Why Union Pacific Stock Isn’t Our Top Pick In Transportation Sector

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Union Pacific

We believe that there are several stocks in the transportation sector that are better than Union Pacific (NYSE:UNP). Union Pacific’s current market cap-to-operating income ratio of 18x compares with 12x for U.S. Xpress Enterprises (USX), 14x for Werner Enterprises (WERN), and 15x for Canadian Pacific Railway (CP).

Does this gap in valuation between Union Pacific and its peers make sense? We don’t think so, especially if we look at the fundamentals of these companies. More specifically, we arrive at our conclusion by looking at historical trends in revenues, operating income, and market cap-to-operating income ratio for these companies. Our dashboard Better Bet Than UNP Stock: Pay Less To Get More From USX, WERN, CP has more details – parts of which are summarized below.

1. Revenue Growth

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Union Pacific’s revenue declined at an average rate of 2.5% over the last three years, as compared to revenue growth of 4.2% for U.S. Xpress as well as that for Werner, and 5.7% growth for Canadian Pacific. Even if we look at the revenue growth over the last twelve month period, Union Pacific’s decline of 10.0% is much worse than 2.0% growth for U.S. Xpress, and 3.7% and 1.1% decline for Werner and Canadian Pacific, respectively.

  • While Union Pacific’s business has been impacted by the Covid-19 pandemic in 2020, even otherwise, the company’s energy freight, especially coal freight, has been on a decline over the last few years. This is due to macro factors impacting the demand of coal, as well as fluctuation in oil & gas prices impacting the overall energy freight business.  Now that multiple countries have initiated vaccination programs, the transportation demand is expected to rise, with a growth in overall economic activity, boding well for Union Pacific in the near term.
  • U.S. Xpress is one of the largest truckload carrier in the Eastern United States, and it has seen a modest increase in volume as well as pricing over the recent quarters. The company has been focused on moving to Variant, a digitally recruited, dispatched, and managed asset-based fleet that uses artificial intelligence. It has already shown 20% improvement in utilization. The company expects to have 1,500 tractors under Variant by the end of 2021, as compared to 700 currently. This is important, as it is expected to improve the company’s margins going forward.
  • Werner has seen a 3.7% decline in revenues in 2020, primarily due to the impact of the pandemic on its business, especially in Q2. That said, the company has also seen a growth in pricing while there has been a slight decline in total fleet. Werner is also building an integrated platform that will connect drivers, brokerage partners, and customers. The company has an in-house product called Edge, while it has also partnered with Mastery Logistics Systems for a cloud-based transportation management system. The new technology will help Werner improve its utilization, and in turn, margins.
  • Canadian Pacific, a large railroad company, reported a 1% decline in revenues in 2020, as growth in grains and fertilizers was more than offset by a decline in metals, minerals, and consumer products shipments. The company, in-line with other railroad companies, has been focused on reducing its operating ratio, which declined to 57.1% in 2020 from 59.9% in 2019, despite a challenging environment due to the pandemic.

2. Operating Income Growth

The three-year average operating income growth for Union Pacific stands at -1%, much lower than 70% for U.S. Xpress, 19% for Werner, and 11% for Canadian Pacific. Better revenue growth for the latter three along with margin expansion has led to higher operating income for these companies. Looking at the last twelve month period, Union Pacific’s 8.4% drop in operating income compares with 119%, 1%, and 5% gains for U.S. Xpress, Werner, and Canadian Pacific, respectively.

The Net of It All

Although Union Pacific’s revenue base is much larger than U.S. Xpress, Werner, and Canadian Pacific, each of these companies has seen higher growth in revenues and operating income than Union Pacific in the last twelve months as well as the last three years.  Yet, they appear to be significantly cheaper than Union Pacific. Despite better profit and revenue growth, these companies have a comparatively lower market cap-to-operating income ratio.

Union Pacific’s persistent underperformance in revenue and operating income growth reinforces our conclusion that the stock is expensive compared to its peers, and we think this gap in valuation will eventually narrow over time to favor the group of comparatively less expensive names. As such, we believe that U.S. Xpress, Werner, and Canadian Pacific are currently better buying opportunities compared to Union Pacific.

While UNP stock looks comparatively expensive, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Canadian Pacific Railway vs. D.R. Horton.

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