Union Pacific’s Earnings: Pricing Is Key Amid Mixed Volume Outlook

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Union Pacific Corporation
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    Quick Take 

  • Union Pacific will report Q2 2013 results on July 18, 2013. The volume outlook is mixed for the second quarter owing to challenges in certain end-markets, such as the agricultural market. Hence, pricing gains will be essential for revenue growth during the quarter.
  • The coal market outlook has changed, and we look for slight growth in coal volumes in the second quarter.
  • We expect strong growth in chemicals volumes helped by rising crude oil shipments. However, we will closely track intermodal volumes this quarter as some weakness was seen in intermodal traffic, according to Association of American Railroads data.

Union Pacific Corporation (NYSE:UNP), one of the leading railroad networks in the U.S., will report its Q2 2013 results on July 18, 2013. Even though the company reported annual volume decline in the previous quarter, its revenue growth was positive on account of core pricing gains. In the second quarter, we believe pricing gains will again be critical for revenue growth as the volume outlook is mixed.

Overall volumes will be impacted by challenges in the agricultural market and in certain product groups of the industrial segment. According to the Association of American Railroads (AAR) report, some weakness in intermodal traffic was seen in the second quarter. [1] However, in an encouraging sign, coal market volumes are expected to post slight growth in the second quarter after several quarters of y-o-y declines. Driven by rising crude oil shipments, the chemicals business is again expected to show strong growth in the second quarter.

Apart from pricing gains, we believe network efficiency and productivity gains are also critical for Union Pacific’s future growth and we will closely track these measures in the quarterly results.

See our complete analysis of Union Pacific here

Recap of Q1 2013 results

Union Pacific posted operating revenue of $5.3 billion in Q1 2013, which represented an y-o-y increase of 3%. The revenue growth came in primarily on account of core pricing gains as the overall volume fell by 2% annually during the quarter. Weakness in the coal and agricultural markets was responsible for the decline in volumes, and it was partially offset by strength in chemicals, intermodal and automotive segments.

Union Pacific’s operating ratio came in at 69.1% in Q1 2013, which marked an improvement of 140 basis points as compared to Q1 2012. Union Pacific aims at sub-65% operating ratio by 2017, and we expect the company to show progress against this strategy in the second quarter as well.

Coal market could see a recovery in the second quarter

While the coal market presented various headwinds to Union Pacific in the past few quarters, the outlook for this market is expected to change in Q2 2013. UNP’s coal volumes had dropped by near 20% in Q1 2013, on account of competition from natural gas for electricity generation, high coal inventory levels at utilities and a loss of a contract at the beginning of the year. However, in the second quarter, Union Pacific expects coal volumes to show some slight growth owing to higher natural gas prices, a decline in coal inventory levels at utilities, and easier y-o-y comparisons.

In Q1 2013, Union Pacific was able to offset weak coal volumes with 16% annual growth in average revenue per car within the coal segment. We believe the coal volume outlook for Q2 is encouraging, and if the company is able to complement this with a similar pricing gain, then it would boost revenue growth for the second quarter.

Agricultural market will be a laggard during the second quarter

Union Pacific’s domestic and feed grain shipments continue to be impacted by last year’s drought, which resulted in lower corn supplies. The company forecasts agricultural volumes to fall by the low double-digits in the second quarter. However, we believe this market could post a recovery in the second half of 2013, driven by easier y-o-y comparisons and a normal agricultural output.

Petroleum products shipments will boost chemicals volumes growth

Driven by strong growth in shipments of petroleum products (such as crude oil and LP gas), Union Pacific is seeing high demand in its chemicals business. In Q1 2013, chemicals volumes expanded by 12% annually, and we expect the company to post a similar performance in the second quarter as well. We expect industrial chemicals and plastics’ shipments to also increase driven by the shale gas boom being seen in North America.

Intermodal volumes look weak in the second quarter

While Union Pacific’s intermodal volumes showed 4% annual growth during Q1 2013, total intermodal traffic witnessed 2% decline during the second quarter period (till June 29, 2013), according to Association of American Railroads report. [1]

We will be closely tracking results in this segment in Q2 2013, to watch out for recent trends. We believe the long term outlook in this segment is positive on account of massive truck to rail conversion opportunities. UNP forecasts domestic truckload conversion opportunity at about 10 million units, along with a 3 million unit truckload opportunity from the Mexican business.

Our $157 price estimate for Union Pacific is almost in line with the current market price.

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Notes:
  1. 2013 UP Weekly Carloads, Union Pacific [] []
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