Why Union Pacific Stock Is A Great Investment Opportunity

Aug. 3.14 | About: Union Pacific (UNP)

Summary

UNP will continue to benefit from the improvement of the U.S. economy.

UNP reported all-time quarterly records in its second-quarter 2014 earnings release, and it gains market share.

UNP has very good valuation metrics and strong earnings growth prospects.

UNP is generating strong free cash flows and returns value to its shareholders by stock buyback and dividend payments.

I find Union Pacific Corporation (NYSE:UNP) stock to be a long-term smart investment right now. Union Pacific will continue to benefit from the improvement of the U.S. economy. The company reported all-time quarterly records in its second-quarter 2014 earnings release, and it gains market share. Union Pacific's stock has performed very well this year and in 2013, and In my opinion, it still has plenty of room to move up. UNP has very good valuation metrics and strong earnings growth prospects. Furthermore, the company is generating strong free cash flows and returns value to its shareholders by stock buyback and dividend payments.

The Company

Union Pacific Corporation is one of America's leading transportation companies. Its principal operating company, Union Pacific Railroad, is North America's premier railroad franchise, covering 23 states across the western two-thirds of the United States. The company was founded in 1862 and is headquartered in Omaha, Nebraska.

Valuation Metrics

The table below presents the valuation metrics of UNP, the data were taken from Yahoo Finance and finviz.com.

Union Pacific's valuation metrics are very good; the trailing P/E is at 19.09, and the Enterprise Value/EBITDA ratio is very low at 9.93. According to finviz.com, UNP's next financial year forward P/E is at 15.58, and the average annual earnings growth estimates for the next five years is very high at 15.37%; these give a low PEG ratio for large cap company of 1.03. The PEG Ratio - price/earnings to growth ratio is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

Latest Quarter Results

On July 24, Union Pacific reported all-time quarterly records in its second-quarter 2014 earnings release, which were slightly better than expectations.

Second-Quarter Highlights

  • Diluted earnings per share of $1.43 improved 21 percent.
  • Operating revenues totaled $6.0 billion, up 10 percent.
  • Operating income totaled $2.2 billion, up 17 percent.
  • Operating ratio of 63.5 percent improved 2.2 points.

In the report, Jack Koraleski, Union Pacific chief executive officer said:

Union Pacific achieved record quarterly financial results, leveraging the strengths of our diverse franchise to handle strong demand in the face of challenging operating conditions. We were pleased to see strong volume growth which, combined with solid core pricing, drove more than a two-point improvement in our Operating Ratio to a record 63.5 percent for the quarter.

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Source: Second Quarter Earnings Release

Dividend and Share Repurchase

Union Pacific has paid dividends on its common stock for 115 consecutive years. The forward annual dividend yield is at 1.86%, and the payout ratio is only 30.8%. The annual rate of dividend growth over the past three years was very high at 29.7%, over the past five years was at 23.9%, and over the past ten years was also very high at 19.2%. I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and UNP's performance has been impressive in this respect.

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Source: Charles Schwab

On July 31, Union Pacific announced that its Board of Directors voted to increase the quarterly dividend on the company's common shares by 10 percent to 50 cents per share. The increased dividend is payable October 1, 2014, to shareholders of record August 29, 2014.

Since the company generates lots of cash, and the payout ratio is low, there is a good chance that the company will continue to raise its dividend payment. In fact, Union Pacific increased its dividend at a double-digit rate in three of the past five quarters.

The Company repurchased 8.3 million shares in the second quarter 2014 at an average share price of $96.84 and an aggregate cost of $806 million. In the first half of 2014, the company repurchased 16 million shares of common stock for $1.5 billion. Since 2007, the company repurchased 228.4 million shares of common stock for about $11 billion.

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Source: Second Quarter Earnings Release

Competitors

A comparison of key fundamental data between Union Pacific and its main competitors is shown in the table below.

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Union Pacific has the lowest PEG ratio and the strongest earnings growth prospects among the stocks in the group, and it also has slightly lower debt-to-equity ratio.

Union Pacific's Margins and Return on Capital parameters have been better than its industry median, its sector median and the S&P 500 median, as shown in the tables below.

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Source: Portfolio123

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The UNP stock price is 2.88% below its 20-day simple moving average, 2.22% below its 50-day simple moving average and 9.29% above its 200-day simple moving average. That indicates a short-term downtrend and a long-term uptrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is negative at -0.42 and descending, which is a bearish signal (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 57.21 which do not indicate overbought or oversold conditions.

Analyst Opinion

Many analysts are covering the stock, and most of them recommend it. Among the twenty-six analysts, eight rate it as a Strong Buy, ten rate it as a Buy and eight analysts rate it as a Hold.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering UNP stock there are only eight analysts who have the four or five star rating, seven of them recommend the stock, and one top analyst has a Hold rating on the stock.

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Source: TipRanks

Major Developments

Union Pacific was able to drive more than a two-point improvement in its operating ratio in the last quarter. Union Pacific's operating ratio of 63.5 percent was an all-time quarterly record, 2.2 points better than the second quarter 2013 and 1.3 points better than the previous all-time quarterly record set in the third quarter 2013.

The operating ratio (expenses divided by revenues) is widely used by railroads to assess the efficiency; lower operating ratio signals rising margin and is positive. Union Pacific's second-quarter operating ratio is a few percentage points below the peer average and a company record.

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Source: Second Quarter Earnings Release

According to Bloomberg, BNSF Railway Co., the only U.S. railroad ordered by the regulator to provide weekly service updates, is losing market share to Union Pacific, its main competitor, as train speeds slow and on-time deliveries drop. The shift in market share had shown up in carload statistics, Union Pacific Chief Executive Officer Jack Koraleski said on a conference call with analysts on July 25. During the second quarter, the Union Pacific's loads rose 8.2 percent while those of BNSF, owned by Warren Buffett's Berkshire Hathaway Inc. (BRKA), gained 4.9 percent.

Second quarter business volumes, as measured by total revenue carloads, increased 8 percent compared to 2013. Volume increased in agricultural products, intermodal, industrial products, automotive and coal. Chemicals volumes declined slightly versus 2013 as a reduction in crude oil shipments more than offset growth in base chemicals. In addition: Quarterly freight revenue increased 10 percent compared to the second quarter 2013, driven by volume growth and core pricing gains.

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Source: Second Quarter Earnings Release

As the economy gradually continues to improve, the company expects business growth opportunities in all of its commodity groups.

Union Pacific's stock has performed very well this year and in 2013. Since the start of the year, UNP stock has gained 16.6% while the S&P 500 index has risen 4.2%, and the Nasdaq Composite Index has also increased 4.2%. Moreover, since the beginning of 2013 UNP stock has gained 55.8%, while the S&P 500 index has increased 35.0%, and the Nasdaq Composite Index has risen 44.2%. Nevertheless, considering its good valuation metrics and strong earnings growth prospects, the stock, in my opinion, is still cheap.

Conclusion

Union Pacific will continue to benefit from the improvement of the U.S. economy. The company reported all-time quarterly records in its second-quarter 2014 earnings release, and it gains market share. Union Pacific has good valuation metrics and strong earnings growth prospects; its PEG ratio of 1.03 is pretty low for large cap company. Union Pacific is generating strong free cash flows, and it returns value to its shareholders by stock buyback and increasing dividend payments. All these factors lead me to the conclusion that UNP stock is a long-term smart investment right now.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.