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Investment Overview for Union Pacific Corporation (NYSE:UNP)
Two important factors have impacted the business prospects of railroad companies such as Union Pacific over the past few quarters -- weak fuel prices and weak coal shipments.
- Weak fuel prices have impacted operations
- Crude oil prices have weakened considerably over the course of the last twelve months, as a result of a global supply glut. This has negatively impacted the fuel surcharge revenues for Union Pacific, which are tied to diesel fuel prices. However, low fuel prices have also helped reduce operating costs for Union Pacific, adding to the effect of other company initiatives to enhance operating efficiency. This has mitigated the impact of top line headwinds on the company's operating ratio.
- Declining coal shipments
- Soft natural gas prices have weakened the demand for coal from utilities. Weak natural gas prices have accelerated the shift towards natural gas as the preferred fuel for electricity generation, with natural gas now accounting for the largest share of U.S. electricity generation. These developments have lowered the demand for coal, which has negatively impacted Union Pacific's coal shipments, which declined around 25% year-over-year in the first nine months of 2016.
- Potential impact of 2016 presidential election
- A change in government post the 2016 U.S. presidential election could boost the business prospects of transportation companies such as Union Pacific. The incoming administration has promised a $550 billion infrastructure spending plan, with an emphasis on transportation infrastructure, including railways. If implemented, improvements in transportation infrastructure, as well as a boost to economic growth from the pro-business stance of the incoming government, could boost the prospects of railroad companies such as Union Pacific.
Below are key drivers of Union Pacific's value that present opportunities for upside or downside to the current Trefis price estimate:
- Union Pacific's EBITDA margin: We currently forecast Union Pacific's EBITDA margin to increase from 46.9% in 2015, to 54.2%, by the end of the Trefis forecast period, driven by the company's productivity improvement initiatives.
There could be an upside of roughly 3% to the Trefis price estimate if margin growth as a result of productivity improvement is above expectations and margins improve to 56.2% by the end of the Trefis forecast period, as opposed to 54.2% in our base case forecast.
- U.S. Rail Carloads of Coal: We currently forecast U.S. Rail Carloads of Coal to decrease from 5.1 million in 2014 to 3.2 million by the end of the Trefis forecast period, as we expect a continuous decline in demand for thermal coal.
The decline in demand for thermal coal could be sharper than expected, particularly if gas prices remain subdued. If U.S. rail carloads of coal decline to 2.2 million tons by the end of our forecast period, as opposed to 3.2 million in the base case, it would imply a 3% downside to our price estimate.
For additional details, select a driver above or select a division from the interactive Trefis split for Union Pacific at the top of the page.
Union Pacific Corporation is the leading railroad network in the United States, engaged primarily in freight transportation. Union Pacific Railroad (UPRR), the largest class-1 railroad in the United States, is the core subsidiary of Union Pacific Corporation. UPRR's route map covers most of the central and western United States, west of Chicago and New Orleans, covering nearly 23 states. Union Pacific competes with Burlington Northern Santa Fe Corporation (BNSF) which covers much of the same territory.
The company-owned tracks are a major strength of Union Pacific. The company operates on 31,838 miles of track out of which 26,009 is owned and the remainder is pursuant to trackage rights or leases. Union Pacific operates on key north/south corridors and is the only railroad to serve all six major gateways to Mexico. UP also interchanges traffic with the Canadian rail systems.
Union Pacific Railroad Company’s business mix includes Agricultural Products, Automotive, Chemicals, Energy, Industrial Products, and Intermodal. Although the company's primary role is transporting freight, it also runs a substantial commuter train operation in Chicago.
Union Pacific's earnings depend upon the volume of freight contracts it sells and the price of those contracts, while its expenses primarily consist of labor, fuel costs, utilities costs, and track maintenance. The largest of Union Pacific's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies, and chemical manufacturers.
We believe the Chemical Freight is the largest contributor to Union Pacific's value at around 21%.
Improving economic conditions to boost growth in chemical shipments
Improving economic conditions in the U.S. will boost shipments of industrial chemicals, driving the division's shipments. Moreover, with oil prices expected to recover gradually from next year onwards, rising drilling activity is expected to translate into higher petrochemical shipments. Rising shipments of these commodities underlie the division's valuation.
Weak coal market
Union Pacific's coal shipments declined 25% in the first nine months of 2016, as the demand for thermal coal fell sharply. Soft natural gas prices have weakened the demand for coal from utilities. Weak natural gas prices have accelerated the shift towards natural gas as the preferred fuel for electricity generation, with natural gas now accounting for the largest share of U.S. electricity generation. Besides the decline in demand for thermal coal, the demand for metallurgical coal, which is used in steel production, has also weakened considerably. Oversupplied global markets, weak steel prices, and a strong U.S. Dollar have weakened met coal shipments, most of which are meant for export markets.
Decline in fuel prices
The decline in fuel prices has been a double-edged sword for the railroad industry. On one hand, it has reduced the fuel surcharge that railroads add to their prices, thereby eating into their top line, while on the other, it has reduced fuel expenses, which has helped offset the impact of lower fuel surcharge revenues on profits. The decline in fuel surcharge revenues has resulted in a decline in average revenue per carload across shipments of various commodities, despite core pricing gains in the case of certain commodity shipments.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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