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Union Pacific Battling Declining Volumes
We continue to be fans of Union Pacific (UNP) on a fundamental level, and we fully expect the company to be gearing up for material improvement further down the line as the end-markets it serves stabilize.
Union Pacific reported weak quarterly results April 21, as operating revenue fell 14% from the year-ago period. The sharp drop was driven by an 8% decline in volume, as measured by total revenue carloads. Coal volume dropped 34%, industrial products volume decreased 10%, and agricultural and intermodal volumes fell in the low to mid-single digit range. Flat chemicals volume and automotive volume growth of 7% were no match for offsetting the other declines, and average revenue per car fell 6% from last year’s first quarter.
The company’s operating ratio saw a slight unfavorable change of 0.3 points to 65.1%, and operating income fell 15% on a year-over-year basis despite a 36% drop in average fuel prices from the first quarter of 2015. Diluted earnings per share fell 11% in the quarter as well, but the firm’s free cash flow conversion remained strong. Free cash flow jumped more than 50% from the comparable quarter in 2015 and was more than 150% of net income.
As Union Pacific continues to work through a difficult operating environment, the firm remains focused on optimizing its network and improving its service. With the uncertainty surrounding its demand outlook, continued emphasis on productivity is likely the best measure for success. Long-term opportunity remains with the company, but near-term challenges will be prevalent.
2016 has been full of many of the same obstacles that were present last year. The recession in the energy market and low commodity prices, the weakness of the global economy combined with the strength of the US dollar, and the demand issues taking place in domestic retail have all contributed to the volume declines in Union Pacific’s business.
Republic Services: Nothing Trashy About These Returns
Republic Services (RSG) has long been our favorite garbage hauler for a variety of reasons. The firm boasts disposal assets that represent a long-term strategic benefit, as they will only become more valuable over time due to a growing regulatory environment and opposition groups.
A variety of factors led to the firm reporting solid top-line growth of 3.6% in the first quarter of 2016, including a 2% increase in average yield, a 2.5% increase in volume, and a slight boost from acquisitions. Fuel recovery fees and energy services served to offset the gains, though only slightly.
Republic Services’ bottom line did not fare as well in the quarter, however, as diluted earnings per share dropped to $0.45 from $0.49 in the year-ago period. This was largely due to restructuring costs related to the firm’s organizational realignment, which it believes will reduce costs and enable local teams to operate more flexibly and effectively. The company is also working to improve the efficiency of its fleet, through both fuel technologies and automation. Further optimization of operational efficiency is expected to come throughout the remainder of this year as the firm opens its state-of-the-art customer resource centers, the first of which was opened April 4.
All things considered, we continue to be high on the fundamentals of Republic Services, and the recent reorganization and efficiency initiatives should only strengthen its position as our favorite garbage hauler. The company will remain a core holding in the Best Ideas Newsletter portfolio, and we hope to continue enjoying similar performance that we have over the past few years. The position in the firm in the Best Ideas Newsletter portfolio has yielded a return of well over 50%, before considering the impact of dividends, which have been nothing but icing on the cake.
Michael Kors Watches to Become Fossilized?
The individual consumer is a difficult entity to analyze, and spending habits are certainly changing as millennials continue to play a growing role in the economy.
On May 10, Fossil (FOSL) reported poor performance in its first quarter of 2016. Sales fell 7% on a year-over-year basis, and management continued to lament the current retail environment, particularly in its watch category. A recent uptake in wearable technology has wreaked havoc on the traditional watch market, and Fossil is dragging other high-end apparel names down with it. Fossil’s watch sales fell 10% on an as-reported basis from the year-ago period in the first quarter of 2016.
Best Ideas Newsletter portfolio holding Michael Kors (KORS), who has yet to report its fiscal 2016 (year-end March 31) results, is one of the victims of the poor performance of Fossil. The two companies remain intertwined and generally trade in sympathy, to a degree. In late 2014, they renewed a global licensing agreement through 2024 in which the two will design, develop and distribute watches under the Michael Kors label. Though Fossil management remains confident the two companies will be able to combat the wearable technology trend with Kors brand smartwatches, we’re keeping a watchful eye on the developments of the situation.
Continued pressure across the retail sector has certainly raised some worries among market participants. On May 11, Macy’s (M) reported poor results in the first quarter of 2016, as continued weakness in consumer spending for apparel remains. We warned about some of the worrying trends in mall-based retailers, “Debt, Debt, and More Debt (April 2016),” but Macy’s performance during period sent shares tumbling violently. Sales momentum continues to deteriorate for the department store giant, as comparable sales fall 6% in the quarter. Macy’s cut its 2016 sales and earnings guidance and emphasized that its “sales trend relative to expectations meaningfully slowed beginning in mid-March,” suggesting the second-quarter could be even worse. Sears (SHLD) and J.C. Penney (JCP) are most vulnerable on this news, but nothing may spare traditional department stores from pain, “Mixed Bag at Department Stores (November 2015).”
Though we still hold the opinion that shares of Michael Kors remain undervalued, we wouldn’t be shocked to see them face pressure in light of the retail “mess.” Michael Kors and Dividend Growth Newsletter portfolio holding Coach (COH) tend to cater to a differentiated, aspirational market than the department-store crowd, but Fossil’s performance was something that we can’t take lightly. We like the diversification that Michael Kors and Coach provide to the newsletter portfolios, but we are growing increasingly concerned with the current operating environment for fashion brands and fashion retailers.