Union Pacific Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Union Pacific Railroad Company is a freight railroad operating in the U.S. It hauls a variety of products, including bulk, industrial, and premium products, and provides services through its vast network, connecting the Midwest and Pacific Coast ports with Canada and Mexico.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Union Pacific Corporation (UNP), a major player in the North American rail industry, operates one of the largest railroad networks in the United States, spanning 32,534 route miles across 23 states. The company’s operations are primarily focused on freight transportation, connecting major West Coast and Gulf Coast ports with key markets in the Midwest, and South and East regions. UNP’s business is structured into three distinct segments: Bulk, Industrial, and Premium. Here’s a detailed breakdown:

  • Bulk: This segment primarily transports grain, fertilizers, food, and coal, and coke. They also carry renewable products like wood pellets and ethanol. Freight revenue from bulk is affected by crop production, global grain trade, and fuel prices. This segment generated 31% of the total freight revenue in 2023 and is usually the most volatile due to exposure to commodity prices and agricultural cycles.

  • Industrial: This division focuses on the transportation of industrial products such as chemicals, plastics, and construction materials, including minerals and metals. The demand in this segment is largely dependent on the US Industrial economy and infrastructure developments. This segment generated 37% of freight revenues in 2023.

  • Premium: This segment specializes in intermodal and finished automobile shipments. Shipments include parts to automobile and other transportation manufacturers. Changes in consumers and producers demand influence growth in this segment. It generated 32% of freight revenues in 2023.

The company’s strategy revolves around its “Safety + Service + Operational Excellence = Growth” framework. This framework underscores the integration of safety protocols with operational efficiency and strong customer service to enhance their bottom line. UNP’s management emphasizes a long-term vision focused on sustainable value creation, with the goal of increasing revenues, enhancing profitability, and providing reliable returns on their investments.

The North American freight rail industry has seen:

  • Shifting Demand: A growing emphasis on supply chain diversification, which creates growth opportunities, but also complexity in logistical planning.
  • Technological Transformation: An increasing adoption of technology to enhance efficiency and capacity, including data analytics, IoT, and automation.
  • Increased Intermodal Competition: Higher reliance on intermodal transport, which is changing market dynamics, especially in container and freight markets.
  • Increasing Focus on Sustainability: There is an increased focus by regulators on clean energy which increases cost and capital investment into new technologies.
  • Workforce Evolution: There is a major labor shortage in the railroad sector with a continued focus on improving working conditions and quality of life for employees as well.

Competitive Landscape

UNP competes with other major North American railroads, most notably BNSF Railway, and with trucking and other transportation options. Here is a breakdown:

  • Intermodal competition: From both large and small freight trucking companies and shipping services that are able to take advantage of the rail lines.
  • Intra-Rail Competition: From other major rail companies in North America.
  • Government Regulation: From the Surface Transportation Board (STB) and other agencies in pricing, routes, and safety.
  • Customer Concentration: The ability to offer volume pricing to major customers.

What Makes UNP Different?

While Union Pacific may be perceived to be a commodity business, some aspects of it’s business provide it a competitive edge:

  • Network Breadth: UNP operates an extensive network, connecting all the major regions of the United States and access to Mexico and Canada.
  • Location: The location of its rail lines in the most populated parts of the country allows it to leverage the demand for shipping to higher margin routes.
  • History of Innovation: UNP has been quick to adopt new technologies and invest in capacity to remain competitive in the sector.

Financial Deep Dive

UNP has had a strong recovery in the last few years but is still affected by a number of factors, mostly due to volatility in its core business segments. Here’s a breakdown:

  • Revenues:
    • 2023: $24.8 billion in freight revenues, up 0.8% year over year. This increase was primarily due to increased average revenue per car, while volume decreased. Total operating revenues for 2023 were $25.0 billion.
    • 2022: Total operating revenues were $24.9 billion, a 12% increase driven by higher shipping rates and fuel surcharges.
    • 2021: Total operating revenues were $21.8 billion, and experienced a 12% growth compared to 2020.
  • Operating Expenses:
  • 2023: Operating expenses increased to $15.3B. The net operating income increased by 4.3%. The company is attempting to reduce costs by cutting down staffing levels.
  • 2022: Operating expenses were $14.4 billion, a 13.9% increase from the previous year due to rising inflation and labor costs.
  • 2021: Operating expenses were $12.1 billion, or 11% lower than previous year driven by COVID-19 impact and decreased crew headcount.
  • Profitability:
    • 2023: Net income was $5.9B down from 2022 due to increased operating expenses. Adjusted operating ratio was 63%, which is the lowest among peer competitors.
    • 2022: Net income reached $6.9B, while diluted earnings per share reached $11.21.
    • 2021: Net income was $6.0B, a significant increase due to reduced costs.
  • Capital Expenditures: UNP had around $3.4B of capital expenditures in 2023. This spending was for safety improvements, locomotive upgrades, and network expansion.
  • Debt: UNP has a debt level of $23.5B. Most of the debt is long-term and investment grade, with some short-term commercial paper issuances. The debt-to-equity is approximately 1.5.

Recent Developments

UNP has faced some challenges in the short term:

  • Decline in Freight Volumes: Over the last few quarters UNP has experienced decreased freight volumes, which negatively impacted its income. This is attributed to demand weakness in the domestic and international freight markets.
  • Labor issues: UNP faces constant negotiations with labor unions which have raised labor costs in the past.
  • Operational Efficiency Problems: UNP had difficulty keeping on schedule which affected operational income and ability to service customers.

Despite these headwinds, the company is implementing strategies to improve efficiency and focus on premium segments to improve profitability. UNP plans to capitalize on growing intermodal demand, with continued focus on building long term partnerships, while improving cost structures to mitigate losses from low freight demand.

Moat: 3/5

Union Pacific’s moat is narrow but defensible: * Scale Advantages: UNP benefits from its large network and high route density, enabling it to efficiently transport goods. This large network would be very difficult for a new competitor to build from scratch * Location: The most advantageous routes are often geographically fixed (e.g. passes over mountains, through major metros, etc). This prevents new players from constructing the network that connects UNP’s customers together. * High Switching Costs: For key customers in the rail industry, the network effects prevent them from switching. Switching a contract with one rail company often is costly or impossible due to infrastructure and network connections.

However, their moat is not “wide” because:

  • Commodity Business: Much of the freight being transported are commodities and pricing is largely fixed, so the company can not increase prices substantially.
  • Competition: Other railway and transportation companies make it difficult for UNP to increase pricing and profits.
  • Government Regulation: The company faces heavy government regulation, both on pricing and capital deployment.

Understandability: 2/5

UNP’s business operations are relatively straightforward, however, understanding the complicated financial accounting that they operate under requires more study. The complex interactions between unions and government regulations also make the business a bit harder to grasp. Furthermore, the high volatility in some of the company’s core segments can also make long-term predictions more difficult.

Balance Sheet Health: 3/5

The company has decent stability but has relatively high leverage. Its large amount of debt is an area of concern. The financial statements are not terribly complicated though which allows for a reasonable assessment of overall company health. The company has a reasonable history of debt servicing as well and has consistently been profitable. The company has had issues controlling operating expenses and has had problems in operations efficiency which may make it difficult to fully leverage its current structure, impacting the debt-to-equity ratio.