Union Pacific: Smooth Sailing Ahead Amid Favorable Business Conditions

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Union Pacific

Union Pacific’s financial results have been characterized by a steady decline in revenue over the past few years, as illustrated by the table shown below. However, the year 2017 is likely to represent a turning point, with revenue set to rise steadily over the next few years.

UNP Revenue 2014-2019

The main reasons for the decline in the company’s top line over the past few years were the declines in coal and metals shipments (which are included in the industrial products category), as illustrated by the charts shown below.

Declines in Coal & Metals Shipments in Past Years

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Union Pacific’s shipments of coal declined by nearly 34% between 2014 and 2016, as a result of a decline in demand from utilities. [1] Benchmark natural gas prices averaged significantly below $3 per MMBTU over this period, which accelerated the shift towards natural gas as the preferred fuel for electricity generation in the U.S. In addition, President Obama’s Clean Power Plan, which mandated a 32% decline in power plant carbon dioxide emissions below 2005 levels by 2030, created a regulatory environment which favored an increasing adoption of natural gas for electricity generation. [2] All of these factors dampened the demand for coal in the U.S., adversely affecting production as well as rail shipments of the commodity over the period 2014-2016.

Besides unfavorable business conditions in the coal industry, the domestic steel industry also had a poor run over the period 2014-2016. Domestic steel producers were adversely impacted by a surge in steel imports, a large proportion of which were sold at unfairly low prices. Competition with these unfairly priced steel imports adversely impacted both steel production as well as steel prices. Shipments in Union Pacific’s Metals & Products sub-category declined by around 33% over the period 2014-2016. [1]

Besides the decline in the shipments of the aforementioned commodities, declining oil prices  over the course of the past few years negatively impacted fuel surcharge revenue for Union Pacific. All these factors dragged down the company’s top line over the past few years.

A Change in Fortune in 2017

The year 2017 is likely to represent a considerable improvement in business prospects for Union Pacific, characterized by a reversal in the negative trends weighing on the company’s top line over the last few years. Coal shipments have risen sharply this year, as a result of a sharp increase in natural gas prices. As per EIA estimates, benchmark natural gas prices are expected to rise to $3.17 per MMBTU and $3.43 per MMBTU in 2017 and 2018, respectively. [3] Rising U.S. natural gas and LNG exports as well as higher demand for natural gas from utilities amid accelerating economic growth are some of the reasons for the increase in prices of the fuel. In addition, the implementation of the Clean Power Plan was stayed by the Supreme Court amid legal challenges by a number of coal producing states. [4] Moreover, the Trump administration has promised to roll back restrictive environmental regulations in order to boost U.S. coal production. While higher gas prices have already boosted U.S. rail shipments of coal, if the federal government successfully enacts favorable regulation, coal shipments could rise further in the coming years.

Besides the U.S. coal industry, domestic steel companies have also witnessed a considerable improvement in fortunes in recent quarters. Based on petitions by domestic steelmakers, the Department of Commerce imposed punitive tariffs on unfairly traded steel imports from a number of countries such as China and South Korea. [5] The imposition of these duties weakened the competition from steel imports to the domestic steel industry, translating into higher production and rail shipments of steel. Moreover, the federal government has outlined plans for a ten-year $1 trillion revamp of domestic infrastructure. If implemented, the infrastructure plan will substantially boost the demand for, and the rail shipments of, steel and other industrial metals.

While recovering shipment volumes are expected to boost the company’s top line, higher oil prices could offer further support. A recovery in oil prices in 2017, driven by OPEC production cuts, is likely to translate into higher fuel surcharge revenue, further supporting revenue growth.

Union Pacific’s business prospects are certainly looking up at the moment, with shipments and revenue set to rise in the coming years, in stark contrast to the past few years characterized by a declining top line. At the same time, Union Pacific’s ongoing productivity improvement initiatives have helped the company rationalize its work force and locomotive fleet. The company is targeting an operating ratio (operating expenses as % of revenue) of 60% by 2019, as compared to 63.5% in 2016. [6] Thus, the company’s fortunes certainly seem to have turned a corner in 2017, with a promising future lying ahead.

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 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. Union Pacific’s Weekly Carloads, Union Pacific Website [] []
  2. The Clean Power Plan: A Climate Game Changer, Union Of Concerned Scientists []
  3. Short Term Energy Outlook, EIA []
  4. Supreme Court puts the brakes on the EPA’s Clean Power Plan, Washington Post []
  5. US issues final antidumping duties for hot-rolled coil steel from seven nations, Platts []
  6. Union Pacific’s Q1 2017 Earnings Presentation, Union Pacific Website []