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Union Pacific Corporation (NYSE:UNP)

March 06, 2013 9:30 am ET

Executives

Robert M. Knight - Chief Financial Officer and Executive Vice President of Finance

Analysts

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. So we're going to get going with the next presentation here with Union Pacific. It's our pleasure to have the Chief Financial Officer and EVP of Finance, Rob Knight. And Rob, go ahead and take things away.

Robert M. Knight

Thanks, Tom, and good morning. I would like to remind everyone listening in today that I will be making some forward-looking statements, and these statements are subject to risks and uncertainties. So please refer to the UP website and SEC filings for additional information about our risk factors.

Let me start with Union Pacific's franchise, a network that is unparalleled in the industry today. Union Pacific's footprint includes 32,000 route miles that travel through 23 states in the Western United States, supporting 6 strong business groups. We view that business diversity as a definite strength of our company. We have extensive access to the West Coast, Gulf and river ports, as well as Mexico, exposing us to an increasing global marketplace, which currently drives over 35% of our business volumes.

We've successfully leveraged that franchise to generate significantly improved profitability over the past several years, outperforming our peers and achieving industry-leading improvements across the board in 2012. We've taken almost 20 points off our operating ratio since 2004 to a record low of 67.8% in 2012. We've grown earnings more than sixfold to $8.27 per share last year. And we've significantly improved our return on invested capital to 14%, which is also a U.S. industry best.

What's most notable is that we accomplished these results with overall volumes running 4% below 2004 levels, including a very weak coal market just last year. It's a testament to the strength and diversity of our franchise, solid core pricing gains and efficient network operations.

The results on Slide 5 validate the strength and agility of our network. In 2012, we reduced slow order miles by 30% to an all-time record low, which reflects the investments that we've made in replacement capital. Strengthening the infrastructure has driven improved network performance by reducing service failures, generating additional capacity and improving asset utilization.

In addition, intermodal train lengths grew to a best-ever record of 172 boxes per train. Manifest train lengths also finished strong, given that much of the manifest growth occurred in the South, which is currently a more constrained area of our network.

We've demonstrated agility in managing through the shifts in mix, including growth in manifest and premium volumes in the South and lower coal shipments in the North. Slide 6 illustrates those market shifts. Last year, overall volume was flat compared to 2011. However, if you exclude the 14% or 300,000 carload decline in coal alone, volume levels were up almost 4%.

Growth in other sectors of our diverse portfolio of business, including shale-related moves, automotive, intermodal, construction-related materials and base chemical shipments offset the weaker coal and grain markets. We saw significant growth in crude oil shipments, up over threefold compared to 2011. When combined with frac sand moves that support drilling activity, these shale-related moves grew more than 80%.

Looking at current volume trends. So far this quarter, volumes are down about 2% compared to last year, which includes the leap year impact from 2012.

Overall, the story much -- looks very much like it did in the second half of 2012, with several very strong markets overshadowed by a few significantly weaker ones. Our shale-related crude oil shipments remain very robust, up over 100% so far this year. Part of that is driven by easier year-over-year comps as our crude oil shipments ramped up throughout 2012.

We're also seeing solid intermodal volume levels this quarter. However, we expect that 8% growth rate to moderate due to timing of the Chinese New Year holiday.

On the flip side, we're seeing continued weakness in our coal volumes. Coal stockpiles and low natural gas prices continue to hamper recovery, and the loss of a legacy contract beginning this year is also having a negative impact on our coal traffic levels. Combined with extended mild winter weather, mine production issues and tighter inventory management at some utilities, we're now projecting coal volumes to be down in the high teens for the first quarter.

Longer term, coal is still viewed as an important source of power generation for the United States and other world markets. New domestic business opportunities associated with power plants being constructed in our served territory could result in a 10 million-ton growth opportunity for us over the next 5 years. With our extensive network, Union Pacific also remains well positioned to serve international markets. Expansion of our export business represents another 8 million-ton opportunity over the next 5 years and could be larger if more terminal capacity comes online in the Pacific Northwest and Mexico.

One final note. Powder River Basin coal remains one of the lowest cost coals in the country. Longer term, this potentially puts Union Pacific in a strong position to backfill coal to the Eastern utilities if demand for higher cost eastern coal continues to decline.

On a longer-term basis, our franchise diversity allows us to access a variety of markets where we expect to see future growth opportunities, most of them supported by a few fundamental drivers. For one, the steady increase in population is the underlying baseline for growth across all of our markets. The U.S. population is projected to grow by 10 million to 15 million people over the next 5 to 7 years, and world population is expected to jump 385 million over the same period. That growth translates into added demand for virtually everything that we move. Population growth also feeds upside potential, with recovery in markets such as housing and the automotive industry.

Union Pacific is also well positioned to benefit from future opportunities in other sectors, including international trade, the global energy market and intermodal highway conversions. So let's take a closer look at these drivers, starting with the current housing trends.

The housing market has recently been one of the brighter spots in the U.S. economy. In 2012, new construction grew more than 25%, although still at depressed levels. Experts are projecting a return to more normalized levels of around 1.6 million housing starts by 2015. Approximately 7% to 8% of our current book of business is tied to housing construction materials and furnishings. Raw materials, including lumber, stone and glass, are currently running 40% below normal run rates.

As housing grows, Union Pacific's network has the best access to the industry to some of the key lumber sources in the Pacific Northwest. When you add in other industrial products, chemicals and related intermodal shipments, a return to a more normal run rate of housing could add roughly 9,000 cars per week for Union Pacific. However, we don't anticipate that happening anytime soon, with housing starts projected around 970,000 for this year, but continued growth in the industry should be a positive for Union Pacific going forward.

From a global perspective, over 30% or $6 billion of our 2012 revenue was tied to international trade, with Mexico accounting for about 1/3 of that business. I'll talk a little bit more about Mexico in a minute.

A wide range of import products from Asia drives our international intermodal business, while imports and exports drive our finished vehicles and parts business. Worldwide demand for food and the shift to higher protein diets drive demand for grain and grain product exports, meat and fertilizers. Low natural gas prices, an important feedstock for plastic production, is shifting production to the United States and could create a growing export opportunity.

Finally, demand for U.S. raw materials, including coal, soda ash, minerals, scrap steel and other materials will continue to play a vital role in the global supply chain. In particular, increasing cross-border trade with Mexico is a franchise strength of Union Pacific. UP is the only railroad that serves all 6 major gateways to Mexico. When you match that with our franchise strengths north of the border, that advantage really comes to life. Trade with Mexico makes up a growing portion of our portfolio, with volume up 9% in 2011 and 5% last year, well outpacing our overall volume growth.

We have the flexibility to work with both Mexican carriers that interchange at the border. Although we're a part owner of the FXE, our Mexico business is fairly evenly split between FXE and the KCSM. U.S. companies have been shifting from offshoring to nearshoring due to increasing transportation expenses and higher labor costs in China.

Since 2007, well over $100 billion of foreign direct investments have been made in Mexico, another $26 billion of investment is forecasted for 2013. We view this trend as a positive for Union Pacific, considering that we currently handle roughly 2/3 of all north/southbound rail traffic. And if you focus just on Mexico automotive traffic, we currently handle roughly 90% of the rail market share in and out of Mexico. In fact, around half of our automotive business is cross-border traffic with Mexico.

In 2012, Mexico produced around 2.9 million vehicles per year, and that number is expected to increase by another 1 million vehicles by 2017. The ramp-up in foreign direct investment is significant from an automotive perspective, with recent announcements from auto manufacturers and tier parts suppliers totaling over $11 billion. New plants being added by international OEMs include Nissan, Mazda, Honda and Audi. New parts suppliers are also investing in Mexico, locating facilities close to the manufacturing plants.

A significant amount of vehicles produced in Mexico are destined for the United States or Canada. Regardless of which Mexican carrier serves directly an assembly plant or a tier supplier, customers can connect with Union Pacific's unrivaled automotive franchise north of the border to access a wide variety network of distribution facilities and interchange locations to reach Western, Eastern and Canadian markets.

Union Pacific's rail franchise is also well-situated to accommodate the growing demand for emerging energy sources here in the United States. Slide 14 illustrates the major North American shale plays and Union Pacific's current crude-by-rail footprint. The growth in oil production from these formations is providing an emerging market opportunity for the rail industry. Currently, the majority of our crude oil shipments are sourced from the Bakken formation for destinations to St. James, Louisiana; Galveston and Houston, Texas. However, as production grows in the Permian and Niobrara formations, we expect these regions to becoming a larger contributor to our book of business.

Crude-by-rail is currently a dynamic market, with customers evaluating new origins and destinations every day. End-market opportunities have expanded beyond the Gulf region to real and potential East and West Coast destinations that aren't served by pipelines today. Although the market continues to evolve, we anticipate future opportunities for crude-by-rail growth, driven by our proven ability to provide an efficient and flexible transportation solution for future demand.

Looking forward, a key element in the sustainability for crude-by-rail is the pipeline versus rail question. The oil industry's belief in the viability of rail is evidenced by the billion-plus investment in both rail loading and offloading facilities, as well as tank cars used to transport the crude oil. Current projected growth rates for crude production in the United States is expected to continue to exceed pipeline capacity in the near term even as pipeline capacity expands.

We also think there could be additional opportunities to displace a portion of crude oil that is currently being imported, driving further demand. In February, we moved more than 300,000 barrels of crude oil a day.

We feel good about our longer-term prospects when you consider our speed to market, our ability to access multiple markets, which allows shippers to take advantage of arbitrage opportunities.

Shale drilling is also producing an abundance of natural gas, which is providing a big boost to the U.S. chemical industry and, in turn, Union Pacific's overall chemical franchise. With high inventories of natural gas at historic low prices, American chemical companies are benefiting from a large feedstock cost advantage in the global marketplace.

In addition, there have been a number of recent announcements for new plant construction, with many located in the South along our premier chemical franchise. The added capacity is expected to come online beginning in late 2014 through 2017. It's still too early to tell how these new developments will impact our business precisely. However, we do view it as a very strong positive for the chemical industry, the U.S. economy and Union Pacific.

Another franchise opportunity with strong growth potential is our intermodal service offerings. We think there is a significant long-term opportunity for continued conversion of highway freight to rail. We've identified 7 million to 10 million annual truckloads susceptible to conversion in our served territory alone. It's supported by an integrated network and a strong value proposition that offers customers reliable, truck-competitive service at an affordable price.

In addition, the motor carrier industry faces continued challenges from regulations. Highway congestion and a deteriorating infrastructure also present service challenges for the industry. Rail moves reliably and consistently over a right-of-way privately-owned, maintained and controlled.

Finally, our environmental advantage and better fuel efficiency create a more economically viable option as fuel prices continue to rise. And we have the capacity to handle that growth.

Since 2000, we've invested more than $1.2 billion in our intermodal terminal network that literally spans our entire system. Our new facility in Santa Teresa, New Mexico, is the latest addition and is slated for completion in early 2014. Integrated along our Sunset Route, the new $400 million terminal will include an intermodal ramp and fueling facility. With an annual capacity of 250,000 lifts, the facility provides Southern New Mexico with an inland port that will serve as a strategic focal point for goods moving across the nation and will support continued intermodal growth opportunities.

As we capitalize on these market opportunities, it's critical that we continue to bring on the right business at the right price. Pricing success is tied to demand and the strength of our value proposition. Greater value earns a higher price in the marketplace. Our balanced mix of pricing documents also serves us well. If the economy picks up, about 2/3 of our business can be readjusted relatively quickly.

Where it makes strategic sense, we've locked in another 1/3 of our business at re-investable rates for the longer term. If you assume that about 1/3 of those longer-term contracts expire each year, we'll see additional repricing opportunities as we move forward. The ones that don't, we will protect with margins if inflation picks up or fuel prices spike even higher. Putting it all together, it supports our growth of achieving continued strong core pricing gains going forward.

In addition to pricing the business at re-investable levels, we need to move it efficiently. For 2012, we generated a best ever 67.8% operating ratio, the first sub-70% operating ratio performance in our history. Moving forward, we expect to see continued improvement over the next 5 years, reaching a sub-65% operating ratio by 2017. Although the road gets a little tougher, we're moving all the right levers: network efficiency, productivity gains and re-investable pricing, to get us there.

In terms of cash deployment, we've invested a significant amount of capital in our business over the past 5 years. And going forward, our projections include a capital plan that averages around 16% to 17% of revenue over the next 5 years. Assuming the economy cooperates, we would expect volume growth and continued core pricing gains to drive top line results. The math alone would imply that our capital spending grows from current levels.

We're spending a little over $2 billion on replacement capital this year and around $450 million on positive train control. We've also invested a sizable amount for service and growth. These investments are critical to support our core pricing initiatives by providing increased value to our customers. However, returns on the new capital investments must, at a minimum, be re-investable. Returns must continue to improve to support significantly higher asset replacement costs and investments that support our safety, service and growth initiatives.

Beyond funding our capital programs, our record profitability and strong cash generation have enabled us to grow shareholder returns. In the past 5 years, we've increased our declared dividend per share over threefold and bought back almost $6 billion of stock. Cash returns in 2012 alone totaled over $2.6 billion, driven by a 30% dividend payout ratio and opportunistic share repurchases. Shareholders have also been rewarded with a stock price that has more than doubled, well outpacing the S&P 500.

Looking ahead, we expect to generate even more cash to allocate over the next 5 years. Even with a larger capital budget, we expect shareholders will receive a bigger piece of the cash pie going forward. Longer term, we remain bullish on our future prospects. We remain committed to achieving strong core pricing gains that meet re-investable levels. We'll build on the strengths of our diverse franchise and future market opportunities, which should help grow profitability over the next several years. We'll remain focused on productivity and innovation to drive efficiency and margin improvements, and we'll continue to make investments for the future but only if the returns justify those investments.

We truly believe in the power and potential of the UP franchise to deliver great returns for our shareholders in the years to come.

And Tom, with that, I'd love to take any questions if there's time.

Question-and-Answer Session

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Yes, great. Rob, we have plenty of time for questions here. So maybe I'll start with 2, as I typically do, and then we'll have plenty of time for the audience, so think of your questions.

Let's see, you updated a little bit the first quarter guidance on coal, I think, down mid-teens to down high teens. You didn't -- I don't think you tweaked the full year view. Right? So you're expecting -- I guess, it implies that you're expecting year-over-year growth in coal at some point this year. Is that a fair way to look at it? And is that second quarter or more likely second half where you'd have room for a little bit of year-over-year growth in coal?

Robert M. Knight

Yes, just kind of a reminder of what we said, we did say that we expect the first quarter, primarily because of difficult comps. Because last year, our coal volumes didn't fall off till very late in the first quarter. We expect first quarter this year to be down high teens, as Tom suggested. But we stuck with the earlier guidance that we gave that said for the full year, we think that our coal volumes will be slightly down. And we also pointed out that there was a 10 million-ton shift of business out of our book when we renewed 80% of our legacy contracts. So Tom, to your point, that does imply that business relative year-over-year does pick up. And if you look at kind of the trough last year was in the second quarter, we certainly hope that, that becomes a point where we cross the lines.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. Let's see. And how would you view the, I guess, stockpile position? I don't know if you mentioned it in the slides, maybe I missed that. But how do you think stockpiles are relative to target?

Robert M. Knight

Yes. Right now, our best assessment is that our utility customers' stockpiles are about, call it, 15 days above normal. So they've come down a couple of days from the peak that they were coming into the year, but we'll see. Weather conditions are always the driver. In fact, every year we say, and it's very true in our business, that the weather, whether it's the winter conditions or an early hot summer, which doesn't feel like we're close to that today, but the earlier and the more Draconian [ph] the summer season is in our network, the quicker you'll see those stockpiles reduce. And that'll be the biggest driver.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay, great. Do we have any questions at this point from the audience? It looks like there's one in the middle of the room, then we'll come back to the front.

Unknown Analyst

You started off by talking how volume is actually lower in 2012 than it was in 2004. I was wondering if you could talk about drivers beyond just housing in the dumps and auto being a little lower? Specifically, I was wondering if you could talk about the impact of dropping bad-behaving traffic that doesn't support your network fluidity goals and how that might have impacted volume over the last almost decade?

Robert M. Knight

It's a great question because I'd say -- while I don't have a precise number to the question of that volume that reduced from the time period of 2004 to 2012, what were the drivers. And it's really kind of all of the above. Just about every one of our commodity groups, led by coal, last year, clearly, volume was off. But I think to your point, which is a very good question, we have had over that 2004 period going forward an attitude of, if business is not willing or capable of meeting re-investable returns on our network and if we can't move that business up to re-investable levels, then we aren't going to haul it just for the fun of it. It's maybe a candidate that doesn't fit our network. So there was some of that in that timeframe. I can't give you an exact number, but it is part of the mix. I think the bigger driver, frankly, was the other economic conditions that drove pretty much all of our commodities down a little bit. But we do have that view that we're not going to just bring volume on for volume sake. It's got to meet re-investable levels. It's got to be the right business that fits operating characteristics, allows us to run safely and efficiently, but average up our returns. And we've proven that with our 20-point reduction in our operating ratio over that timeframe.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Then we've got one in the front here and then over on the other side in the front.

Unknown Analyst

You mentioned the 90% share you have of rail hauling from the auto plants in Mexico into the U.S. and, obviously, significant expansions coming over the next few years. It seemed to me that the customers would have an interest in seeing more sort of a balanced competitive environment. And I guess, I'm curious on your thoughts on whether as you see this expansion, you think you can actually retain a 90% share or you think there's going to be some natural dilution just by virtue of an expansion of the market opportunity?

Robert M. Knight

I'm not giving guidance that it'll be 90%, but I would fully expect that it will maintain a very strong share position. And the reason for that is if you look at our unparalleled auto network in the United States, so if a car's produced in Mexico, let's say, as an example, regardless of where it's produced in Mexico, and it's destined for a dealer in Los Angeles, it's likely going to be handed to us somewhere in the United States, either from FXE or KCSM, so that we can take it to our premier auto distribution facility in Los Angeles, as an example. So it really is a result of the 42 strategically located auto distribution facilities that we have in the western half of the United States, and that gives us a very strong position and a very strong relationship, if you will, with the OEMs. And that's the reason for the high market share.

Unknown Analyst

And then just on the intermodal market, you talked a little bit about the growth opportunity there. And I'm curious, what are you seeing in terms of pricing from the intermodal service providers? Is there stabilization in the market? I think at one point in time, there'd been a pretty intense competitive dynamic. So could you speak to what you're seeing in terms of pricing in the intermodal market?

Robert M. Knight

Yes, I mean -- and I don't have perfect visibility to what the intermediaries are pricing to the customers, but I know that they compete just as we compete for the underlying rail service. And I know that we've moved our pricing up. You've heard me talk over the years about the fourth-party contracts that kind of held us back from being able to price to market, both in terms of gaining real price and fuel surcharge recovery. We've cleared the deck on those, and so we're able to kind of control our own destiny. Ultimately, the price to the ultimate customer by the intermediaries, I mean, it's a competitive environment. And I think they'll always compete, so I don't see there's any change in that. And I think a strong economy clearly would benefit probably all players in that equation.

Unknown Analyst

But you're not seeing any impact on the rail component in terms of your ability to price on the rail component?

Robert M. Knight

No.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

I think we had -- yes, one over here on the far side in the front.

Unknown Analyst

I just wanted to ask you specifically about your access to the maquiladoras for your car -- your automotive industry through El Centro. So it seems to me that there's a lot of congestion, a lot of traffic there, and that the alternative has been to truck out of the maquiladoras to your line. Do you see a future growth opportunity there? It seems like they're kind of reaching full capacity in that region.

Robert M. Knight

Yes, I can't give you any precise numbers, I'm just not close enough to it, other than to say that with our strength in the South, our strength in the Sunset Route, the development of the Santa Teresa, New Mexico, and our access to the Mexican market through the existing rail interchange, I think it's a -- we're well positioned to leverage that. But I can't give you any greater technicolor in terms of precisely what types of trends we're seeing right now. I'm just not close enough to that.

Unknown Analyst

I'm talking specifically about the automotive facilities that are in that region and how you access them, given your network in the United States.

Robert M. Knight

We access them either -- if they have rail capability, we access through rail with our rail partners in Mexico or we also work with the trucking partners that might -- if they don't have the rail access or if they're receiving parts, let's say, via truck, we certainly are in a relationship to partner with the truckers.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Another question in the front. Yes.

Unknown Analyst

Can you give us an update on your fuel surcharge strategy? And also, do you have any business relationship with FedEx or UPS?

Robert M. Knight

Let me start with the second part of the question. Yes, we have a relationship with both UPS and FedEx. In fact, UPS has typically been, for a long term, a user of rail. And we've had a long-term relationship with UPS, and FedEx is more recently. In terms of our fuel surcharge strategy, you've heard me say over -- since I've been CFO since 2004, we're not going to sleep at night until 100% of our business has adequate fuel surcharge mechanisms in place, and we're not there yet. So we continue to make progress in terms of making sure that each piece of business that we have on our network has adequate fuel surcharge mechanisms. Primarily, the reason we're not there yet is some of the legacy contracts that we've not yet been able to touch since 2004 are still in front of us. And those are the ones, generally speaking, that don't have the adequate coverage in place yet. So our strategy is to get there.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

I think we have one in the middle of the room.

Unknown Analyst

I was encouraged by the somewhat bullish longer-term view on coal and that got me thinking about, is there an asymptote here somewhere? I understand weather is going to vary at every single year. But do you feel like once we're through the conversion, do you see a point where we end up, I don't know, at 50% of where we were? Any color on that would be helpful.

Robert M. Knight

Yes, I certainly hope so. And I'm not going to give specific numbers, but certainly, using this year as a good example, and I think most of you know this, the Western coals are cleaner coals, are lower cost coals, are lower sulfur coals. So they are more attractive, if you will, from an environmental standpoint. Have we hit the bottom in the Western coals? I certainly hope so. We know gas prices will play a factor. We know EPA and environmental issues will always be around. But it certainly feels like the falloff that we experienced in 2012, and certainly as to Tom's question earlier alluded to, it feels more like we're doing this now. How long that will go on? We certainly hope it goes on for a long time. Our view would say, our society needs the coals. And these are cleaner coals, lower cost coals. They feel like they're here to stay, in my mind. Exactly what that line will look though, we'll have to kind of stay tuned.

Unknown Analyst

Is there an export opportunity for Western coal?

Robert M. Knight

Yes, that's a great point. The question was, is there an export opportunity for Western coal? We exported -- it's relatively small in the West compared to the East, but we exported at Union Pacific, in 2012, roughly 8 million tons last year. And we said that without further infrastructure investment on the West Coast ports, we expect that number to double in the next 5 years. Still relatively small book of our business, but doubling, we'll take it. But if you look at all the different efforts that are underway on the West Coast, at various port expansion initiatives that are in various forms of discussion and in evaluation, if you add them all up, the capacity that they're all kind of counting on is about 100 million tons a year of export on the West Coast. Now there's all kinds of environmental hurdles that they have to clear. And likely, all of them won't get built. But I would suggest that if our society sort of turns their head on coal in the United States, that further incents other countries to want to take our coal, so...

Unknown Analyst

[indiscernible]

Robert M. Knight

Various parts of the world. I mean it's...

Unknown Analyst

[indiscernible]

Robert M. Knight

Well, right now, it's not built. A lot of our coal today...

Unknown Analyst

Europe.

Robert M. Knight

Europe today, but the future expansion opportunities, I think, are certainly much broader than that in terms of...

Unknown Analyst

Houston.

Robert M. Knight

Houston, our coal -- a big part of our export coal today is through Houston, and that's going to Europe.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Another wrinkle on that, is that primarily -- is that all Colorado coal that's going to Houston? Or is there some PRB that's actually going as well?

Robert M. Knight

Mostly Colorado, Utah, almost exclusively....

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. So when you say, the 8 million going to 16 million tons in 2017, you're assuming that all that growth is Colorado coal.

Robert M. Knight

Yes, yes.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. And that PRB export would all be upside to that?

Robert M. Knight

That's right.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. Question on this side of the room?

Unknown Analyst

Could you talk about your crude-by-rail business and how it might be impacted by approval or disapproval of the Keystone? And then, more broadly, kind of the effect of any further pipelines on the crude-by-rail segment?

Robert M. Knight

Our planning assumption is that the pipelines ultimately get built at some point in time. And we're confident that we will play a role in the construction of those pipelines, by the way, with our Industrial Products business. So we're well situated to help them with that process. But even with that assumption, we believe, working with the producers, that the advantages that rail offer, speed to market, flexibility, allowing them to play the arbitrage, and all the new formations coming online with greater production, that our crude-by-rail growth will grow from where it is today even with the assumption the pipelines get built. It's an interesting changing dynamic environment that we're experiencing as we speak. There's not an origin or a destination location that I can think of that we're not in some level of discussion with. I mean, just kind of all of the options that you can think of are being evaluated and discussed and kicked around by the producers and other intermediaries. So it's an exciting market. And if you look at certainly in the western half of the United States and in the Gulf, if you look at all the different alternatives in that part of the country, you couldn't overlay a better map than the Union Pacific franchise on top of that. So we will play, in one form or another, with virtually every one of the combinations that are being evaluated.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Rob, another element on that. In one of your slides, you showed the different regions you originate and terminate business. What's -- and talked about Niobrara and Permian as being future opportunity. Do you have any sense for the timing of that? Should we think of that as really a 2014 event? Or is it possible that in third quarter, fourth quarter earnings, you're talking about it and you say, hey, we saw some new business out of the Niobrara or out of the Permian?

Robert M. Knight

I can't give you an exact timeline, Tom, but I'd say it's possible that it could be later this year. I mean, I think both those formations are trying to ramp up as quickly as they can. So how much volume might that result in 2012 (sic) [2014], we haven't given guidance on it because it is such a dynamic market. And by the way, we talk a lot about the oil trains themselves, which is clearly an important piece of this, but there's also another component that's a plus for Union Pacific. And that's the movement of sand, frac sand, into those formations is also a plus and a growing opportunity. So I think stay tuned, it's possible that we'll see some stronger ramp-up at those formations. But we'll see.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. So possible later this year but maybe more likely a little further out?

Robert M. Knight

More likely, yes.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay.

Unknown Analyst

Question, locomotive efficiency. What's happening with efficiencies in locomotives? Possible switch to gas power instead of diesel? And give us an update on your unionization position, not politically, just your own.

Robert M. Knight

On utilization?

Unknown Analyst

No, unionization, union situation.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

The labor union.

Robert M. Knight

Yes, question on locomotives. I mean, the new technologies seemingly every year come out with more efficient locomotives, more fuel-efficient locomotives, more maintenance efficient, if you will. We're taking 100 new locomotives this year. We took 200 locomotives last year. So we're staying on the leading edge, if you will, of some of that -- those new technology because they offer efficiencies in power and in maintenance and fuel. What was the second part of your question?

Unknown Analyst

Conversion to gas.

Robert M. Knight

Yes, conversion to -- I mean, that's getting a lot of attention. We, the OEMS, the whole industry is studying it. I think we're probably a long ways off before you'll actually see a wholesale shift over to gas from diesel. But certainly, we and, equally important, the producers and the manufacturers of locomotives are doing all kinds of testing. So you never say never on that, but there's a lot of capital investment kind of behind that from an infrastructure standpoint that would have to be addressed. And those are going to be probably the bigger hurdles to clear when that day comes. So I'd say it's probably still a fairly long ways off. Unionization, I mean, we just recently renegotiated our 5-year contract with our labor unions. And we have a very good relationship with our unions and are quite satisfied with -- I think, both parties, all parties are satisfied with the agreements and the relationships.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Do we have other audience questions? We got time for 1 or 2 more.

I will fill in with another one here, Rob, and we'll see if there's another one from the audience. You mentioned -- I think you had some comments on utilization or train length in merchandise and intermodal and favorable trends over the last several years. How would you view your capacity in the merchandise network? And when we think about that growth in housing type of business, I think most of that would be carload or merchandise business. So do you -- what's your capacity position; if housing starts continue to improve, should we think of that as really coming into existing train starts as opposed to driving new train starts?

Robert M. Knight

Yes, and the answer, kind of, it depends. Let me talk about the capacity more broadly first. If you look at our network, we -- you've heard me say that at a macro level, we have a network that's built to handle 195,000 to 200,000 7-day carloadings. And today, we're running about 175,000. So we're way off the trough, but we're also not anywhere near the peak. And in 2006, we actually averaged for the full year 192,000 7-day carloadings, and we've been investing capital ever since. So we've actually done it before albeit at lower velocity levels in '06. At a macro level, we've got the capacity. If you look at our -- we've got 3 major regions in our railroad: North, West and South. We have a nice challenge on our hands right now with all the growth in the southern part of our network, with the shale, with a lot of construction activity, with the Mexico franchise, autos in particular, chemicals, all doing very strong in the southern part of our network. We're nearer to capacity in the South right now. We're redirecting capital. We're redirecting locomotives and other assets into the South to stay ahead of the curve, while we've got more than an excess capacity in the West right now and in the North. So at a macro level, that's how things shape up. Specifically to your housing question, one of the differentiating items of Union Pacific in the West is our manifest network. And what that is, is a lot of strategically placed terminals that allow us to handle the smaller cuts, if you will, that the manifest network and housing network requires. And we've got capacity to handle that. In fact, as I indicated in my comments, our housing today is running at something like 40% lower than what we used to run. So we handled it before, we certainly can handle it now. So we've got -- bottom line is, if housing were to recover to that 1.6 million unit, let's say, kind of level by the next couple of years, we're confident that we'd be able to handle that. The South would be the area that we'd have to continue to -- as we are, continue to make investments to stay ahead of the curve to meet the housing demand growth in the South on top of all the other growth opportunities that are coming in the South. Long way of saying, we feel like we're prepared to handle that with our planned additional investments that we're making.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

If you look at average manifest train lengths and then what the potential could be, I know it's kind of a theoretical comment, but what would -- is it 10%, 15%, something like that, in terms of the siding capacity, things like that, that would constrain your train length in merchandise?

Robert M. Knight

Yes, we've got room to grow in virtually every bit of our business to extend train lengths, but that doesn't constrain us. I mean, for example, if there was a particular route where there was a particular type of train that the sidings couldn't accommodate us to extend that train, all is not lost because we would just simply run another train if the demand was there. So we have the terminal capacity and the track capacity, infrastructure capacity. And clearly, we would fill out existing trains where we could as a first step. But if that's even -- if that's gated for whatever reason, that doesn't block us from being able to meet the growth in demand.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Very good. I think with that, we're going to end. Rob, thank you very much for your time and remarks. Michelle and Mary, thanks also for joining us here.

Robert M. Knight

Great. Thank you.

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