Union Pacific Will Lean On Intermodal And Chemicals Growth In Earnings

Union Pacific Corporation (NYSE:UNP) is one of the leading railroad companies in the United States. It is expected to report its Q1 2013 results on April 18, 2013. In a presentation at the JPMorgan aviation, transportation and defense conference in March, Union Pacific’s management reported that UNP’s overall volumes were down by 2% during the first nine weeks ending on March 2, 2013. Weakness in the coal market, which accounts for around 20% of the company’s revenues, was the main reason for the drop in overall volumes. Coal volumes saw a steep y-o-y decline of 22% during the first nine weeks of 2013. Excluding coal, the overall volume was up by 4% during the period. ^[1]

The agricultural market also continues to be challenging and UNP’s agricultural volumes decreased by 10% during the first nine weeks of 2013. However, growth in the chemicals and intermodal businesses looks encouraging, and their volumes rose by 12% and 8% respectively during the period. We think pricing gains, network efficiency and productivity gains will be the key pillars for Union Pacific’s future growth, given the challenging conditions in various end-markets.

Our $141 price estimate for Union Pacific is in line with the current market price.

See our complete analysis of Union Pacific here

Recap Of Q4 2012 Results

In Q4 2012, Union Pacific’s freight revenues saw an increase of 2%, underscored by core pricing gains and fuel surcharge recoveries as its volumes were down by 2% for the quarter. The average revenue per car grew by 5% annually in Q4 2012. Weakness in the coal and agricultural markets was partially offset by growth in the chemicals and automotive businesses during the quarter.

UNP’s operating ratio contracted by 120 basis points annually to 67.1% in Q4 2012. The decrease in operating ratio augurs well for the company’s outlook, in the wake of challenging conditions in several end-markets. It aims to achieve a sub-65% operating ratio by 2017, and we will keep a track of the company’s success against this strategic initiative in the future.

Coal And Agricultural Markets Remain Week

During the first nine weeks of 2013, Union Pacific’s coal volumes saw a steep decline of 22%. High coal inventories at utilities, coupled with competition from natural gas continue to dampen the demand for coal by utilities. The company’s loss of a legacy contract further affected its coal volumes. While the export coal market is growing, it is only partially offsetting the decline in the domestic coal market.

Union Pacific expects coal volumes to decline by the high-teens in Q1 2013, on account of tougher y-0-y comparisons and challenging conditions in the coal market. ^[2] However, in the long term, we expect the pace of decline in the coal market to decelerate as natural gas prices have started to move northwards of $3.5 (per million BTU) in March 2013. Its price was recorded at around $4 at the end of March, and continuation of this trend could lead utilities to opt for coal for producing electricity. ^[3]

In the agricultural business, Union Pacific recorded 10% y-o-y decline in volumes during the first nine weeks of 2013. This segment continues be affected by lower grain shipments and ethanol shipments. The last year’s drought had a higher impact on the territories served by UNP. The company expects agricultural volumes to decline by a high single-digit rate in Q1 2013. We think that the outlook for this segment could get better during the second half of 2013 with recovery in crop output.

Chemical And Intermodal Businesses Are Seeing High Demand

Growing chemicals business represents a key growth driver for Union Pacific. Its chemicals volumes saw an impressive growth of 12% during the first nine weeks of 2013. The high demand in this segment is being fueled by higher crude oil shipments, which rose by more than 100% for UNP during the period. We expect crude oil and petroleum products shipments to post rapid growth in 2013, as the growth in overall oil production continues to outpace current pipeline capacity. Shipments of plastics and industrial chemicals could also see high demand due to continued growth in the U.S. chemicals sector on account of the shale gas boom.

The intermodal business represents another sweet spot for Union Pacific. UNP’s intermodal volume grew by 8% during the first nine weeks of 2013. We expect continued growth for UNP’s domestic intermodal business throughout 2013, driven by higher truck to rail conversions and the company’s investments to increase its capacity in the area.

Mixed Outlook In Other Markets

Union Pacific ‘s automotive volumes which saw 13% rise during 2012, grew by only 2% during the first nine weeks of 2013. We expect this segment to record slow growth in 2013, against last year’s high base. While the North American light vehicle production continues to rise, the growth rate is forecast to slow down to around 3% in 2013 compared to about 18% growth last year.

Shipments of industrial products saw 3% decline in volumes during the first nine weeks of 2013. While higher construction activity and shale gas growth could boost demand within this segment in 2013, the demand could be offset by lower shipments in categories such as military and hazardous waste shipments due to reduction in federal funding. The weakness in steel and scrap markets is also expected to impact this segment in Q1 2013.

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1. J.P. Morgan Aviation, Transportation & Defense Conference, Union Pacific, March 6, 2013 [↩]
2. Union Pacific’s Management Presents at JPMorgan Aviation, Transportation and Defense Conference (Transcript), Seeking Alpha, March 6, 2013 [↩]
3. Natural Gas Spot and Futures Prices (NYMEX), U.S Energy Information Administration, April 3, 2013 [↩]