We think that Trinity Industries (NYSE:TRN) currently is a better pick compared to Union Pacific (NYSE:UNP). TRN stock trades at just 1.6x trailing revenues, compared to 7.6x for UNP. This gap in Trinity’s valuation makes sense to a certain extent given the superior margins for Union Pacific. However, we believe that the gap in valuation of both the companies will narrow eventually, boding well for TRN stock. Both the companies have seen lower sales due to the Covid-19 pandemic. But now that nearly half of the U.S. population is fully vaccinated, the demand is expected to rise over the coming quarters, auguring well for both the companies. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue growth as well as operating income and operating margin growth. Our dashboard Union Pacific vs. Trinity Industries: UNP stock looks overvalued compared to TRN stock has more details on this. Parts of the analysis are summarized below.
1. Revenue Growth
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Union Pacific’s revenues have declined 15% to $19.3 billion over the last twelve month period, compared to $22.8 billion in 2018. The decline over the recent past can be attributed to the impact of the Covid-19 pandemic on the overall demand, and a broader decline in coal shipments, given the increased demand for cleaner sources of energy, and favorable natural gas prices. Looking at Trinity Industries, its total revenue declined 28% to $1.8 billion over the last twelve-month period, compared to $2.5 billion in 2018. This can be attributed to fewer railcar deliveries, amid lower demand during the pandemic.
Even if we were to look at Q1 results, Trinity Industries’ total revenue of $399 million reflected a large 35% y-o-y decline, implying that the situation hasn’t improved much for railcar demand. Union Pacific also saw a 5% y-o-y decline in Q1 revenues. However, as we look forward, both the companies will likely see a strong rebound in Q2, given a favorable comparison to the prior year quarter, which was significantly impacted due to the lockdowns, and an overall recovery in demand due to gradual opening up of the economy over the recent months.
2. Operating Income
Union Pacific’s operating income declined to $7.7 billion over the last twelve-month period, compared to $8.5 billion in 2018, primarily due to lower revenues, partly being offset by 250 bps growth in operating margins. Railroad companies, including Union Pacific, have been focused on improving their operating ratio over the past few years, and this has helped the company’s bottom-line, even during the challenging year, 2020. Union Pacific’s operating ratio of 60.1% in Q1 2021 compared favorably with 62.7% seen in 2018.
Trinity Industries’ operating loss of $293 million over the last twelve months period compares to operating income of $319 million in 2018. This can be attributed to both lower revenues and a large decline in operating margins to -16.4% over the last twelve-month period, compared to 12.7% in 2018. This can primarily be attributed to a nearly $400 million impairment charge recorded by the company for its small cube covered hopper railcars in 2020. Looking at Q1 2021, operating margins improved to 15%, compared to around 12% in the prior year quarter.
The Net of It All
We know that Union Pacific has a much larger revenue base, it has seen better revenue and operating income growth both over the last twelve-month period as well as over the last three years, and its operating margins are far superior when compared to Trinity Industries. However, are these numbers biased due to the impact of the pandemic? It appears so. The impact of Covid-19 was far more meaningful on Trinity Industries than Union Pacific. If we look at the last twelve month sales decline for Trinity Industries, it was -41%, compared to only -10% for Union Pacific. For perspective, Union Pacific’s revenue growth for the last twelve-month period a year ago was -5.2%, much lower than the 16.8% growth for Trinity Industries. Similarly, the operating margin growth was comparable for both the companies for the last twelve-month period a year ago.
It is very much likely that both the companies will see a strong rebound in demand, when the Covid-19 crisis winds down, and we believe that the rebound will be more profound for Trinity Industries. The company is also expected to see improved pricing going forward, led by higher steel prices. While we believe that Union Pacific will continue to trade at a higher multiple compared to Trinity Industries, we think the difference in valuation for both the companies will likely narrow going forward in favor of the more attractively priced candidate, implying better returns for TRN stock.
While TRN stock may perform better compared than UNP, 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 Kansas City Southern vs Canadian Pacific Railway.