EUR 850.00 For Business Accounts Only

Morningstar | Union Pacific Implements Network Wide Precision Scheduled Railroading in a Soft Demand Environment

Union Pacific continues to improve its profitability, most recently by implementing principles of precision scheduled railroading beginning in late 2018. While its operating ratio is much better than where other railroads began their PSR plans, we think this is the surest path to the best OR. Historically, success came a couple of decades after partial deregulation in 1980, as the railroad eliminated unprofitable routes and gained efficiency during industry consolidation. Rails rightsized assets, reduced crew size, and deployed technology. When 2009 carloads slid 16%, UP nimbly cut costs faster than sales declined, then steadily improved its operating ratio from 2010 to 2015. Even an 18% coal carload decline in 2015 couldn't keep UP from reaching record margins, though an additional 20% coal car decline the following year kept further improvement at bay. UP's $23 billion of 2018 revenue was heaviest in coal, intermodal, and industrial products. Even though we believe coal is in a secular decline, cheap Powder River Basin coal is still a giant franchise for the rail. We estimate energy, including coal, will produce $4.6 billion of revenue at UP this year. Premium intermodal and autos freight now constitutes 31% of UP's top line, and we consider intermodal to be the secular growth driver.For years, part of the UP story was the upside potential remaining in repricing old contracts, some of which failed to fully reflect market rates, but no material legacy contracts remain at this point. We think the market has been disappointed by modest core price increases during 2016-18, but we believe that over the long term, UP will price to outpace inflation in absolute dollars.We are impressed by progress made so far and project more record-setting margins in coming years. UP produced a prodigious $5 billion of free cash flow (cash from operations less capital expenditures) in 2018--about 23% of sales--and paid out $2 billion in dividends and $8 billion in share repurchases. The firm has quadrupled dividends per share from the start of 2010 through mid-2018, and at times it vies with Norfolk Southern for the highest dividend yield among the rails.