What Will Drive Union Pacific’s Near Term Growth?

by Trefis Team
Union Pacific Corporation
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Union Pacific Corporation (NYSE: UNP) is seeing strong growth in its Intermodal business of late, due to constraints in the trucking industry. In addition, there has been a ramp up in sand shipments amid increased drilling activity in the U.S. However, Coal shipments continues to remain lackluster given the trends in natural gas prices. These trends will likely continue in the near term, and the company’s growth will primarily be led by the Intermodal segment, along with its efforts to bring down the operating ratio. We have created an interactive dashboard ~ What Is The Outlook For Union Pacific? ~ on the company’s expected performance in 2018. You can adjust the revenue and margin drivers to see the impact on the company’s overall revenues, earnings, and price estimate.

Expect Intermodal To Drive Near Term Growth

We forecast a low double digit growth in Union Pacific’s Intermodal segment revenues for the full year. Both volume as well as pricing will aid the segment growth. Volume will likely be driven by continued constraint in the trucking industry, amid The Hours-of-Service safety regulation, which is now fully implemented. This increases the competitive advantage of railroads over trucks. As shippers move to railroads to ship freight, Union Pacific’s Intermodal volume should benefit from the same. Pricing growth will partly be led by higher fuel surcharges. Looking at H1 2018, the Premium segment volume grew 4% and average revenue per unit grew 6%. Note that Intermodal is reported under the Premium segment by Union Pacific under its new segment reporting structure.

Expect Agriculture And Coal Freight To Benefit From Higher Fuel Surcharge

Agriculture freight revenues have seen a low single digit revenue growth in H1 2018, as the lower volume was offset by better pricing. The segment volume is being impacted by the weakness of the U.S. agricultural products in the global markets, which has taken a toll on export shipments. This trend will likely continue in the near term, especially for wheat grain, and the shipment volume for the full year is expected to be lower.

Looking at Coal freight, we don’t expect any significant growth in volume, as natural gas prices are trading below the 2017 average, which will continue to impact the coal demand. However, export coal has seen strong growth in the recent quarters, and it is expected to remain strong in the near term, and offset most of the decline on the utility side. Higher fuel surcharges will likely aid the average revenue per unit, thereby driving the segment revenue growth. In fact, pricing for every reported segment has grown in H1 2018, primarily due to higher fuel surcharges. This can be attributed to the rally in crude oil prices in the first half of 2018. Also, for the full year, crude is expected to average around $72 per barrel, reflecting a 32% growth over the prior year average, according to EIA.  This should bode well for the railroad companies.

Given the trend in oil prices, frac sand, and oil related shipments, should see a rise in the near term. The U.S. oil production is expected to be 10.7 million b/d in 2018, the highest annual average U.S. crude oil production level ever. Despite higher production, prices are much higher than the 2017 average. Higher oil prices will likely boost drilling activity and increase the demand for crude oil related shipments, as well.  In fact, increased shale drilling activity has led to a 24% jump in shipments of frac sand in the previous quarter, and this trend will likely continue in the near term.

Overall, we expect the Intermodal segment to drive the company’s near term growth. We currently forecast the earnings of $7.90 per share in 2018. We forecast a price to earnings multiple of 20x by the end of 2018, which is slightly lower than most of the estimates for the sector, to arrive at our price estimate of $156 for Union Pacific, which is slightly above the current market price.


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