Union Pacific Corporation (NYSE:UNP) surprised us with its Q3 earnings as it posted a 5% increase in revenues while competitors CSX Corporation (NYSE:CSX) and Norfolk Southern (NYSE:NSC) reported revenue declines. What is more surprising is the 13% increase in operating income due to a 2.5 percentage point decrease in operating ratio, which dropped to 66.6%.  All of these metrics are quarterly records for the company and are extremely impressive in the context of the uncertain macroeconomic backdrop that has plagued the other railroads.
Core Pricing Gains Drive Growth
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- Union Pacific’s Q1 2016 Earnings Review: Cost Reductions Partially Offset Impact Of Top Line Headwinds
- Union Pacific’s Q1 2016 Earnings Preview: Decline In Shipment Volumes And Fuel Surcharge Revenue To Negatively Impact Results
- How Did The Decline In Shipments And Oil Prices Impact Union Pacific’s Operating Ratio In 2015?
- Union Pacific Corporation: A Look Back At The Year 2015
- What Would Be The Impact Of A 100 Basis Points Decline In Union Pacific’s Share Of U.S. Rail Intermodal Shipments?
As expected, UNP’s freight volumes were slightly down during the quarter. The decline was driven by a 12% decrease in coal volumes and a 2% decline in agricultural and industrial products. The declines in these segments were offset by an 18% increase in chemical volumes and a 13% increase in automotive volumes.
What we didn’t expect during the quarter was the drastic increase in core pricing. Union Pacific increased the average revenue per car for each of its segments, the largest of which was an increase of 9% in coal freight prices. Due to these pricing gains, overall freight revenues increased 4%.
What was however impressive was that, despite the price increases, the company was able to improve overall customer satisfaction to 94%. In our opinion, these core pricing gains and increase in customer satisfaction put the company in a great position to weather the slowdown in freight volumes. As volumes decline, UNP seems to have the pricing power to maintain revenues.
Improving Operating Ratio
Union Pacific posted a quarterly record in terms of its operating ratio, which declined 2.5 percentage points year-over-year. We place a lot of value on this metric because if UNP can’t increase pricing as it sees a slowdown in volumes, it can still maintain profitability by decreasing its operating ratio.
Management Needs to Stay Proactive
The world economy has not shown signs of strength during the third quarter. The slowdown in growth is expected to continue well into next year as the IMF has cut its global growth forecasts to 3.6%, down from 3.9% in June, with warnings on potential future cuts. 
With this macroeconomic backdrop, management will need to take quick actions to adapt to constantly changing market conditions. A solid customer satisfaction rating is helpful, but the company will have to be quick to make changes to its pricing, cut costs and choose the best regions to deploy its fleet if it intends to maintain or improve on this quarter’s results.
Q4 Guidance From Management
UNP’s management expects the economy to stay steady at best, and possibly see some weakening towards the end of the year. It expects the fourth quarter to resemble the third in that freight volumes are expected to remain flat to down. In such an environment, it will look to increase pricing to drive revenue growth and cut costs to improve bottom-line growth. Notes: