The Secret To Union Pacific’s 75% Gains

by Trefis Team
Union Pacific Corporation
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The stock price of Union Pacific (NYSE:UNP), one of the world’s largest railroad companies, is up over 75% since the end of 2016. But how did the company pull off such impressive gains, as its revenues grew a mere 9% over the same period? Well, there is a valid reason, of course. As it turns out, the net earnings margins (profits as a percent of revenues), expanded a strong 610 bps from 21.2% to 27.3% between 2016 and 2019, driven by the company’s focus to reduce its operating ratio. Our dashboard on Union Pacific’s Revenues And Stock Price Change Mismatch provides the key numbers behind our thinking, and we explain more below.

What Brought About A Change In Margins & Multiple?

The expansion in Union Pacific’s net margins was brought about by lower compensation & benefits expenses, as well as a lower effective tax rate. The company’s biggest expense item, compensation & benefits, has declined over the recent years, both in absolute dollar value ($4.8 Bil to $4.5 Bil), as well as a percentage of revenues (23.8% to 20.9%). This can be attributed to a mix of lower volume related costs, lower management and administrative costs and employment tax refund. Though volume related costs is expected to remain low in the near term, due to the impact of Covid-19 on total shipments, it may not persist in the long run.

That said, the company has been focused on reducing its operating ratio from 64% in 2016 to 61% in 2019, and it aims to achieve 55% over the next few years. Compensation & benefits being the biggest expense item could see further decline when looked as a percentage of revenue. Railroad fuel prices trending lower in 2020 will also help save fuel costs, though they are also a part of revenue in the form of fuel surcharge being levied to the customers. Railroad fuel price index has plummeted roughly 50% year-to-date. The margins going from 21.2% to 27.3% coupled with a 9% increase in revenues from $19.9 billion to $21.7 billion has meant that the earnings per share surged 65% from about $5.09 per share in 2016 to $8.41 a share in 2019. Lower volumes resulted in lower revenues in 2019, as we detail in our analysis on Union Pacific Revenues.

While the margins growth was the key to the change in stock price, the expansion of P/E Multiple from 19x to 21x also helped. However, the multiple has declined around 6% in the recent weeks to 20x currently, due to the potential impact of the Covid-19 pandemic on the U.S. economy, and in turn, on Union Pacific’s railroad operations. Union Pacific also appears pricey compared to other railroad companies, which have much more conservative multiples. For example, CSX trades at 17x trailing earnings and Norfolk Southern trades at 18x. Considering this, we think there is a possibility for the P/E multiple for Union Pacific to return to a historically average level of around 18x. Our analysis on Union Pacific: How Low Can Union Pacific Stock Go? explores a downside scenario for the company with the underlying numbers.

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