Union Pacific: A First-Class Ride

| About: Union Pacific (UNP)

In 1862, Abe Lincoln approved the Pacific Railroad Act sent to him by congress, and the Union Pacific Railway (NYSE:UNP) was born. The railroad has chugged through some stormy weather, going bankrupt in the 1870s and again in 1893. The turn of the century found Union Pacific not only recovered but strong enough to begin making acquisitions. A reading of Union Pacific's history proved fascinating; an investment in its future should prove profitable.

Union Pacific is part of an oligopoly. Eighty percent of the railroad industry's revenue is generated by four lines; Union Pacific and Burlington Northern Santa Fe in the west, and CSX Corp. (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC) in the east. Union Pacific is the largest of the four. In 2010, Burlington Northern was bought up by some guy out of Omaha by the name of Warren Buffett. These four lines compete for customers on a daily basis, and at the same time share assets and complete customer shipments for one another.

I'm sure we can all agree on the fact that railroading is a mature industry. There aren't going to be a lot of surprises coming down the tracks. In a mature sector, whether it's selling doughnuts, manufacturing ballpoints or running a railroad, one of the few ways to distinguish yourself is to outsell, out-manufacture or outrun your competition. Offering your customer a better product at a lower price while still making a profit is easier said than done. Let's see how Union Pacific does against CSX and Norfolk Southern.

Profit Margin for Trailing Twelve Months (TTM)

  • UNP 18.84%
  • CSX 15.81%
  • NSC 15.84%

Operating Margin/TTM

  • UNP 32.23%
  • CSX 29.41%
  • NSC 28.30%

Return on Investment/TTM

  • UNP 9.55%
  • CSX 7.13
  • NSC 6.77%

Return on Assets/TTM

  • UNP 8.48%
  • CSX 6.23%
  • NSC 5.89%

Net Income per Employee for the year ending 12/31/2012

  • UNP $85,000
  • CSX $58,000
  • NSC $56,500

Union Pacific's dominance in profitability over its peers can be explained in large part by its ever shrinking operating ratio, which currently stands at 67.8%. CSX carries a ratio of 70.6%, while Norfolk Southern comes in at a hefty 73%. Union simply has more money to use as it sees fit. If the company needs a new locomotive, it has the cash to buy one. If it wants to pay off a little debt, it has the cash to do so. And my particular favorite, if Union Pacific wants to increase its dividend, well it has the means to do that too.

Speaking of dividends, UNP stock yields 2% and the payout ratio is 30%. The dividend has been on the rise since 2007 and has been really accelerating since 2011.

The big question facing UNP and by extension its shareholders is that black stuff called coal. Union hauls a lot of it and at present, coal isn't very popular either with environmentalists or the powers that be in D.C. In fact, Union's coal revenues were down 7% in 2012. Be that as it may, Union Pacific seems to have answered the question. Through diversification and efficiency, Union had a record fourth quarter and year. Of Union's six revenue sources, four posted upbeat numbers. They include chemicals, automobiles, inter-modal and industrial products. Agricultural products joined coal on the downside. One last thing about coal. It will always be with us. Whether we use it here or sell it to the rest of the world, coal will remain a viable source of energy. It will continue to be mined and transported.

As you are well aware, the railroad industry is extremely cyclical. There are some who will say that Union's earnings may have topped out and it would be wise to wait before buying in. They could be right. I won't argue that premise because I've never been any good at timing cycles, trends, stock market swings or anything else for that matter. My golf swing is proof of that. It seems, however, that the mood of the country would suggest we have a lot of upside in this economy. It feels like the second inning to me; but that's just me.

There might be one huge source of revenue that many investors are overlooking when it comes to Union Pacific. The shale oil boom. And that's what it is my friend, a veritable boom. I can personally attest to it. I live in a small town in Wisconsin. There is an area some 10 miles west of my house, in which the hills are composed of the special sand used in hydraulic fracturing or fracking, a vital step in obtaining shale oil. Farmers are selling their land and becoming millionaires overnight. Old railroad lines are being refurbished and reopened. I see it happening every day.

What better thought for a UNP shareholder than that of a Union Pacific train bringing fracking sand into the drillers, and then hauling out the oil the drillers extricate. And by the way, calling shale drilling a boom might be a mistake. The very term suggests brevity. This shale phenomenon has legs. There are some experts who suggest that with the addition of shale oil, this country could become energy independent in a decade or less. There are other experts who claim that shale drilling won't last a decade. I wonder if the latter folks are the same ones that predicted the world would run out of oil --10 years ago. My money is on the former group. It's also on Union Pacific Railroad.


Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in UNP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.