- Train lengths have gotten longer such that Union Pacific operates more efficiently.
- The operating ratio has come down nicely from 84% in 2000 to 60% in 2020.
- Shareholder returns since the year 2000 have been excellent despite limited growth in top line revenue.
My thesis is that Union Pacific (NYSE:UNP) shows how to have excellent shareholder returns without prodigious revenue growth. Revenue for 2000 was nearly $11.9 billion and 20 years later it was a little over $19.5 billion for a CAGR of just 2.5%. However, the total shareholder return from 12/31/2000 to 12/31/2020 was fantastic because Union Pacific improves the bottom line by stressing the operating ratio which is the operating expenses divided by operating revenue. The company has brought this down from 84% in 2000 to 60% in 2020 such that the operating margin and the cash flow yield have gone up.
CompaniesMarketCap.com shows the market cap going up prodigiously over the years:
Image Source: CompaniesMarketCap.com
Of course the total shareholder return is much more than just market cap increases. There are also all the dividends issued over the years and all the shares that were repurchased. The 2000 10-K says there were 247.4 million shares outstanding as of February 28, 2001 and the stock split history shows there was a 2 for 1 split in May 2008 and another 2 for 1 split in June 2014 such that one would expect there to be nearly a billion shares if there were no splits and no buybacks. The 2020 10-K says there were only 669.8 million shares outstanding as of 1/29/21 so the benefit of buybacks has been immense. Putting these factors together, the Custom Stock Alerts site shows that Union Pacific shareholders did extremely well over the years:
Image Source: Custom Stock Alerts
In November 2009, it was announced that Berkshire Hathaway (BRK.A) (BRK.B), as a 22.6% owner of BNSF, was buying the remaining 77.4% in a transaction that valued BNSF at $44 billion including the assumption of $10 billion in debt. In other words, if we put aside the debt assumption then Berkshire paid approximately $26.3 billion for the 77.4% of BNSF they didn't already own. Skeptics at the time pointed out that coal revenue was sure to decline and that top line revenue growth would be limited. Skeptics were right about this but Berkshire CEO Buffett seemed prescient knowing BNSF and Union Pacific could do just fine improving the bottom line without significant top-line revenue growth.
Top-line revenue growth for both Union Pacific and their BNSF peer has been tepid but cash flow growth for both railroads has been prodigious. The dotted lines show the way I look at FCF for these two rails which is cash from operations less cash from investing:
Image Source: Author's spreadsheet from company filings
Historically, capex has been higher than depreciation for railroads such that investors have to be skeptical with accrual earnings and focus heavily on free cash flow [FCF]. Historically, I think a P/FCF ratio has been more useful in this industry than the standard P/E ratio. But FCF can be confusing when companies define it differently. Union Pacific sometimes defines it as cash provided by operating activities less cash used in investing activities less dividends. My definition of FCF does not subtract dividends. The 2020 Build America report shows that the free cash flow conversion in recent years has been excellent such that the P/E ratio has been more telling than in the past:
Image Source: 2020 Build America report
The 2017 Fact Book shows how the return on invested capital [ROIC] went up after 2004:
Image Source: 2017 Fact Book
The higher the free cash conversion, the more sense ROIC makes as a measurement since the net income is "real" when it is close to free cash. Here are the numbers after 2017 from the 2020 10-K filing:
Image Source: 2020 10-K filing
There are many reasons as to why FCF has grown much faster than top-line revenue. Compensation and benefits dropped from 36% of revenue in 2000 when there were 50.5 thousand employees to 20% of revenue in 2020 when there were 31 thousand employees. Equipment and other rents dropped from 11% of revenue to 4% over the same period. Free cash flow increased by about $1 billion per year when the federal tax rate went down from 35% to 21%.
The longer the train, the lower the cost per unit. The length of trains has gone up over the years which brings about savings with crews and fuel. A July writeup on Superintendent Carl Garrison quotes Executive VP Beth Whited regarding the benefits of longer trains:
In Los Angeles, Carl's team worked with domestic and international intermodal shippers to grow intermodal train length on Union Pacific's Sunset Corridor by over 50% in the last 24 months. This has allowed for a 15% reduction in crew starts, a 16% increase in gross ton mile/crew hour worked, and a 20% increase in gross ton mile/train.
I can't find the average overall length for all types of Union Pacific trains in 2000 but the 2001 Intermodal Team presentation shows their intermodal trains averaged about 5,000 feet back in 2000:
Image Source: 2001 Intermodal Team presentation
A decade later in the 1Q10 call, Operations EVP Dennis Duffy said the average overall length for all types of trains was 5,500 feet at the time:
The average train length that we have is for the entire system, all of our network is about 5,500 [feet]. We grew that over 10% year-over-year, quarter-over-quarter. Our biggest growth obviously was in the intermodal side.
The 2020 10-K shows that the average overall train length went up 10% from 7,036 feet in 2018 to 7,747 feet in 2019 and up another 14% to 8,798 feet in 2020. Canadian Pacific (CP) 10-K and 40-F filings show similar improvements. Their average train lengths excluding local traffic have gone from 5,608 feet in 2009 to 7,929 feet in 2020.
It's crucial to keep fuel costs low when trying to increase FCF without the benefit of significant growth in top-line revenue. The November 2009 Comparative Evaluation of Rail and Truck Fuel Efficiency Report shows how rail outperforms trucks with respect to fuel efficiency based on distance. It's over 2,000 miles from Los Angeles to Chicago and the fuel savings for rail over truck on that journey are immense:
Image Source: November 2009 Comparative Evaluation of Rail and Truck Fuel Efficiency Report
The 2000 10-K for Union Pacific shows that the 2.92 million intermodal revenue carloads made up nearly 33% of all 8.90 million revenue carloads. By 2020, the 10-K shows that the 3.15 million intermodal carloads were up to almost 41% of all 7.75 million revenue carloads. The above fuel efficiency report says that double-stacked intermodal tend to be especially fuel efficient:
Double-stack trains tend to be more fuel efficient than other types of trains, despite their higher average speeds and poorer aerodynamic performance. The fact that intermodal operations do not require subsequent switching operations to classify rail cars contributes to the better performance of double-stack trains. The wide variation in fuel efficiency of double-stack and mixed trains as opposed to auto and Trailer-on-Flatcar [TOFC] trains is justified by the smaller number of movements analyzed in the latter trains.
The Union Pacific Technology page says that distributed power provides fuel savings of 4-6 percent compared to standard locomotive power. Then CEO Jim Young explained the way it works at the June 2011 Bernstein Conference:
We have some technology called distributed power. Been around the industry for probably 15 years. The way the math works is when you operate a train, instead of having all of your power upfront, computer technology today and communications has allowed us to redistribute that power so we can put two units in front, maybe one in the back, or one in the middle. What happens is you improve - there's an exponential impact in terms of train dynamics. We can get more loads per train with the same amount of horsepower when it's distributed. Improved service, improved safety for us, and really drives our efficiency. If you look at '08, about a third of our business operated under distributed power, and this year, we think it'll be just over 60%. That's an example of many where we are using technology to really drive efficiency.
The 2009 Fact Book shows how the use of distributed power increased from 2007 to 2009:
Image Source: 2009 Fact Book
I've been guilty of not studying some companies deeply when top line revenue growth prospects aren't exciting. We've seen over the years with Union Pacific that this can be a big mistake.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of UNP, BRK.A, BRK.B, VOO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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