Union Pacific (UNP) is one of the leading railroad companies in the United States, with operations west of the Mississippi, a region which covers two-thirds of the country. With this network, the company connects U.S. with six major points of entry for goods into Mexico, which has earned $1.8 billion in revenues or 10% of total revenues, from freight to and from Mexico. This figure increased to 16% in 2011, and we think that Union Pacific's connections to Mexico will be an important driver of business growth for the company in the coming years. Trade between the two countries is expected to rise as Mexico is forecast to export more goods into U.S. than China by 2018.
Chinese Wage Hikes Benefit Mexico's Manufacturing
One primary reason for the rise in Mexico's manufacturing industry is because manufacturing in China is becoming more and more expensive. Average yearly wage increases were around 14% in the previous decade, and major economists believe that this trend will continue over the next five to 10 years. Additionally, the Chinese Yuan is thought to be an undervalued currency because China has been keeping exchange rates low by buying U.S. dollars. The country has U.S. dollar reserves of $3.2 trillion, this is three times higher than Japan, which has reserves of approximately $1.1 trillion. If these foreign currency reserves fall to Japan-like levels, the U.S. dollar will depreciate against the Chinese yuan, making Chinese imports more expensive for U.S.
To combat this trend, companies seeking to export to the U.S. will be forced to find alternative sources for manufacturing, to ensure that they can stay price competitive. Mexico is the best choice for such companies because its proximity to U.S., keeps shipping costs low, which is also a concern in an economic environment where oil prices have risen drastically. Another factor that makes Mexico a reasonable option is NAFTA, the free trade agreement that it has signed with U.S., which gives it preferential tariff treatment in comparison to China.
Union Pacific Has Strong Presence on Mexican Border
If Mexico's manufacturing base increases as expected, Union Pacific will be the railroad company which stands to benefit. It is the only major railroad company in the U.S. to serve all six major trade junctions with Mexico. The company has a major presence in Texas, with lines running through El Paso and Brownsville, and these Texas hubs connect Mexico to the east coast of the U.S., through major cities such as Chicago. As imports from Mexico increase, we expect Union Pacific’s rail network to see an increase in total freight traffic, primarily for industrial products.
Exports to Mexico Will Also Increase Traffic for Union Pacific
While Mexico's imports to the United States will drive an increase in traffic for Union Pacific, we think that bigger contributor to the company's top line growth could be exports from the U.S. Mexico's population has increased almost 10% in the previous five years, and the country has a relatively young population with a median age of 27 years. The relatively young population gives Mexico a strong consumer base, which can provide a solid ground for an increase in the country’s consumption. At present, Mexico's GDP per capita is at $14,800, and has been steadily increasing from the $13,900 level it hit in 2009.
Mexico is currently the second largest goods export market for the U.S. that exported $200 billion worth of goods in 2011, up 20% from 2010. We think that as Mexico's economy manufactures more goods, it will contribute to a rise in the disposable income of the average Mexican consumer, and is likely to increase Mexican consumption over the coming years. A big Mexican consumer base will require an increasing number of goods from the U.S., and due to Union Pacific's presence along the Mexican border, the company is likely to benefit from an increase in exports as well.
We currently have a $129 price estimate for Union Pacific, which is approximately the same as the current market price.
Disclosure: No positions.