Union Pacific Q4 2015 Earnings Review: Top Line Headwinds Negatively Impact Results

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Union Pacific (NYSE:UNP) announced its fourth quarter results and conducted a conference call with analysts on January 21. [1] As expected, lower shipment volumes and fuel surcharge revenues (as a result of a decline in locomotive diesel prices) negatively impacted the company’s Q4 revenues. Freight revenues declined 16% year-over-year to $4.86 billion, with lower volumes and fuel surcharge revenues accounting for 9% and 6.5% of the decline in revenues, respectively. [2] Union Pacific’s operating ratio (operating expenses as a percentage of revenues) deteriorated 180 basis points year-over-year to 63.2% in Q4 2015. [3] A combination of lower fuel and other operating expenses, partly as a result of lower shipment volumes, and productivity improvements, helped prop up the company’s operating ratio, partially offsetting the impact of top line headwinds. The key takeaway from the earnings conference call was the management’s recognition of the adverse business environment and an emphasis on controlling costs and boosting operational efficiency in response to the prevailing business environment.

Decline in Shipment Volumes

Union Pacific’s shipment carloads declined significantly in Q4, with year-over-year declines in coal and industrial products shipment carloads the heaviest at 22% and 16%, respectively. [3] Weak demand for coal from utilities drove down shipments of the commodity. Soft natural gas prices and the federal government’s crackdown on power plant carbon dioxide emissions has expedited the growth in natural gas based electricity generation, undermining the demand for coal. The market share of coal in U.S. electricity generation stood at 32% in Q4 2015, down from 37% in the corresponding period of 2014. [1]

Brent Crude Oil Prices, Source: Y Charts

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Besides coal, the company’s Industrial Products segment also reported a sharp decline in shipments, with shipment carloads declining 16% year-over-year. [3] As a result of the sharp decline in oil prices over the last twelve months (as illustrated by the chart shown above), shale drilling activity has declined considerably. As a consequence of the reduced shale drilling activity, frac sand and steel shipments, which are associated with shale drilling, have declined considerably, negatively impacting the shipments of the Industrial Products division.

Operating Expenses

Union Pacific’s operating expenses stood at $3.29 billion in Q4 2015, around 13% lower year-over-year. [3] Fuel expenses declined 48% year-over-year, primarily as a result of a decline in locomotive diesel prices (due to lower crude oil prices), with lower shipment volumes also contributing to the decline in fuel expenses. Besides lower fuel expenses, in order to match its workforce with the prevailing demand conditions, Union Pacific furloughed an additional 1,200 track, engine, and yard employees, as compared to the number at the end of Q3. [1] In addition, the company’s locomotive fleet was 13% lower year-over-year in Q4 2015, reflecting lower shipment volumes. These initiatives helped lower the company’s operating expenses, partially offsetting the impact of lower revenues on the operating ratio.

Focus on Cost Control

The management noted during the earnings conference call that shipment volumes are likely to remain under pressure in 2016, with weakness in demand for coal and weak oil and gas drilling activity expected to keep shipments subdued. As top line growth is likely to remain muted in the near term, the management stressed upon controlling operating costs, matching workforce and locomotive fleet with demand, and boosting the productivity of Union Pacific’s operations. With challenging business conditions expected to persist in the near term, the management’s emphasis on controlling costs and improving productivity will certainly stand the company in good stead in the near term.

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Notes:
  1. Union Pacific Corporation Q4 2015 Earnings Call Transcript, Seeking Alpha [] [] []
  2. Union Pacific’s Q4 2015 Earnings Presentation, Union Pacific Website []
  3. Union Pacific’s Q4 2015 Earnings Release, SEC [] [] [] []