freight
The Intermodal Freight business is profitable due to firm pricing and high incremental margins, leading to a strong earnings outlook. Intermodal freight rates are likely to improve as trucking prices increase and legacy contracts are repriced. Due to the high exposure of legacy contracts, intermodal services are highly impacted by contract renewals and repricing.
The Intermodal segment carries high incremental margins as they are mainly dependent on train lengths, which can be altered at any time based on the number of containers added.
Increasing freight demands and productivity with eventual economic recovery
The freight railroad industry is highly sensitive to economic conditions. Volumes fall during economic slowdown, leading to a decline in railroad freight revenues. The U.S. economy has been slowly recovering from the economic crisis and this bodes well for volumes in most segments. The recent rebound in the housing market further bodes well for the economy and railroads.
Consistent pricing improvements
The pricing power of railroads with the long standing exemptions from regulation has been a key issue in the success of railroads. Railroads have steadily improved rates during the past 10 years primarily through legacy contracts renewals and repricing. Most rails claim to target long-term 4-5% annual price increases, or greater than railroad cost inflation. Union Pacific saw core pricing gains of 4.5% in 2011 and 2012. In Q4 2013, this figure was recorded at 3.5%.
Coal market continues to stay challenging in 2014
The coal market continues to stay challenging for the company in 2014. In the latest earnings call, the company's management expects a lost legacy contract to depress coal volume levels. However, the company is positive in its outlook with coal exports and believes that with improvement in domestic inventory levels, coal volumes may see an upswing.
In addition, the company expects pricing gains in the coal segment to decrease in 2014 compared to 2013 levels. We believe this could be an important determinant to UNP’s revenue growth in 2014 as volume growth cannot be reliably predicted at this stage.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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