Union Pacific Earnings Preview: Agricultural And Industrial Shipments Will Likely Offset Sluggish Chemicals Shipments

Union Pacific Corporation (NYSE:UNP), one of the leading railroads in the U.S., is set to announce its second quarter results on October 23. We expect to see an increase in revenue and volume driven by growth across Union Pacific’s Agricultural, Industrial and Intermodal segments. Union Pacific’s Chemicals shipments may be sluggish due to narrow crude oil spreads.

Revisiting first quarter 2014

Union Pacific posted overall revenue growth of 10% in the second quarter 2014 to reach $5.7 billion, ^[1] driven by double digit volume growth in 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.

See our complete analysis of Union Pacific here

Chemical carloads could be sluggish due to crude oil shipments

Union Pacific’s crude oil shipments are highly dependent on the spread between Western Texas Intermediate (WTI), produced in the US, and Brent crude oil, which is sourced from the North Sea. 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.

During the three months ended September 2014, the spread between the WTI and Brent averaged $4 per barrel, which is significantly narrow. ^[2] The impact of this narrow spread can be seen on Union Pacific’s petroleum products carloads, which declined 3% year-on-year during the third quarter through the week ended September 27, 2014. ^[3] This should have a negative impact on Union Pacific’s Chemicals shipments. However, growth in other chemical shipments should more than offset the decline in crude oil shipments.

Union Pacific’s chemicals carloads were up 4% during the third quarter through week ended September 27, 2014. This reflects the increase in chemical activity in the U.S. during the third quarter. According to the latest data provided by the American Chemistry Council, chemical activity was up 3.9% year-on-year during the third quarter. ^[4]

Last year’s strong harvest should drive Agricultural shipments

Last year’s strong corn and soybean harvest should help drive Union Pacific’s Agricultural shipments. In 2013, corn production grew 30% and soybean by 8%. ^[5] This had a favorable impact on Union Pacific’s first and second quarter grain shipments which grew by 39% and 43% year-on-year respectively. We believe that the same trend has continued to impact Union Pacific’s grain shipments in the third quarter, which grew 33% during the third quarter through week ended September 27, 2014.

Union Pacific’s grain mill products carloads have also benefitted from the high corn production. High corn production has led to a decline in its price. Low corn prices encourage an increase in ethanol production, which is a part of Union Pacific’s grain mill products carloads. This should have a favorable impact on Union Pacific’s Agricultural shipment volumes and revenue.

Housing and construction activity will drive Industrial shipments

Housing starts have been fluctuating a lot in 2014. After a strong 1.117 million in July, housing starts declined to 956,000 in August. ^[6] However, these numbers were up 24% and 8% year-on year in July and August respectively, indicating a continued upward trend. Housing starts increased 18% year-on-year in September. Building permits have also been up year-on-year. These trends are driving the forecast for a 7.7% increase in housing starts in 2014. ^[7] Additionally, construction spending in the U.S was also up 6% year-on-year over the two months, July and August 2014. ^[8] Union Pacific’s Industrial shipments, which includes shipments of housing and construction related material such as lumber and gravel, should benefit from the growth in housing and construction activity.

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1. Union Pacific 2014 Second Quarter News Release Financials, July 2014, www.up.com [↩]
2. Crude Oil Spot Prices, www.eia.gov [↩]
3. Union Pacific’s Weekly Carloads 2014 Week 39, www.up.com [↩]
4. Chemical Activity Barometer, www.americanchemistry.com [↩]
5. Crop Production 2013, www.usda.gov [↩]
6. US Housing Starts Historical Data, www.ycharts.com [↩]
7. NAHB Housing and Interest Rate Forecast, September 16, 2014, www.nahb.org [↩]
8. US Construction Spending Chart, www.ycharts.com [↩]