Union Pacific (UNP) reported solid second-quarter results July 24 and raised its quarterly dividend 10% today. The headline to the railroad’s second-quarter results said it best: All-Time Quarterly Records. The firm’s operating revenue advanced 10%, operating income increased 17%, and diluted earnings per share leapt 21%, to $1.43, all over the same period a year ago. Union Pacific’s operating ratio—the inverse of the operating margin in railroad speak—advanced 2.2 points, to 63.5%, as efficiency improvements and price increases drive the higher levels of profitability. Ongoing improvement to the firm’s operating ratio is core to our fundamental thesis on the company.
Railroads simply have fantastic business models, and we think the group is on the cusp of a multi-year cycle of material pricing gains. Real (inflation-adjusted) pricing power is evidence that a firm has key competitive advantages supporting its business. Volumes, as measured by total revenue carloads, will be tied to the cyclical economy, though Union Pacific is presently benefiting from continued strength in the metric. Total revenue carloads increased 8% compared to the same period in 2013 thanks to increases in agricultural products, intermodal, industrial products, automotive and coal.
The company’s operating ratio of 63.5% was an all-time quarterly record, more than a full percentage point better than the previous all-time quarterly record set in the third quarter 2013. Management remains optimistic about the second half of the year, and while the potential impact of weather on grain and coal may become a speed bump, continued operating efficiency and pricing gains should drive profits and its operating ratio ever lower.
Image Source: Union Pacific
Valuentum’s Take
Each railroad has its own unique strengths and weaknesses, but Union Pacific seems to have the most things going for it. We expect the firm’s operating ratio to be among the best in the group by the end of this decade, and we like its exposure to growth in Mexico as well as future export expansion on the West Coast. The firm is levered to coal, though we note its mix is more of the Powder River Basin variety, which should continue to take share from CAPP coal in the domestic market. The firm also boasts a strong Valuentum Dividend Cushion score and a decent annual yield.