Union Pacific: The Year 2015 In Review

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The year 2015 has been a fairly challenging one for Union Pacific (NYSE:UNP), with significant top line pressure as a result of declining shipments and fuel surcharge revenue. Falling shipments of coal and frac sand have primarily been responsible for the decline in Union Pacific’s shipment carloads. The decline in diesel prices as a result of weakening crude oil prices negatively impacted the company’s fuel surcharge revenues as well. However, on the cost side, lower fuel prices helped Union Pacific lower its expenses, and along with its productivity enhancement measures, helped the company report a better operating ratio in the first nine months of the year (operating expenses as a percentage of revenue). In this article, we will look back at the how the year 2015 panned out for Union Pacific.

Declining Shipments

Union Pacific’s shipments declined roughly 6% year-over-year in 2015. [1] The main reasons for the decline in shipments have been lower shipments of coal and petroleum products.

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Declining demand for coal from utilities drove down Union Pacific’s shipments of the commodity. Low natural gas prices and a crackdown on power plant carbon dioxide emissions by the federal government, have quickened the pace of adoption of natural gas as the fuel of choice for electricity generation in the U.S., undermining the demand for coal. New regulations envision a 32% reduction in power plant carbon dioxide emissions from 2005 levels by 2030, which is bad news for coal since the carbon dioxide emissions intensity of coal is much higher than that of natural gas. [2] Coal’s share of U.S. electricity generation stood at 35% in Q3 2015, down from 38% in the corresponding period of 2014. [3] Union Pacific’s coal shipments stood 18% lower on a year-over-year basis in the first nine months of 2015. [4]

Brent Crude Oil Prices in 2015, Source: Y Charts

Weakness in oil prices, as illustrated by the chart shown above, has negatively impacted drilling activity in the U.S. This was responsible for the decline in Union Pacific’s shipments of frac sand, which is used in hydraulic fracturing. The weakness in drilling activity also negatively impacted the company’s steel shipments, which were further negatively impacted by competition to the domestic steel industry from steel imports. The combination of these factors resulted in a 10% decline in the company’s industrial products shipments in the first nine months of 2015. [4]

Top line headwinds largely contributed to the decline in Union Pacific’s stock price this year, as illustrated by the chart shown below.

Union Pacific Stock Price in 2015, Source: Google Finance

Lower Fuel Surcharge Revenues and Lower Fuel Expenses

The decline in highway diesel prices as a result of the weakness in crude oil prices resulted in lower fuel surcharge revenues for the company this year. The impact of lower fuel surcharge revenues was felt in the company’s average revenue per car, which stood 3% lower on a year-over-year basis in the first nine months of 2015, mainly because of lower fuel surcharge revenues. [4] Though the weakness in diesel prices negatively impacted fuel surcharge revenues for the company, lower fuel prices also helped the company rein in its operating expenses. In addition, in response to the top line pressure facing the company, Union Pacific management instituted measures to boost the productivity of its operations. The cumulative impact of lower fuel expenses and productivity improvement measures was reflected in the company’s operating ratio, which stood at 63.1 in the first nine months of 2015, as compared to 64.2 in the first nine months of 2014. [4]

With coal fast being replaced as a means of generating electricity by natural gas, the company’s coal shipments will remain under pressure next year, too. In addition, weak oil prices are likely to negatively impact Union Pacific’s frac sand shipments, too. With Union Pacific likely to face top line pressure next year as well, controlling costs and focusing on improvements in productivity will remain key to maintaining profitability in 2016. Thus, the company’s strategy in 2016 is likely to mirror the focus on cost reduction and productivity enhancement that the company displayed this year.

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Notes:
  1. Union Pacific’s Week 51 Carloading Report, Union Pacific Website []
  2. Obama’s New Climate-Change Regulations to Alter, Challenge Industry, Wall Street Journal []
  3. Union Pacific Corporation Q3 2015 Earnings Call Transcript, Seeking Alpha []
  4. Union Pacific’s Q3 2015 10-Q, SEC [] [] [] []