Union Pacific Corporation (NYSE:UNP) is one of the leading railroad companies in the United States and the biggest publicly traded railroad west of the Mississippi. The company generates most of its revenues from freight transportation which includes agricultural products, automobiles, chemicals, energy, industrial products and intermodal freight. In 2012, its revenues grew by 7% to reach $20.9, billion owing to core pricing gains and higher fuel surcharge recovery. Its operating margin was recorded at 32% in 2012.
Going forward, we believe the key trends affecting the company include weakness in agricultural and coal markets. We believe these factors will present headwinds to Union Pacific’s volume growth in 2013.
What Are The Key Commodity Groups For Union Pacific?
While the revenue contribution of most commodity groups is fairly equitable in Union Pacific’s total revenues, intermodal and coal are the two leading groups, each accounting for around 20% of the total freight revenues in 2012. Industrial products, agriculture and chemicals are the next major groups contributing for 18%, 17% and 16% of the total freight revenues respectively. Automotive has the lowest share (9%) in the company’s freight revenues.
While automotive and chemicals saw the maximum annual revenue growth of 20% and 15% respectively in 2012, the revenues from coal and agricultural commodity groups registered an annual decline of 4% and 1% respectively.
What Are The Key Operating Expenses For The Company?
Compensation and benefits as well as fuel are the two largest cost components for Union Pacific and they accounted for 33% and 25% of the total company’s operating expenses respectively in 2012.
Purchased services and materials, and depreciation are other key cost components which represented 15% and 12% of the company’s operating expenses respectively in 2012.
What Are The Key Trends Affecting Union Pacific?
Challenging Conditions In The Coal Market
Union Pacific continues to be plagued by challenging conditions in the coal market on account of increased substitution of coal with cheaper natural gas for electricity generation. In Q4 2012, coal volume declined by 17% annually, due to higher coal inventory levels and lower natural gas prices. We feel this factor will continue to weigh on Union Pacific’s volumes in 2013.
Weakness In The Agricultural Market
Union Pacific registered 9% annual decline in agricultural products volume in Q4 2012, due to drought conditions in the Midwest. The drought led to reduced supply of corn which caused a decrease in domestic feed grain shipments. Ethanol shipments were also affected by high corn prices and lower demand for gasoline. Moreover, feed grain and wheat exports from the U.S. declined due to increased world supply and higher US prices. We feel these challenging conditions will persist until H1 2013, and then a recovery may take place.
Exposure to Mexico Will Drive Growth
Close proximity to the Mexican market is one of the key factors driving Union Pacific’s growth. Revenues from Mexican business increased by 8% y-o-y, to account for 10% of total revenues in 2012. The trade between Mexico and US is rising as greater manufacturing operations are being shifted to Mexico, on account of labor wage hikes in China and Mexico’s close proximity to the U.S. Moreover, U.S. exports to Mexico are also increasing with the growth in the Mexican economy. Union Pacific is gaining from this trend as it is the only major publicly traded railroad company in the U.S., which connects to all six major trade junctions with Mexico.
We currently have a $141 price estimate for Union Pacific, which is approximately same as the current market price.