Union Pacific Earnings Preview: Earnings To Dip On Coal, Fuel Headwinds

Union Pacific (NYSE:NSC) is set to announce its second quarter 2015 results on July 23. ^[1] The railroad operator is likely to report a decline in revenues and earnings as most commodity carloads have seen negative trends. According to Union Pacific’s carloads report for the week ended June 27, its total carloads, excluding intermodal, declined 11%. ^[2] Coal volume declines were among the heaviest. We also expect to see a decline in fuel surcharge revenue due to the falling fuel prices, and the net negative impact from fuel will likely temper earnings.

In the first quarter, Union Pacific reported relatively stagnant revenues at $5.6 billion. ^[3] Low fuel prices helped boost Union Pacific’s operating ratio (operating expenses expressed as a percentage of revenue), leading to a 7% rise in operating income. This also helped boost the railroad’s earnings per share by 9%, to reach $1.30.

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Heavy Coal Volume Declines To Present Headwinds

The demand for coal at U.S. electric utilities has declined through the first half of 2015, as the spot price for natural gas remained lower than $3 per million btu, a level at which utilities generally start moving away from coal. ^[4] This is also evident from the rise in natural gas consumption at electric utilities, which grew 25% year-on-year in April, ^[5] while coal consumption declined 11% year-on-year, leading to a 30% rise in coal stockpiles. ^{[6] [7]}

On the export front, U.S. coal has been suffering from weak metallurgical and thermal coal prices in the global market. Coal prices have slumped due to high exports from Australian coal suppliers and low demand from China. The strong U.S. dollar has also presented headwinds. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. This has led to steep declines in railroads’ export coal carloads.

These trends have led to a decline in Union Pacific’s coal carloads. According to its carload report for the quarter to date ending June 27, coal carloads declined 27% year-on-year. ^[1] Not only will the decline in carloads impact the railroad operator’s top line but also its coal revenue per unit, primarily due to a lower mix of export coal.

Low Fuel Prices Could Temper Top And Bottom Lines

In the first quarter, Union Pacific’s fuel surcharge revenue declined 4% as a result of the steep drop in fuel prices. However, the declining fuel prices led to a net positive benefit for Union Pacific as its fuel bill declined $357 million. ^[2] This is because the fuel surcharge is based on two month lagged values of highway diesel prices, while fuel expenses are based on spot prices. Since fuel prices have declined continuously, spot prices are lower than prices two months back, leading to lower fuel expenses than fuel surcharge revenues.

Presently, the price of U.S. on-highway diesel fuel has been fluctuating around its lows, as crude oil prices have showed some upwards momentum. In the second week of April, the average price of U.S. on-highway diesel fuel declined to a low of $2.75. ^[8] However, it climbed to $2.91 by the fourth week of May. Thereafter, the U.S. on-highway diesel fuel price has continued to gradually decline, ending the fourth week of June with an average price of $2.84.

This situation does not bode well for Union Pacific, since fuel expenses are likely to be in line with fuel surcharge revenues, despite the two month lag. As a result, Union Pacific might witness a net negative impact from the fluctuations in fuel price in the second quarter, which would impact its operating ratio.

Sluggish Intermodal Volumes

In the first quarter, Union Pacific’s intermodal carloads declined 3% year-on-year due to labor disputes at west coast ports, which caused shutdowns and backlogs and also led to many shippers moving their merchandise to the east coast. ^[2] A turnaround was expected in the second quarter, since negotiations between the International Longshore and Warehouse Union (ILWU) and the Pacific Maritime Association (PMA) ended. However, with the decline in fuel prices, trucking rates became very competitive with railroads, leading to lower highway to rail conversions. This has led to sluggish growth in Union Pacific’s intermodal carloads. According to Union Pacific’s carloads report for the week ended June 27, its intermodal volumes grew just 2%. ^[1]

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1. Union Pacific Corporation Invites You to Join Its Second Quarter 2015 Earnings Release Broadcast, July 16, 2015, www.up.com [↩] [↩] [↩]
2. Union Pacific’s 2015 Week 25 Carloading Report, www.up.com [↩] [↩] [↩]
3. Union Pacific’s 2015 Q1 News Release/Financials, www.up.com [↩]
4. Henry Hub Natural Gas Spot Price, U.S. Energy Information Administration [↩]
5. Table 2.4.A. Natural Gas: Consumption for Electricity Generation, June 25, 2015, www.eia.gov [↩]
6. Table 2.1.A. Coal: Consumption for Electricity Generation, June 25, 2015, www.eia.gov [↩]
7. Stocks of Coal: Electric Power Sector – April 2015, June 25, 2015, www.eia.gov [↩]
8. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov [↩]