Union Pacific Corporation Fundamental Analysis

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Union Pacific Corporation

Last Updated: 25 Jan 2023

NYSE: UNP

GICS Sector: Industrials

Sub-Industry: Railroads

https://www.up.com/

You can download a summary of Union Pacific's fundamental analysis in PDF here.

Management

Union Pacific Management

CEO: Lance Fritz

Tenure: 7.9 years

Union Pacific Corporation's management team has an average tenure of 2.7 years. It is considered experienced.

Source of Revenue

Union Pacific Railroad Company, the principal operating company of Union Pacific Corporation, operates the railroad business in the United States.

The company is a Class I railroad operating in the U.S. Union Pacific and has 32,452 route miles, connecting Pacific Coast and Gulf Coast ports with the Midwest and eastern U.S. gateways and providing several corridors to key Mexican gateways. The company serves the Western two-thirds of the country and maintains coordinated schedules with other rail carriers to move freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada, and Mexico. Export and import traffic move through Gulf Coast and Pacific Coast ports and across the Mexican and Canadian borders.

Union Pacific only has one reportable operating segment but categorised its revenue into three commodity groups: Bulk, Industrial and Premium

Bulk

Union Pacific’s bulk shipments consist of grain and grain products, fertiliser, food and refrigerated, and coal and renewables.

The company accesses most major grain markets, connecting the Midwest and Western U.S. producing areas to export terminals in the Pacific Northwest and Gulf Coast ports as well as Mexico. The company also serves significant domestic markets, including grain processors, animal feeders, and ethanol producers in the Midwest and West. Fertiliser movements originate in the Gulf Coast region, Midwest, western U.S., and Canada for delivery to major agricultural users in those areas as well as abroad.

Union Pacific network supports the transportation of coal shipments to independent and regulated power companies and industrial facilities throughout the U.S. Through interchange gateways and ports, the company’s reach extends to eastern U.S. utilities as well as to Mexico and other international destinations. Coal traffic originating in the Powder River Basin (PRB) area of Wyoming is the largest portion of the Railroad’s coal business. Renewable shipments consist primarily of biomass exports and wind turbine components.

Union Pacific Source of Revenue

Source: Union Pacific

Industrial

Union Pacific has an extensive network that facilitates the movement of numerous commodities throughout North America. The Industrial group comprises several categories: construction, industrial chemicals, plastics, forest products, specialised products, metals and ores, petroleum, liquid petroleum gases (LPG), soda ash, and sand.

Commercial, residential, and governmental infrastructure investments drive shipments of steel, aggregates, cement, and wood products. Industrial and light manufacturing plants receive steel, nonferrous materials, minerals, and other raw materials. The industrial chemicals market consists of a vast number of chemical compounds that support the manufacturing of more complex chemicals.

Plastic shipments support automotive, housing, and durable and disposable consumer goods markets. Forest product shipments include lumber and paper commodities. Lumber shipments originate primarily in the Pacific Northwest or western Canada and move throughout the U.S. for use in new home construction and repairs and remodelling. Paper shipments primarily support packaging needs. Oil and gas drilling generates demand for raw steel, finished pipe, stone, and drilling fluid commodities.

The company's petroleum and LPG shipments are primarily impacted by refinery utilization rates, regional crude pricing differentials, pipeline capacity, and the use of asphalt for road programs. Soda ash originates in southwestern Wyoming and California, destined for chemical and glass producing markets in North America and abroad.

Premium

Union Pacific's premium category includes finished automobiles, automotive parts, and merchandise in intermodal containers, both domestic and international. The domestic business includes container and trailer traffic picked up and delivered within North America for intermodal marketing companies and truckload carriers. The international business consists of import and export traffic moving in 20 or 40-foot shipping containers that mainly pass through West Coast ports, destined for one of the company's many inland intermodal terminals.

The company's franchises serve five vehicle assembly plants and connect to West Coast ports, all six major Mexico gateways, and the Port of Houston to accommodate both import and export shipments. In addition to transporting finished vehicles, Union Pacific provides expedited handling of automotive parts in both boxcars and intermodal containers destined for Mexico, the U.S., and Canada.

Union Pacific Corporation Fundamental Analysis | Union Pacific Corporation Reportable Segment Revenue FY2021 | Fundamental Analysis by The Globetrotting Investor

Union Pacific Corporation Reportable Segment Revenue FY2022

Union Pacific Economic Moat

Union Pacific Corporation Economic Moat

Economic Moat: Narrow

There are many ways to identify Union Pacific Corporation’s economic moat, but I focus on the above 5 types. The rating is purely subjective and based on my in-depth understanding and analysis of Union Pacific Corporation. Please check my summary to understand more about the economic moat.

Performance Checklist

Union Pacific Performance Checklist

Is Union Pacific Corporation’s revenue growing YoY for the past 5 years consistently? Inconsistent.

Is the net income growing YoY for the past 5 years consistently? Inconsistent.

Is the cash flow from operating activities growing YoY for the past 5 years consistently? Inconsistent.

Is the free cash flow positive for the past 5 years? Yes.

Is the gross margin % consistent/ growing for the past 5 years? Yes.

Is the EPS growing for the past 5 years? Inconsistent.

Union Pacific Corporation Fundamental Analysis | Union Pacific Corporation Revenue, Net Income, Operating Cash Flow, and FCF | Fundamental Analysis by The Globetrotting Investor

Union Pacific Corporation Revenue, Net Income, Operating Cash Flow, and FCF (USD Million)

Is the free cash flow per share growing for the past 5 years? Yes.

Union Pacific Corporation FCF per Share

Union Pacific Management Effectiveness

Management Effectiveness

Is Union Pacific Corporation’s ROE consistently at 12%-15% YoY for the past 5 years? Yes.

Union Pacific Corporation Return on Equity

Is the ROIC consistently at 12%-15% YoY for the past 5 years? Yes.

Union Pacific Corporation Return on Invested Capital vs Weighted Average Cost of Capital

The trendline for the number of shares outstanding is declining, which is something that an investor would be pleased to see.

Union Pacific Corporation Fundamental Analysis | Union Pacific Corporation Shares Outstanding | Fundamental Analysis by The Globetrotting Investor

Union Pacific Corporation Shares Outstanding (Million Shares)

Union Pacific Corporation Financial Health

Union Pacific Financial Health

Union Pacific Corporation Financial Health (USD Million)

Current Ratio: 0.8 (fail my requirement of >1.0)

Debt-to-EBITA: 2.8 (barely pass my requirement of <3.0)

Interest Coverage: 8.1 (pass my requirement of >3.0)

Debt Servicing Ratio: 12.9 (pass my requirement of <30.0%)

Dividend

Union Pacific Dividend

Current Dividend yield: 2.56%

Have the dividend payments been stable for the past 5 years? Yes.

Have the dividend payments been growing for the past 5 years? Yes.

Union Pacific Corporation’s dividend payments are reasonably covered by its earnings and its cash flows.

Union Pacific Corporation Valuation

Union Pacific Valuation

Estimated intrinsic value: $138.14

Value is calculated using discounted cash flow method (taking into account their cash and debt) and scenario planning.

Average free cash flow used: USD$5,800M

Projected growth rate: 8% - 10%

Beta: 1.13

Discount rate: 8.0%

Date of calculation: 25 Jan 2023

Union Pacific Corporation EV-to-EBITA vs its peers

Union Pacific Corporation Price-Earnings Ratio vs its peers

Union Pacific Corporation Historical Price-Earnings Ratio

Additional Resources

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My Top Concern

Union Pacific must manage fluctuating demand for its services and network capacity before it starts to pose a risk to the company.

The company's business may be negatively impacted by changes in demand for its services, such as a reduction in demand for certain commodities or changes in consumer preferences. This can lead to increased costs, including higher operating costs and costs for storing equipment, workforce adjustments and other related activities. Additionally, if demand exceeds the capacity of the Union Pacific network, they may experience network difficulties such as congestion and reduced velocity, which could compromise the level of service provided to customers.

The company is taking measures to improve its transportation plan and add capacity, but cannot guarantee that these measures will fully address any service shortcomings resulting from demand exceeding their planned capacity. These operational difficulties could have a negative impact on the company's financial performance.

The next concern that I have is that a sizeable portion of Union Pacific’s revenue involves the transportation of commodities to and from international markets, including Mexico, Canada, and Southeast Asia. Interruptions of trade with these countries, such as deterioration of security for international trade and businesses, new laws or regulations, and adverse economic developments, could negatively affect customers and entities that rely on rail transportation services in the U.S. and have a material adverse effect on the company's financial performance. These interruptions of trade could also affect the company's results of operations, financial condition, and liquidity.

Summary for Union Pacific Corporation

Summary for Union Pacific

Union Pacific, a North America Class 1 railroad, has its source of moat stems from its cost advantage and efficient scale.

Class 1 railroad is defined as a railroad which has revenue reported exceeding the threshold established under regulations of the Surface Transportation Board. With annual adjustments for inflation, I am not certain about the threshold amount. Class 1 railroads are the largest rail carriers in North America. In 1980, there were forty Class 1 railroads, but as the industry consolidated, there are just seven Class 1 freight railroads remaining in 2021 and Union Pacific is one of them.

Cost advantage is the main contributing factor for Union Pacific moat in the freight transportation industry. Railroads are the most cost-effective option for transporting goods where no waterway connects the origin and destination, particularly for low value-per-unit weight freight. Railroads are also more fuel efficient than trucking, and they make more economical use of resources and labour as they can carry more freight at once. This means that the company can scale faster and better as compared to other freight companies if the need arises.

Another significant cost-advantage factor is route density. The existing Class I railroads, such as Union Pacific, have a major advantage in the unit and marginal costs due to their dense network and high volume of customers across various end markets and locations. It is rationally unlikely that any new rail lines will be constructed, boosting the incumbent Class I railroads competitive advantage.

This also leads to another Union Pacific economic moat, which is efficient scale. The high upfront infrastructure costs and the potential for overcapacity in the face of limited demand make it uneconomical for new competitors to enter the market. The existing network of track and assets of U.S. Class I railroads is nearly impossible to replicate and it does not make any sense to do it. In addition, the cost and difficulty of obtaining rights to build a new mainline also act as a deterrent for new entrants.

The industry consolidation, which was facilitated by the 1980 Staggers Act, also help strengthen Union Pacific’s efficient scale. Its network captures roughly half of the rail volume in the region presenting a huge barrier to entry for potential competitors. The consolidation has also allowed the remaining railroads to reinvest and become highly profitable.

However, Union Pacific still lacks in other areas of moat such as creating high switching costs for its existing customers. With only cost advantage and efficient scale, I will rate Union Pacific’s economic moat as narrow.

Union Pacific’s performance is stable but not satisfactory. Even though revenue, net income and operating cash flow are not consistent, the company’s gross margin has climbed steadily over the past 5 years to a level that is above the industry average. Union Pacific margins have shown strong resilience during past economic downturns in the freight industry and despite significant losses in coal volume in recent years, indicating a strong competitive position.

Both Union Pacific ROE and ROIC have met my minimum requirement of 12% consistently over the past 5 years. Its ROE is almost twice its industry average and its ROIC is almost 1.5 times its WACC. These ratios suggest that Union Pacific has strong management effectiveness in allocating capital.

However, its financial health is not that good. Although Union Pacific met three out of four of my debt requirements, overall, its debt structure needs to be monitored. Its net debt-to-equity ratio has increased over the past 5 years to a level that is considered high. It has very poor liquidity as compared to its industry and its short-term assets show that Union Pacific cannot cover either its short-term or long-term liabilities.

With high uncertainty and a narrow economic moat, I will assign a 40% margin of safety. Henceforth, with an estimated intrinsic value of $138.14, I will only invest in Union Pacific if it is trading in the range of $83.

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Union Pacific Corporation Fundamental Analysis