Union Pacific’s Revenue To Grow On Agriculture, Intermodal, Industrial Shipments

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Union Pacific (NYSE:UNP) will be reporting its fourth quarter and annual earnings on January 22. We expect to see its annual revenues grow on increases in carloads of grains and construction material, and intermodal shipments. The railroad’s profitability should improve driven by its strong operating ratio (operating expenses expressed as a percentage of revenue).  For the year 2014, we estimate revenues of $23.8 billion, compared to consensus estimate of $23.9 billion, and earnings per share of $5.51, compared to consensus estimate of $5.62.

In the third quarter, Union Pacific’s revenue grew 11% year-on-year, to reach $5.8 billion, driven by double digit volume growth in its Industrial and Agricultural segments. [1] Union Pacific’s coal shipments were flat and chemicals were sluggish during the quarter. The railroad’s operating ratio improved 2.5%, to reach 62.3%, bringing it well in line to achieve its target of a sub-65 operating ratio for the year. A decline in operating ratio bodes well for Union Pacific’s shareholders since it translates to higher net profits and cash flows.

See our complete analysis of Union Pacific here

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Strong Harvest To Drive Agricultural Shipments

Strong corn and soybean output in 2013 and 2014 have helped drive Union Pacific’s Agricultural shipments for 2014. In 2013, corn production grew 30% and soybean by 8%. [2] The U.S. Department of Agriculture estimates a 2% increase in corn output and 19% increase in soybean output in 2014. [3] This has had a favorable impact on Union Pacific’s grain carloads, which have grown 26% during the year. [4]

Union Pacific’s grain mill products carloads, which include ethanol, have also benefited from the high corn production, growing 5% in 2014. [4] High corn production led to a decline in its price, which encouraged an increase in ethanol production. The increase in grain and grain mill products carloads should help drive Union Pacific’s revenue and volumes for its Agriculture segment.

Intermodal Will Likely Grow On Tightening Trucking Capacity

According to its carloading report, Union Pacific’s intermodal carloads in 2014 are up 8%, which should help drive revenue growth. [4] In the first half of 2014, intermodal volumes grew as shippers imported their holiday season merchandise earlier than usual due to concerns regarding the possible disruptions that could have been caused by the ongoing labor contract negotiations between ILWU and PMA. However, base level growth in Union Pacific’s intermodal volumes has primarily come from the tightening trucking capacity in the U.S.

The Hours-of-Service safety regulation for commercial vehicle drivers added pressure on the trucking industry, which was already suffering from a dearth of truck drivers and declining fleet sizes. Because of this limited trucking capacity, shippers began to move their merchandise by rail rather than trucks. Comparatively lower costs also made railroads a more attractive option.

Housing and Construction Activity Will Drive Industrial Shipments

Though housing starts have fluctuated a lot in 2014, they remained 8.2% higher for the year to date ending November 2014. [5] [6] Additionally, construction spending in the U.S was up 6.4% year-on-year over the same period. [7] Union Pacific’s construction related shipments, which includes lumber, gravel, crushed stone, and sand, benefited from the growth in housing and construction activity and saw double digit growth in 2014. [4] This should help drive Union Pacific’s revenue generated from its Industrial segment.

Weak Crude Oil Carloads May Temper Chemicals Shipments

In 2014, Union Pacific’s petroleum carloads, which include crude oil, declined 6% year-on-year due to high crude oil production in the Petroleum Administration for Defense District (PADD) 3 region and narrow spreads between the Western Texas Intermediate (WTI) and Brent crude oil. [4]

Of late, crude oil production in the PADD 3 region has been growing very rapidly compared to PADD 2, which includes the Bakken region from where most of Union Pacific’s crude oil shipments originate. [8] Due to the high production in the PADD 3 region and its proximity to the Gulf Coast, refineries situated near the Gulf coast did not have to look to the PADD 2 regions to fulfill their demand for crude oil. Additionally, they did not have to rely on railroads to transport the crude oil due to the existence of a strong pipeline infrastructure connecting the PADD 3 region to the Gulf coast refineries.

The narrow spreads between WTI and Brent made it more profitable for U.S. refineries to import Brent crude oil from the North Sea rather than to procure domestically produced WTI. This is because of the comparatively high transportation costs of railroads, which would likely eat into the refineries’ margins.

Though the decline in crude oil carloads will present headwinds, growth in Union Pacific’s Chemicals segment volumes will likely remain a sluggish net positive due to the rise in chemicals production in the U.S. According to the latest data provided by the American Chemistry Council, chemical activity was up 3.3% year-on-year in December 2014. [9] This has helped Union Pacific’s chemicals carloads grow 4% during the year.

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Notes:
  1. Union Pacific 2014 Third Quarter News Release Financials, October 23 2014, www.up.com []
  2. Crop Production 2013, www.usda.gov []
  3. Crop Production, January 12, 2015, www.usda.gov []
  4. Union Pacific’s 2014 Week 53 Carloadings Report, www.up.com [] [] [] [] []
  5. New Residential Construction, December 16, 2014, www.census.gov []
  6. NAHB Housing and Interest Rate Forecast, January 5, 2015, www.nahb.org []
  7. US Construction Spending Chart, www.ycharts.com []
  8. Crude Oil Production, www.eia.gov []
  9. Chemical Activity Barometer, www.americanchemistry.com []