Agricultural And Intermodal Shipments Drive Union Pacific’s Earnings

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Union Pacific (NYSE:UNP) reported its second quarter 2014 results posting strong growth in revenue and volume. Its revenue grew 10% year-on-year, to reach $5.7 billion, driven by double digit volume growth at its Agricultural and Intermodal segments. Union Pacific’s Chemicals segment was the only one that showed a decline in carloads during the quarter.

Despite the 6% year-on-year  increase in operating expenses, Union Pacific’s operating ratio (operating expenses expressed as a percentage of revenue) improved by 2.2%, to reach 63.5%. This was primarily due to strong revenue growth. Net income increased 17%, driving a 20% increase in earnings per share.

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Last year’s strong corn production helps drive Agricultural shipments

In 2013, corn production grew 30% leading to a decline in its price. [1] The increase in corn production and corresponding decline in price benefited Union Pacific. Higher corn production, along with high soybean production, led to a 43% increase in Union Pacific’s grain carloads in the second quarter. The low corn prices encouraged an increase in ethanol production which helped drive Union Pacific’s grain products carloads by 8%.

We believe that last year’s strong harvest will continue to have a positive impact on Union Pacific’s Agricultural shipments. Ethanol production is expected to increase from 13.3 billion gallons in 2013 to 14.2 billion gallon in 2014. [2] [3] This should also have a favorable impact on Union Pacific’s Agricultural carloads in the coming quarters. However, from the fourth quarter 2014 onwards, growth rates may slow down since the previous year’s fourth quarter also had a favorable impact from last year’s harvest.

Union Pacific’s intermodal volumes increase in anticipation of labor negotiations

Union Pacific’s intermodal volume grew 12% driven by high container traffic at West Coast ports as shippers increased their imports in anticipation of negotiations between International Longshore and Warehouse Union (ILWU) and Pacific Maritime Association (PMA) for renewal of their union contract, which expired on July 1st 2014. In order to avoid any risk arising out of the ongoing negotiations, retailers increased their holiday season imports leading to five–year high container volumes at U.S. ports. [4] This helped increase Union Pacific’s international intermodal volumes but also partially tempered its revenue per carload.

We expect to see continued growth in Union Pacific’s intermodal volumes driven by growth in demand as shippers continue to shift to rail given its advantage over trucks. Union Pacific’s Santa Teresa facility, which became operational in June 2014, will also contribute to growth in intermodal volume. However, since some of Union Pacific’s international volumes had been pulled up into the second quarter, growth rates may be slightly lower in the coming quarters.

Chemical carloads decrease due to decline in crude oil shipments

Union Pacific’s chemical carloads decreased 1% due to a 24% decline in crude oil shipments driven by narrow spreads between Western Texas Intermediate (WTI), produced in the US, and Brent crude oil ,which is sourced from the North Sea. [5] The spreads represent the price difference between WTI and Brent. If the spread is wide enough such that even after accounting for transportation costs WTI is cheaper than Brent, then it makes more sense for refineries to use WTI. The narrower the spread, the less profitable it becomes for refineries to ship crude by rail since shipping costs would eat into their margins. Refineries would then prefer to ship crude oil through pipelines or import Brent rather than use WTI.

Crude oil production in the U.S. is projected to grow by 1 million barrels per day to reach 8.5 million barrels per day in 2014. [6] This might have a positive effect on Union Pacific’s crude oil shipments. However, expectations of tightening spreads between WTI and Brent may continue to present headwinds for Union Pacific’s chemical carloads. [6]

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Notes:
  1. Crop Production, www.usda.gov []
  2. U.S. Fuel Ethanol Data Summary, www.eia.gov []
  3. Ethanol Outlook Brightens, July 23 2014, www.agweb.com []
  4. Retailers Step Up Holiday Imports In Case Of A West Coast Port Strike, June 9 2014, www.forbes.com []
  5. Crude Oil Spot Prices, www.eia.gov []
  6. SHORT-TERM ENERGY OUTLOOK, July 8 2014, www.eia.gov [] []