The Year 2016 In Review: Decline In Top Line Impacts Margins But 2017 Looks Promising For Union Pacific

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The year 2016 was characterized by top line pressure for Union Pacific, with the emphasis remaining on controlling costs in order to maintain profitability. A decline in overall shipments and fuel surcharge revenue translated into a decline in the company’s revenue for the year. Lower fuel expenses and the company’s cost rationalization efforts partially offset the impact of the decline in revenue on profits. Going forward, the strengthening of the U.S. economy and the policies of the incoming White House administration are likely to boost the prospects of rail companies such as Union Pacific.

Lower Shipments & Fuel Surcharge Revenue

Union Pacific’s shipment volumes declined considerably, with the company’s coal and industrial products segments leading the decline. Declining demand for coal by utilities and a shift towards cheaper natural gas as the preferred fuel for electricity generation by power plants translated into a sharp decline in U.S. rail shipments of coal as well as Union Pacific’s coal shipments.

Apart from the decline in Union Pacific’s coal shipments, lower industrial products shipments also contributed to the decline in the company’s overall shipments. A decline in oil and gas drilling activity negatively impacted rail shipments of frac sand and tubular steels (both used in oil and gas drilling). In addition, competition from unfairly traded steel imports to the domestic steel industry also affected rail shipments of steel, translating into lower industrial products shipments for Union Pacific. The following table summarizes the decline in Union Pacific’s shipment volumes.

UNP Decline in Shipments 9 M 2016

Apart from a decline in shipments, lower fuel surcharge revenue as a result of lower fuel prices also weighed on the company’s top line. The decline in the average revenue per carload for Union Pacific was largely due to lower fuel surcharge revenue.

UNP Average Revenue Per Carload 9M 2016

Focus On Cost Rationalization

With a decline in the top line weighing on Union Pacific’s operations, cost reduction became essential for the company management to negate the impact of lower revenue on profits. A combination of lower volume related costs and the company’s cost rationalization efforts could only partially offset the impact of top line headwinds on the operating ratio, as illustrated below.

Operating Ratio UNP 9M 2016The Road Ahead

While 2016 was a tough year for Union Pacific, the company’s fortunes could improve substantially next year. The incoming White House administration has outlined plans for a $1 trillion revamp of domestic infrastructure. [1] The President-Elect has also promised to take a tough stance against unfairly traded steel imports. If the President-Elect delivers what he promises, Union Pacific’s shipments, particularly the laggard industrial products shipments, will likely get a sharp boost. In addition, an increase in oil and gas drilling activity with a recovery in oil prices next year is likely to further boost petroleum related shipments as well. [2] The President-Elect has also promised to revitalize the coal industry. [3] Whereas revitalizing the coal industry with gas prices remaining relatively low is likely to be challenging, any measures taken to boost coal production could help prop up the company’s coal shipments. In any case, the slew of measures proposed by the incoming administration to boost the economy bodes well for Union Pacific’s shipment volumes, with 2017 expected to witness a recovery in top line growth after the decline seen this year.

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Have more questions about Union Pacific? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Union Pacific

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Notes:

  1. Trump’s $1 Trillion Promise vs. Congress, Wall Street Journal []
  2. Oil stable as planned output cuts start to materialize, Reuters []
  3. Trump’s big plan for the coal industry just got even harder, CNBC []