Union Pacific (UNP): Volume Slides, Operating Efficiencies … Strong

Posted on Jan 29 2016 - 12:42pm by Dan

When I listen to the conference call of a company, I take some notes. And therefore … I thought that to help out new folks as they navigate conference calls, I would start posting my notes, as I’ve taken them. We have made this a continual feature here at Sharpe Trade with the stocks that we have mentioned in the free Sharpe Income project.

Union Pacific (UNP) recently reported earnings on January 21st, 2016.  The stocks price has dropped by approximately 6.5 % since they released earnings.  As I have mentioned previously here on Sharpe Trade, this is a stock that I use in the equities section of my own personal income accounts …

Union Pacific (UNP)
1 Hour Chart

Union Pacific UNP

So what’s ‘the low-down’ for this quarter?

You can find my notes on last quarter’s earnings here, and as follows are a few notes from my desk as I listened to this quarters Conference Call and looked over the headline numbers …

Union Pacific (UNP) – From January 21, 2016

  • $1.42(6) Est. / $1.31 in Actual EPS
  • Total Revenue of 5.2 Billion, down from 5.5 Billion last quarter, and down from 6.15 Billion One Year Ago.
  • Net Income of $1.1 billion for the fourth quarter of 2015.   Last quarter there was a 6.5% decrease in volumes, and this quarter there is a 9% decrease in volumes, despite solid pricing gains.
  • Profit Margins dipped just ever so slightly, but still near 23%, and Operating Margins are impressive for a Railroad, near over 30%.  Significantly lower fuel expense along with volume related reductions and productivity improvements drove the expense reduction. The net result was a 19% decrease in operating income to $1.9 billion.  Compared to the fourth quarter of last year our fuel consumption rate increased 1% driven by negative mix while our average diesel price declined 39% to $1.61 per gallon.
  • Balance Sheet remains an impressive fortress, with only 25% debt, and Free Cash Flow totaled $524 million for the year.
  • Carload volumes decreased in 5 of 6 commodity groups with Coal down 22% and Industrial Products down 16%.
  • Last quarter, Automotive in the commodity group was up 5%.  This quarter, Automotive was up 8% vs. 2014.
  • Expenses and Operating Margins … they continued to adjust resources with what they feel are gains in productivity initiatives.  Quarterly operating ratio of 63.2%.   In the previous quarter, is was 60.3%.  So last quarter they stated there was still room for improvement, and these statements seem to be correct for this quarter.
  • Core pricing gains of 3.5%, while average revenue per car declined 8% in the quarter.  Decline in volume, as well as the lower average revenue per car drove 16% reduction in freight revenue.
  • Ag Products revenue down 12% on 5% reduction and 7% decrease in average revenue per car; with Grain down 12% in the forth quarter.  What led this, seems to be high worldwide production, coupled with the strong U.S. Dollar, leading to weak exports with grain exports down by 23%, while domestic grain shipments saw a gain.
  • Automotive revenue was up 1% for the quarter; with an 8% increase in volume, offset by a 6% reduction in average revenue per car.  Last quarter, Finished Vehicle shipments were up 5%.  This quarter, Finished Vehicle shipments were up 8% with strong consumer demand.  2015 annual sales of U.S. were 17.5 million vehicles, levels last reached 15 years ago.  Seasonally adjusted annual rate for the fourth quarter was 17.8 million vehicles.
  • Chemicals revenue was down 7% for the quarter with 2% reduction in volume and 5% decrease in average revenue per car.  Lower crude prices and price spreads impact on crude oil shipments which were down 42% for the fourth quarter.  Liquid Petroleum Gas (LPG) markets showed strength in demand.  Petroleum products volume was down 6%, primarily due to slowing in China.
  •  Coal continues to show weakness; down 31% in the fourth quarter on a 22% volume decline and an 11% decrease in the average revenue per car.  Southern Power River Basin tonnage was down 25% in the quarter due to mild weather and low natural gas prices.
  • Industrial products revenue down 23% and 16% decline in volume and 8% decrease in average revenue per car for the quarter.  Reduced rig counts, reduced shale drilling resulted in 42% decline in minerals volume; driven by 52% decrease in frac sand car loadings.  Metal shipments down 27% from softening industrial production, reduced drilling activity and strong Dollar.
  • Intermodal revenue down 12% in the quarter primarily drive by market volume headwinds of several ocean carrier customers.  Trans Pacific strait remained sluggish driven by weaker U.S. retail sales.
  • In 2016, they notice several headwinds of U.S. Dollar, low energy prices, sluggish retail sales, but are optimistic for other markets.
  • Last quarter, Employee safety record had improved 12% to record low of 0.92 reportable incidents per 200,000 employee hours.  Now, safety performance of our full year reportable personal injury rate improved 11% versus 2014 to a record low of 0.87. Rail equipment incidents / derailments, reportable rate increased 14% to 3.42, driven by an increase in yard and industrial reportables.  Will continue to focus on human factors and hardening infrastructure.  Public safety accidents improved 3% versus 2014 to 2.28 Crossing Accidents per Million Train Miles.  Velocity improved 13% and terminal dwell improved 5%.  Fourth quarter velocity of 27 Miles Per Hour was best for volume handled.
  • Operating, at the end of the year they had approximately 3,900 employees either furloughed or in AWS (Alternative Work Status), compared with 2,700 at the end of the third quarter.  Active locomotive fleet down 13% from the fourth quarter of 2014.  Train length ran at a record as well as a efficiency gain within terminals with an 8% decline in the number of cars switched.  Coal is about only program where train length is optimized although still opportunities; every other commodity group has plenty of train length productivity opportunity.  Will be very cautious about hiring in 2016.  Invested $4.3 Billion in 2015 for process and productivity improvements on the network, and are targeting $3.75 Billion in 2016, to harden infrastructure, replace older assets and to improve safety of network, with plans for 230 locomotives, and an additional 70 in 2017.
  • After dividends, Free cash flow totaled $524 million for the year; and there were some doubling of dividend in the first quarter of 2015, which affected this.  On the Balance Sheet, increased debt by 24% resulting in an all in adjusted debt balance of about $17.4 billion at year end 2015.  Debt to Assets around 25%.
  • Questions and Answers: Question:  Volumes seem pretty bad right now.  Maybe not quite as bad as 2009, yet still getting jobs growth in the U.S.  How does UNP look at the environment right now? That U.S. headed into a broader recession or is this just limited to energy and industrial and other specifics in UNP that look worse than the broader economy?  Answer:   Impact to railroad has been obvious, and although U.S. consumer at the moment seems to be buying, they have concerns about the U.S. Labor participation rate, and the fourth quarter retails sales for goods was not that great.  Answer gave no prediction to recession, however the statement is that they have yet to see any offsets to the headwinds that they are facing in their business.  Their focus is to get price in the marketplace, drive efficiency to their network.  They clearly stated that the volume drop off as the 2015 year progressed quarter to quarter and entering 2016 is dramatic and it is dramatic in historical reference but it is nothing, it is not approaching what we experienced in 2008 to 2009. Although again, a 6% decrease year-over-year and a quarterly 6%, 7%, 8%, 9% decrease year-over-year is pretty dramatic volume change.  Question:  Remaining on outlook for 2016 … how much more can UNP control the expense side, with all of these headwinds, as head into the new year?  Answer: UNP is confident they can control what they can control which again is the productivity, quality of service, continue to drive positive price but there is so much uncertainty at this point in time in terms of what the absolute volumes will be and what the mix of those volumes will play out. So, thus, why UNP is not in a position right now to give earnings guidance.  UNP feels they are in a much better posture entering 2016 from a realizing productivity in a headcount perspective, getting the resources right for the volumes than they were when they were entering 2015.  Question:  Another modeling question on expectations for tipping point of UNP to stay positive.  Answer:  Can’t give a guidance, though understand the point of the question, UNP can assure shareholders that there is obviously a tipping point at some point, if that were to go so negative it would flip the other — flip negative. But focus is to squeeze out productivity and continue to drive price where UNP can and with that focus, can’t give a direct answer as to where that tipping point is.  Inflation expectations for 2016 is 2%.  Union Pacific (UNP) not giving up for volume, and their focus remains, not for attracting volumes, but value pricing focus.  As well, UNP does not expect to see $5.75 record earnings, but that is simply because they can’t see any change to the headwinds, but they will not give guidance and they understand anything could change in the future.  On Mergers:  Union Pacific (UNP) does not support mergers or consolidation in the current environment. UNP believes that the regulatory outcomes, the regulatory impact would be substantial. The Service Transportation Board has been clear. That in the next merger that they consider it has to enhance competition not just maintain it. It has to improve operations for customers and they also have to consider downstream impacts whether one merger triggers a string of consolidations.  Union Pacific (UNP) has shared they are focused on safety, focused on efficiency, focused on an excellent customer experience.  Union Pacific (UNP) does not think that a merger enhances those efforts. Matter of fact Union Pacific (UNP) believes it would have a negative impact on service and be a headwind disincentive to capital investment.  On Mexico:  They are very bullish, with vibrant economy and growing middle class, and UNP has access to the six rail gateways. 

In summation, the trend from earlier in the year continued into this quarters earnings.

That is, railroads such as Union Pacific (UNP) are shipping less.  Volumes continue lower. This quarter, the drop in North American Energy hit the rails particularly hard.  But on the flip-side, Union Pacific continues to improve their operating efficiencies to offset these headwinds; and thus grow into a leaner and meaner railroad and transportation company …

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