The Macro Environment Can't Get Any Better For Union Pacific

| About: Union Pacific (UNP)


Union Pacific’s previous quarter reported revenues hitting a record figure as demand persisted. Cost management brought a 21% increase to earnings.

The macro environment is favorable for all of Union Pacific’s segments.

This complements the expansion phase the company is going through.

Union Pacific's (NYSE:UNP) stock has appreciated a whopping 24% in one year. The transportation industry is less affected by macro environmental factors since it's a basic necessity for many companies. As with most economic indicators which are subject to business cycles, growth in rail and freight traffic previously decelerated after a recovery in 2010. However, recent indications have shown that rail transport is set to improve. One of the reasons behind this improvement is the decision made by consumers to change their traveling choices and firms as they look for cheaper transportation options.

Also, there has been a material shift among businesses regarding the use of rail transportation. The factors support Union Pacific's strong operational history which improved after the company reported its quarterly results last month. In this article, I will take you through those earnings before discussing the future potential of this freight company.

Second Quarter

During the period, Union Pacific's total revenue grew 10% to a new quarterly record of $5.7 billion. Shipments increased 8% compared to the figure reported in 2013 as demand persisted across 5 of the 6 segments (Agricultural Products, Intermodal, Industrial, Automotive and Coal). The chemical segment, which saw volumes falling, was compensated by higher prices that brought a net positive contribution to total revenue. The company also charged higher prices overall (+250 bps) and was partially offset by the product mix that produced a 1.5% improvement in average revenue per car.

Hence, the top line element for investors was satisfying since industry improvements were clearly visible in the results. Fuel prices remained constant at $3.1 per gallon bringing no material increase apart from more mileage taken to accommodate higher volume. The compensation expense remained under control as well despite the company running a less optimal network and the persistence of inflation. These two cost segments make up 56% of the company's costs and keeping them under control helped to increase earnings further.

The net result was diluted earnings per share growing 21% to 143 cents. The company's future is prosperous given the present macro environment. Let's begin with agriculture. Last year, Union Pacific experienced a short US corn supply while at the same time world production improved leading to lower exports and reductions in domestic demand for livestock feeding. This temporarily hurt profits. However, the growing strength in US supply and lower commodity prices are presently driving feed grain exports. This explains why agricultural volumes were up 16% in the last quarter.

The North American automotive production increased 4% since the figure reported in the same quarter of 2013. Also, the sales recovery that started in March hasn't stopped gaining strength. I believe this should support the ongoing demand for automobiles. Supplementing this are the parts required and the 8% growth in volume last quarter. Chemicals, which lately saw volume declines, should also improve though not as high as agriculture owing to shale-related drilling. Also, to a lesser extent, ingredients used in nylon production can boost the top line for chemicals.

The housing market will also support the industrial segment. Lumber shipments already grew 17% in the last quarter with the recovery. The frac sand used in shale-related drilling will also boost sales helping the industrial and chemicals segments. For coal, low inventory levels and higher natural gas prices should drive demand.

These trends complement the company's decision to expand. Union Pacific has recently increased the frequency of its two intermodal services. Both the Portland-Chicago and Northern California-Chicago are part of Union Pacific's top premium intermodal services with four-day delivery in the morning.

Similar investments are scheduled for the year. These enhancements will give customers access to Union Pacific's extensive rail network and add more to the appeal of rail transportation. The company is making a record $4.1 billion investment this year as part of the program.

Bottom Line

Union Pacific will be hiring 5000 workers this year. This may put temporarily cost pressures but investors should focus on the long-term prospects of this company. The demand is there, so there is no issue in the top line. With fuel prices stable at the moment, the company should have progress smoothly for the future. The latest dividend of 50 cents per share doesn't hurt either. With fundamental such as return on equity, assets and debt levels all standing better than the industry, there is no better stock in rail transportation than Union Pacific. Therefore, I recommend buying the stock.

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.