Morningstar | Union Pacific Reports Solid 61.7% Operating Ratio; New Operating Plan Comes With No New Guidance
Union Pacific increased third-quarter EPS by 43%, but what's more important to the stock price is management commentary on implementing precision scheduled railroading. Investors have been clamoring for PSR at all railroads not using it after the late Hunter Harrison developed and deployed it in four tremendous rail turnarounds. During the past few quarters, we’d say any executive team that does not swear some allegiance to PSR invites an activist to campaign for its ouster. We were not impressed by the lack of detail and change in UP's PSR capitulation call a month ago, but the Oct. 25 earnings call alleviated some concerns. We maintain our wide moat rating and will increase our fair value estimate modestly.Key takeaways include solid 10% revenue growth on 6% carload growth and 1.75% core price improvement, a good operating ratio despite a 34% fuel price increase, and continued share repurchases. The OR was a solid 61.7%, flat with the prior-year period, yet constrained from improvement in part due to network congestion and mix shifts (decline in frac sand and increase in low-rate intermodal).
UP is starting PSR with an OR 10-15 percentage points better than where Canadian Pacific or CSX began, so it requires less dramatic change. We found the following encouraging since August: over 150 new transportation plans; publishing car-based key performance indicators; reducing three operating divisions to two; 6% reduction in management employees and more to come; active locomotives down 8% and train and yard employees down 2%; closure of a locomotive facility and considering terminal rationalization; and shifting customer care from marketing to operations. We’re surprised that management has not updated OR guidance (60% by 2020 and 55% long run), and we think adopting PSR would be accelerated by filling high ranks with managers steeped in PSR for years elsewhere, but UP says it has operating and network planning employees with deep PSR experience.
Union Pacific, through its operating subsidiary, Union Pacific Railroad Company, is a Class I railroad operating in the United States. The company's network included route miles, linking Pacific Coast and Gulf Coast ports with the Midwest and eastern United States. 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 for the handling of freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada, and Mexico. The company's business mix includes agricultural products, energy, industrial, and premium.
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