What Could Potentially Cause A Threat To Union Pacific’s Ongoing Rally?

Union Pacific Corporation (NYSE:UNP) has had a great year, 2017, as its operational performance has improved sharply, owing to the rebound in the coal and metal shipments (Read: A Turnaround Year For Union Pacific). Further, the company’s relentless efforts to bring down its operating ratio through work force rationalization, improved fuel efficiency through longer train lengths, and lower locomotive servicing and repair costs, have enhanced its profitability notably compared to the previous years. Consequently, the railroad company’s stock has not only rallied close to 30% through the year, but the company is also returning a higher value to its shareholders in the form of dividends and a share repurchase program. However, while everything seems to be working in Union Pacific’s favor, we expect its rising debt obligations to cause a threat to its ongoing rally in the coming quarters.

Over the last couple of years, when the railroad industry was struggling due to the weak dynamics in the US coal and commodities markets, UNP’s cash flow position had been deteriorating. As a result, the company was forced to take on incremental debt to meet its capital spending and other operational needs. To put things in perspective, the company’s long term debt grew from $9.6 billion in 2013 to $15 billion in 2016. An additional debt of $5 billion in a span of 3 years not only weighted on the company’s capital structure, it also increased its interest payments drastically. For instance, the company, which incurred interest expense of roughly $525 million in 2013, paid close to $700 million in 2016, representing an annual jump of almost 10% in the last three years. As a consequence, the US-based company’s earnings (GAAP) dropped to $5.07 per share in 2016, a fall of roughly 6% in the last two years.

With the improving fundamentals of the US railroad industry, Union Pacific has been actively utilizing its growing cash flows to return higher value to its shareholders (Read: Union Pacific To Share Its Growth With Its Shareholders). However, the company has shown weak signs of paring down its rising debt profile. On the contrary, the company has raised additional debt of $1.8 billion (net of repayments) year-to-date, further contributing to its levered balance sheet.

Since UNP has around $1.3-$1.4 billion of debt maturing annually for the next three to four years ^[1], we estimate that its cash flows, post capital spending and dividend payments, may not be sufficient to meet its debt repayment needs. Accordingly, we anticipate the company’s long term debt to rise at a steady rate in the coming years, which could weigh on its profitability as well as shareholder value.

Feel free to use our interactive platform to create our own scenarios and visualize its impact on Union Pacific’s stock price. We have a price estimate of $130 per share for the company, which is in line with its current market price.

See Our Complete Analysis For Union Pacific Corporation Here

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1. Union Pacific’s 10-Q, 26th October 2017 [↩]