Union Pacific (UNP) is one of the largest railroad companies in the United States with a market capitalization of approximately $60 billion. The company operates most of its rail lines west of the Mississippi River and its biggest competitor in this region is privately owned Burlington Northern Santa Fe, which was bought by Warren Buffett’s Berkshire Hathaway in 2009. In 2011, Union Pacific generated $20 billion in revenues with EBITDA margins of approximately 40%. But as this is a capital intensive business, total capital expenditures were around $3 billion.
UNP has pricing power
Union Pacific is the only company in our coverage universe whose revenues grew year-over-year during the third quarter of 2012, while Norfolk Southern (NSC) (a major railroad east of the Mississippi) saw its earnings fall by a massive 27% y-o-y. This top-line growth was primarily due to pricing gains which offset volume declines, a sign that Union Pacific maintains pricing power in its regions of operation and can pass off an increase in cost along to the consumers.
Unlike for the other railroads in our coverage universe, intermodal revenues are the biggest contributor to UNP’s value. The company generated around $45 per thousand revenue ton-miles with around 80 billion revenue ton-miles in 2011, which led to about $4 billion in revenues. We expect intermodal revenues to increase by 25% to around $5 billion by 2015 primarily due to an increase in intermodal revenue ton-miles over this time period.
A demographic trend that will benefit Union Pacific’s intermodal revenues is that the US population in both California and Texas (both states where UNP has a strong presence) has increased over the last decade.  This means that a manufacturer will have to ship to these regions to reach the end consumers, which will be beneficial to intermodal providers like Union Pacific. Additionally, the fact that the baby-boomer population in the United States has started to retire could mean that they will move to retirement hotspots like Southern California or Arizona, which again will give Union Pacific’s rail routes and intermodal network a bigger customer base to cater to.
Coal Freight To Remain an Issue
The energy freight business of Union Pacific is its third largest segment, contributing about 18% of its total value. Overall, revenues for this segment were down in 2012 because coal revenue carloads declined 12% during the year. We don’t expect this trend to reverse in 2013 as low natural gas prices in the United States are likely to persist and will probably have an adverse effect on coal prices.
Therefore, the only way that Union Pacific will be able to mitigate revenue decline in this segment is by increasing its revenue per carload of coal freight. The company was able to do this in 2012 as the decline in coal carloads (12%) was offset by an increase in prices, as total coal revenues only fell around 3%. Overall, this is a testament to Union Pacific’s pricing power and we expect that it will be able to increase revenue per carload of coal freight going forward.
We currently have a $129 price estimate for Union Pacific, which is approximately the same as the current market price.
Disclosure: No positions