Union Pacific Posts Strong Growth Despite Increase In Operating Expense

Union Pacific Corporation (NYSE:UNP), one of the leading railroads in the U.S., posted overall revenue growth of 6% in the first quarter 2014 to reach $5.6 billion. ^[1] Growth in revenue was driven by a 5% increase in volume and 1% increase in average revenue per car. Volume grew broadly across all segments. Despite growth in operating expenses, the company managed to boost net earnings by 14% to reach $1.09 billion, driving an increase in earnings per share by 17%.  Union Pacific’s operating expenses grew 3% due to increase in costs as a result of the harsh winters.

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Operating Ratio Improves Despite Increase In Expenses

Union Pacific’s operating ratio, which is its operating expenses expressed as a percentage of revenue, declined 2% year-on-year in the first quarter 2014 despite the increase in operating expense.  Growth in revenue outpaced increase in operating expenses, leading to improvement in the operating ratio. Union Pacific is targeting to bring the ratio down to sub-65% levels by 2017. ^[2] 

In order to maintain operations during the harsh winter weather, Union Pacific increased employee and locomotive count. Locomotive fleet was increased by 600 units and employees by 550. This led to 3% increase in compensation and benefits expenses, and 9% increase in purchased services and materials expense. Fuel expense increased 2% due to the negative impact of the winter weather which was partially offset by the decline in average fuel price.

Agricultural Shipment Volumes Grow Due To Strong Harvest Season

Union Pacific’s agricultural shipment volume grew 13% in the first quarter on the back of a strong harvest in the U.S. in 2013. ^[1] Its grain shipments, which include corn and soybean, increased 39% due to the high production last year. ^[3] Corn and soybean production in the U.S. increased 30% and 7% respectively. ^[4] Additionally, higher corn production led to lower corn prices which encouraged ethanol producers to increase production and export, thereby adding to volumes of ethanol shipments. Revenue per unit increased 3%, complementing the increase in agricultural volume and leading to a 16% increase in revenue for the segment.

The second quarter agricultural shipments are also set to benefit from last year’s strong harvest. However, agricultural shipments for the second half of the year will be dependent on this year’s crop production. ^[2]

Growth In Auto Parts Shipments Help Offset Decline In Finished Vehicle Shipments

Union Pacific’s automotive shipments grew 2% due to 9% increase in shipments of auto parts, which more than offset declines in finished vehicle shipments. ^[1] Finished vehicle shipments declined 3% primarily due to the severe weather. ^[3]

Despite growth in volumes, revenue for the segment remained relatively stagnant due to decrease in revenue per unit. Revenue per unit declined due to change in method for accounting of per day charges for containers for auto parts. ^[2] These charges will now be a part of the “Other revenues” line item of Union Pacific’s income statement. This change led to a 2% decline in automotive revenue per unit but a 15% increase in other revenue.

Finished vehicle shipment volumes are expected to recover in the second quarter with improvement in weather conditions.

Coal Shipments Show Positive Growth After A Long Time

After declining for the past two years, Union Pacific’s coal shipments grew in the first quarter 2014. Coal shipment volume grew 7% on account of improving domestic demand. ^[1] Domestic coal demand had been suppressed for some time due to competition from natural gas and inventory overhang at utilities. However, rising natural gas prices and declining inventories have helped rejuvenate domestic demand for coal. Coal inventories at utilities have declined from 185 million short tons in 2012 to 148 million short tons in 2013. ^[5] Volume growth was partially offset by decline in revenue per unit, leading to a 3% growth in revenue. However, revenue per unit declined 4% due to unfavorable mix of shipments and lower fuel surcharges. ^[2]

The favorable conditions in the domestic market should continue to drive growth in coal shipments in the second quarter as well. Union Pacific believes that weather conditions during the summer will influence coal shipments during the second half of the year.

Construction And Shale Related Volumes Help Growth In Industrials Shipments

Union Pacific’s industrial shipments revenue grew 10% driven by strong growth in volume and modest growth in revenue per unit. Volume grew 9% on the back of growth in construction and shale related shipments. In the first quarter 2014, lumber & wood products shipments grew 2% and crushed stone, gravel and sand shipments grew 15% due to an increase in the overall construction spending in the U.S. Spending on construction increased from $928 billion in November 2013 to $945 billion in February 2014. ^[6] Union Pacific’s shale related shipments grew 22% in the quarter due to the shale boom.

Weather related disruptions partially tempered growth in housing starts in the beginning of 2014. However, the housing construction market is still poised to grow in 2014 given the high number of building permits and growth momentum in the housing market. Building permits increased from 945,000 in January 2014 to 1,014,000 in February 2014. ^[7] Combined with continued growth in shale related shipments, this should ensure growth in industrial shipments in the second quarter 2014.

Intermodal Shipments Post Moderate Revenue Growth

Union Pacific’s intermodal revenue grew 4%, driven by 3% increase in volume and 1% increase in revenue per unit. ^[1] Volume growth was primarily fueled by strong growth in domestic intermodal volume which was up 8% due to addition of new customers and growth at existing customers. However, international intermodal shipments declined 1% due to difficult comparison with last year’s first quarter performance. ^[2] Union Pacific expects intermodal volumes to grow throughout 2014, due to growth in truck to rail conversions and improved economic activity.

We are in the process of incorporating Union Pacific’s first quarter earnings into our model and shall be revising stock price estimate shortly.

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1. Union Pacific 2014 First Quarter News Release Financials, Jan 23 2014, www.up.com [↩] [↩] [↩] [↩] [↩]
2. Union Pacific’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, April 18 2014, www.seekingalpha.com [↩] [↩] [↩] [↩] [↩]
3. Union Pacific’s Weekly Carloading Report, www.up.com [↩] [↩]
4. National Agricultural Statistics Service – Crop Production, www.usda.gov [↩]
5. Short Term Energy Outlook, April 8 2014, www.eia.gov [↩]
6. Construction Spending, www.census.gov [↩]
7. Building Permits Data, www.census.gov [↩]