Even though Union Pacific Corp. (UNP) is coming off its best quarter in its history, it appears the slow economy and pricing pressure will challenge the company into 2014.
Pricing strength isn't expected to continue as it did in the last quarter or 2013 as a whole, with Union Pacific CFO Rob Knight saying the company isn't likely to repeat its 2013 pricing performance in 2014.
The share price plunged almost $7.00 on the news, although it has gained over 1 percent of that back as I write.
I don't see any of this as a negative, but rather a probable opportunity to get in at a better price in the months ahead.
Since March 2009 the company has been steadily climbing, rising from just under $35.00 per share to over $152.00. But since early May 2013 the shares of the company have been flat, pointing to concerns over the weak American economy.
I think the share price is going to fall over the next several months in response to the inability of the company to grow through pricing power, providing an excellent entry point.
The strength of the economy will determine how much the price will fall, as Union Pacific is considered a bellwether of the U.S. economy because of the variety of products it ships, as well as being the largest railroad company in North America.
Unless there is a surprise in the performance of the U.S. economy, Union Pacific won't perform as it has in the recent past because of flat volume and limitations on how much its core prices can be raised.
Revenue per car and freight revenue in general both rose by 5 percent over the last year. That won't be the case in the year ahead.
Coal and Pricing
Going forward there is a possibility coal transports will increase in the 4th quarter, which would help to offset the lower prices. That isn't a surety though because the Powder River Basin received 3 feet of snow, which has resulted in a significant slow start to coal deliveries in the quarter. The company asserts most of that will be made up in the remainder of the 4th quarter, but that remains to be seen.
It appears it will at minimum result in smaller shipments than expected. If that's the case, or if volumes are significantly lower than expected, that, combined with the lower pricing power, could end with numbers lower than anticipated. This is something that needs to be followed throughout the quarter to see if the company can make up for the slow start for coal in the quarter.
With the slow start any weather that would have an impact going forward would make it difficult to catch up in the short term.
Federal Reserve Tapering
Another element that is in play is the effect of the speculation concerning whether or not the Federal Reserve is going to start tapering. If it does, it could have a dramatic effect on the share price of Union Pacific.
Obviously tapering would have an impact on numerous businesses, but Union Pacific, because of it being in the railroad business and being the largest railroad in North America, would probably be affected more than the majority of businesses.
The tapering talk alone will at least result in Union Pacific remaining flat, and if it underperforms in the quarter, that combination will contribute to the share price falling even further than I look for.
If the Fed does end up cutting back some or all of the stimulus, it would put a lot of downward pressure on Union Pacific until the effects on the U.S. economy are known.
Again, it's the position of Union Pacific being an economic bellwether that makes them disproportionately vulnerable to the Fed tapering.
Expectations Versus Performance
In its latest earnings report Union Pacific is very positive in its outlook, but I think it is basing that upon just about everything going right.
I think the company believes it can go through another quarter relatively unscathed because it still has some pricing power to counter the flat volumes; even though the pricing power is weakening.
This creates a good scenario for investors because I don't think Union Pacific is going to perform to the level that has been asserted over the next six months. If I'm right, that means the share price is going to drop, which will provide opportunity to add to a position or open a new one.
Coming off of its best quarter in history also sets the company up for a disappointing near-term performance.
This article focuses on the next 6 months to a year for Union Pacific, where the weak U.S. economy, possible tapering, coal challenges, and overall flat volumes will make it difficult for the company to perform as it has recently.
I don't view that as a negative but a great opportunity to add to or open a position in the company. Over time Union Pacific will continue to grow, but I see challenges emerging in the short term, which could push it down close to its 52-week low of about $116.00 per share. The share price could fall by about 20 percent or so at the current share price to reach that level.
If it wasn't for the tapering talk in the near future, I would look more at a 10 percent pullback, based upon lower pricing power, coal, and flat volumes. But the exposure of Union Pacific to the overall health of the U.S. economy makes it extremely vulnerable to the actions of the Federal Reserve, and that will hit the company hard when it happens. Just the talk leading up to potential action will put downward pressure on the company, whether the Fed cuts back or not.
For those wanting to boost their position or take a new position in Union Pacific, it would be wise to set some capital aside for when this downturn happens. It should occur in the next several months.