Before the opening bell on July 19, Union Pacific Corporation (UNP) released operational results for its second quarter of fiscal year 2012. The Company reported that revenue increased 7.5% to $5.22 billion from $4.49 billion year over year on the back of slightly stronger volumes, higher prices, and increased fuel surcharges. Total rail revenues, improved 6.9% to $4.91 billion from $4.60 billion year over year, which was inline with the Street's forecasts. I had modeled for revenue of $4.89 billion as I expected the drop in coal to have a larger impact on the top line. UNP reported earnings of $2.10 per share, up from $1.59 per share year over year, which easily surpassed the Street's $1.97 per share forecast. My forecast called for earnings of $1.99 per share.
When valuing railroad companies, I monitor three metrics: volume, operating ratio (operating expenses as a percentage of revenue), and pricing (revenue per unit). During the quarter, volumes improved 0.5% with strong growth in Automotive (+15.2%) and Chemical (+12.0%) shipments, which in turn were offset by the decline in Energy (-16.9%) shipments. The drop in Energy shipments, mainly as a result of coal, was expected as the nation had a mild winter, utility companies were at target levels for coal, and many plants began to make the switch to natural gas. Operating ratio improved to 67.0% from 71.3% year over year and from 70.5% sequentially as fuel costs declined 2.4% year over year. In terms of cost per gallon, fuel prices declined 2.4% year over year to $3.21; sequentially it declined 0.6%. Revenue per unit (RPU) improved 6.4% year over year, which is lower than we have seen for UNP in many quarters, but still better than the other rails that we monitor. All six segments saw RPU growth compared to the second quarter of 2011, led by Energy (+10.1%) and Automotive (+8.3%). The following tables show the Company's revenue, volume, and RPU for the quarter.
Fuel costs were down during the second quarter, which helped to improve the operating ratio. Each of the other line items on the Company's income statement was down year over year as a percentage of revenue (save for equipment and other rental costs, which was flat at 8.3% of revenue). Management has continuously been able to operate more efficiently, and now with lower fuel prices, there should be an even higher margin. Fuel surcharges typically lag approximately six months behind the actual cost of fuel. So in times of falling prices, it benefits UNP, while in times of rising prices, UNP sees it as a headwind.
The coal to natural gas dilemma will continue to be a problem for all the rails, not just UNP, as other EPA rules are enacted over the coming months and years. Additionally, natural gas is much cheaper to use right now, which is also prompting some utility companies to make the switch early. Automotive shipments rebounded nicely and were a bright spot during the quarter; however, the segment is cycling relatively easy comparisons due to the earthquake and tsunami in Japan, which caused a massive decline in shipments of Japanese produced vehicles. Agricultural shipments fell 1.7% compared to the second quarter of 2011, and there is a large potential for more declines as the drought afflicts much of the United States.
Despite weaker Energy shipments, the easy comparisons in the Automotive segment, and the potential for continued declines in the Agricultural segment, UNP still managed to easily surpass expectations on the bottom line. As a result, I still like shares of UNP at this level. The stock is near all time highs, but has been appreciating despite the weakness in the US economy. There are concerns that a slowdown in the Chinese economy could have a ripple effect and really cause a drop in export shipments; however, I expect UNP to manage the storm better than most in the industry. The stock is relatively fairly valued in terms of PE relative to the rest of the space, but the growth potential is higher with UNP. The stock pays a 2.0% dividend, has almost $4.0 billion of current assets, and $2.8 of operating cash flow. I expect another dividend increase following the third quarter earnings announcement.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.