Union Pacific Q3 Earnings Review: Cost Control In Focus In The Backdrop Of Weak Shipment Volumes

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Union Pacific (NYSE:UNP) announced its third quarter results and conducted a conference call with analysts on October 22. [1] As expected, weak shipment volumes and lower fuel surcharge revenues negatively impacted the company’s top line. Freight revenues declined 10% year-over-year to $5.22 billion, with lower volumes accounting for a 6.5% decline in revenues. [2] Lower fuel surcharge revenues offset gains in core pricing to account for the rest of the decline in freight revenues. However, despite weaker shipment volumes, Union Pacific’s operating ratio (operating expenses as a percentage of operating revenues) improved by 200 basis points year-over-year to 60.3 in Q3 2015. [3] A combination of lower fuel and other operating expenses, partly as a result of lower shipment volumes, and productivity improvements, helped boost the company’s operating ratio. The key message from the earnings conference call was the management’s commitment towards controlling costs, including a willingness to rationalize operations in response to poor business conditions.

Lower Shipment Volumes

Union Pacific’s shipment carloads declined significantly in Q3, with year-over-year declines in coal and Industrial Products shipment carloads the heaviest at 15% and 12%, respectively. [3] Weak demand for coal from utilities drove down railway shipments of the commodity across various operators. Weak natural gas prices and a crackdown on power plant carbon dioxide emissions has accelerated the pace of adoption of natural gas as the preferred fuel for electricity generation in the U.S., undermining the demand for coal. Coal’s share of U.S. electricity generation stood at 35% in Q3 2015, down from 38% in the corresponding period of 2014. [1] In addition, high levels of coal inventories at utilities further dampened the demand for the commodity.

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Besides coal, Union Pacific’s Industrial Products segment also witnessed a sharp decline in volumes, reporting a 12% decline in shipment carloads. Due to the sharp decline in oil prices over the last twelve months (as illustrated by the chart shown below), there has been a significant reduction in shale drilling activity. As a result, there has been a sharp reduction in frac sand and steel shipments, which are associated with shale drilling, negatively impacting Union Pacific’s Industrial Products shipments.

Decline in Brent Crude Oil Prices, Source: Y Charts

Operating Expenses

Union Pacific’s operating expenses declined 13% year-over-year to $3.35 billion in Q3 2015. [3] Fuel expenses declined 45% year-over-year, largely due to declines in locomotive diesel prices (as a result of lower crude oil prices). In addition, the company benefited from lower volume related operating expenses. Moreover, in order to closely match its workforce with the prevailing demand conditions, the company has furloughed an additional 1,500 track, engine, and yard employees, as compared to the number at the end of Q2.  [1] In addition, the company’s locomotive fleet has also been reduced since the end of Q2, in response to lower shipment volumes. The cumulative impact of these savings has resulted in Union Pacific reporting an improvement in its operating ratio, despite lower shipment volumes.

Focus on Cost Control

The management acknowledged in the earnings conference call that shipment volumes are likely to remain weak in the near term. An adverse regulatory environment and weak gas prices are likely to negatively impact coal shipments going forward. Furthermore, with oil prices unlikely to rise significantly in the near term, Union Pacific’s Industrial Products shipments are likely to remain subdued as well. With significant top-line growth unlikely in the near term, the management has stated that controlling operating costs, matching resources with demand, and improving productivity of operations, remain the key thrust areas for the company. Union Pacific has already demonstrated agility in rationalizing its operations in response to changing business conditions. A focus on cost control and maintaining profitability will certainly stand the company in good stead in the near term.

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Notes:
  1. Union Pacific Corporation Q3 2015 Earnings Call Transcript, Seeking Alpha [] [] []
  2. Union Pacific’s Q3 2015 Earnings Presentation, Union Pacific Website []
  3. Union Pacific’s Q3 2015 10-Q, SEC [] [] []