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Summary

  • UNP continues to show nice results, driven by strong underlying volume growth.
  • The company is well diversified in end markets and has an amazing track record for the past decade.
  • I am awaiting a buying opportunity at market multiples, awaiting a pullback to $90 per share.

Union Pacific Corporation (NYSE:UNP) continues its impressive long term march upwards. Shares have seen an incredible performance over the past decade while the company operates in the ¨boring¨ and ¨old-fashioned¨ rail business.

I like shares but am awaiting a better entry point after multi-year momentum has pushed the valuation above market-wide levels.

Key Results For The Second Quarter

Union Pacific posted second quarter revenues of $6.01 billion, a 10.0% increase from the year before. Topline sales came in ahead of consensus estimates at $5.98 billion.

Operating a railroad business is very profitable these days with Union Pacific posting a 16.7% jump in earnings towards $1.29 billion.

Thanks to a modest pace of share repurchases, which is not uncommon these days, earnings rose by 21% to $1.43 per share on a diluted basis, beating consensus estimates by a penny.

Looking At The Growth Drivers

Union Pacific is quite well diversified as it operates six main segments which each reported year-on-year revenue growth. Both intermodal as well as industrial product sales were up by 16% to $1.15 billion and $1.13 billion, respectively. Agricultural sales were up by 19% to $934 million while coal, chemical and automotive sales rose between 1 and 3%.

In total the company transported 2.43 million carloads which represents an 8% increase compared to last year. Prices were up by 1% to an average of $2,329 per car.

The company showed great operating leverage in the business model driven by cost control. While reported revenues were up by 10%, overall operating expenses rose by just 6%, thereby explaining a 17% jump in operating earnings.

Valuation

Operating a railroad is a very capital intensive business. An astonishing $45 billion in real properties such as rails and cars are prevalent on Union Pacific's $51 billion balance sheet.

Total cash and equivalents stood at $1.5 billion, while total debt of $10.8 billion results in a net debt position of about $9.3 billion. It also should be noted that the company has operating leases with an estimated present value of nearly $ 3 billion at the moment.

Given that Union Pacific has about 905 million shares outstanding currently, and its shares trade around $102 per share, the company is valued at about $92 billion. On a trailing basis, Union Pacific generated sales of $22.8 billion on which it earned about $4.7 billion.

As such, equity in the business is valued at 4 times annual sales and 19-20 times trailing earnings.

Old School Business, Impressive Growth

Despite operating in a very old-fashioned industry, there is real money to be made in railroads. Between 2004 and the current moment on a trailing basis, Union Pacific has grown revenues by nearly 90%. This results in a compounded annual growth rate of about 6% per annum.

Margins were up significantly which has resulted in an earnings explosion combined with cumulative share repurchases of about 15% of the outstanding share base. Given the only modest increase in leverage during this time, relative leverage has come down a lot as operations and profitability has grown in relation to the company's net debt position.

Amidst these good times, Union Pacific is returning cash to its investors. The pace of share repurchases totaled 3.3% during the quarter, accompanied by a 1.8% annual dividend yield.

All of these operational improvements, and the margin expansion in particular, has paid off big time for investors who have seen shares increase from about $15 in 2004 to current levels around a $100 per share.

Final Takeaway

Union Pacific continues to move forwards being well diversified across multiple industries and it is not just the reliance on the oil boom which is driving volume growth. Agriculture remains a very strong driver, driven by grains, corn but also domestic beer. Of course crude and fracking is a main driver as well, while the housing recovery is helping as well. Other strong results were shown by demand for the transportation of potash as well as chemicals.

What has been underlying the long term returns is the continued improvement of the operating ratio which fell by a full 2.2% to 63.5% of sales. The long term fall in this ratio is a testament to Union Pacific's strong operating performance.

This and volume growth has resulted in the profit explosion which in its turn has boosted the shares upwards. So far this year shares are up 20% to levels above a $100, while they traded as low as $40 as recent as the second half of 2011.

The strong competitive position of Union Pacific results from its impressive and large network across major parts of the US. This gives it a very strong position versus its main competitors which are of course trucking companies. Given the location and the characteristics of the goods being transported, water or air transport is often no viable alternative.

As the company remains optimistic about the second half of the year, all signs are still on green, although I am the first one to admit that shares trade around all-time highs now amidst a strong economic background. I like the structural competitive position and exposure to the economic oil and gas revolution, and I am willing to pay a market multiple of about 17-18 times earnings of the company.

This translates into a $90 target to pick up some shares in my opinion and I will keep shares on my radar in case of an unexpected sell-off.

Source: Union Pacific Corporation - Steady As She Goes, Buy On Dips