Work on a transcontinental railroad for the US began in 1862 when Abraham Lincoln signed the Pacific Railway Act. It transformed America and gave birth to the original Union Pacific (UNP). Now, 150 years on, the iconic firm and economic bellwether is reporting record results and things are set to get better.
- Supplying US shale oil boom
- Cyclical recovery under way
- Great control of costs
- Re-pricing legacy contracts
- Coal volumes falling
- Drought hits grain shipments
Warren Buffett certainly thinks so. Buying its rival, Burlington Northern Santa Fe, three years ago was "a bet on the country", said the Sage of Omaha. It also left Union Pacific the only way for investors to play this particular theme.
Much of Union's success is down to diversification. Operating 32,000 miles of track across 23 central and western states, it's North America's largest railroad. A fifth of revenue comes from coal, but volume fell 12 per cent in the latest quarter. Union, however, is making a fortune delivering special sand, drill pipes and other kit to drillers for shale oil and gas in the south and on the Canadian border.
Two years ago, Union moved just 4,400 carloads of crude oil. This year, chief executive Jack Koraleski believes it will be nearer 140,000. True, producers are investing heavily in new pipelines, but Union will still carry the materials to build them and its flexible trains have the edge over fixed-point pipelines. They're faster, too.
Union already has heavy exposure to the booming Gulf Coast chemicals industry - taking crude oil and gas to the refining hubs and then shipping the finished products to markets. Volumes rose 18 per cent in the latest quarter. It also ships more cars than any other railroad west of the Mississippi, and US auto sales are running at their highest levels since March 2008. It's a highly profitable operation - quarterly revenue jumped 15 per cent to $436m - and one which broker FBR Capital Markets believes is capable of growing by 13 per cent until 2014.
A slice of that will come from Mexico. Four years ago, the country became the largest supplier of auto parts to the US and capacity keeps expanding. Well placed on all the major cross-border points, Union should profits from this.
Elsewhere, Union is pulling railcars out of storage to cope with the recovering US housing market. New home construction grew at its fastest pace in over four years last month and volume for lumber and wood products jumped over 11 per cent in the first week of October.
More containers full of imported goods are being shifted from ships and trucks onto trains, too. Intermodal freight is Union's biggest revenue generator and 2012 looks like being another record. Management thinks it could convert another four million truckloads to the railway. "We foresee several years, if not decades, of continued growth in the segment," says FBR Capital.
UNION PACIFIC (US: UNP) | ||||
|---|---|---|---|---|
| ORD PRICE: | $124.34 | MARKET VALUE: | $58.5bn | |
| TOUCH: | $124.33-124.34 | 12-MONTH HIGH: | $129.27 | LOW: $94.24 |
| DIVIDEND YIELD: | 1.9% | PE RATIO: | 15 | |
| NET ASSET VALUE: | $40.30 | NET DEBT: | 43% | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($bn) | Earnings per share ($) | Dividend per share ($) |
|---|---|---|---|---|
| 2008 | 18.0 | 3.66 | 4.58 | 0.98 |
| 2009 | 14.1 | 2.97 | 3.76 | 1.08 |
| 2010 | 17.0 | 4.43 | 5.58 | 1.31 |
| 2011 | 19.6 | 5.26 | 6.78 | 1.93 |
| 2012* | 21.0 | 6.29 | 8.20 | 2.40 |
| % change | +7 | +20 | +21 | +24 |
Beta:1.1 *Deutsche Bank Securities forecasts £1=$1.60 | ||||
There are a couple of problems. Union's revenue from agriculture fell 4 per cent in the third quarter, and this summer's drought means America's corn crop will be the smallest in six years.
Domestic coal is the biggest worry, though. Union indicates that the percentage drop in sales volumes in the final quarter will be somewhere in the low to mid-teens given high inventories and cheap natural gas. True, a bitterly cold winter would be of help. Even so, analysts at JP Morgan are already factoring in volume growth of 5 per cent for next year, whatever the weather.
What's more, a further $350m of legacy contracts, mainly coal, are up for renewal and re-pricing in the first half of 2013. Finance chief Robert Knight says most of that's front-end loaded, so that should boost profits in 2013 and 2012.
Pricing and Union's slick operations will contribute, too. Its operating ratio - railroad costs as a percentage of sales - hit a record low of 67 per cent latest quarter. It was nearer 90 per cent when Mr Knight took over. That performance makes a target of 65-67 per cent in 2015 look cautious, especially since JP Morgan has already pencilled in 64 per cent for 2014. It seems likely that management will set a new target when they meet analysts in Dallas on 30 October.
