UP’s Fritz: “Second Quarter Proved Very Challenging”

Written by Andrew Corselli, Managing Editor
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“Demonstrating the transformation our company is experiencing through the implementation of Unified Plan 2020, we were able to largely mitigate the impact of that volume loss," said Lance Fritz, UP Chairman, President and CEO.

Union Pacific (UP), the fifth Class I to report second-quarter 2020 financials, was hit hard, like most of its peers. Net income of $1.1 billion, or $1.67 per diluted share, was 41% lower than the $1.6 billion, or $2.22 per diluted share, reported in 2Q19.

UP’s 2Q20 operating revenue of $4.2 billion was down 24% yearly. 2Q20 business volumes, as measured by total revenue carloads, decreased 20% compared to 2019. Volumes for all three business teams—bulk, industrial and premium—“declined in the quarter due to the deteriorating economic conditions brought on by the COVID-19 pandemic.”

“Although the state of global economy is somewhat uncertain given the lingering impact of the COVID-19 pandemic, Union Pacific currently expects full-year 2020 carload volumes to be down around 10% or so compared to 2019,” the company said.

In addition:

  • Quarterly freight revenue declined 24%, compared to 2Q19, as core pricing gains were offset by lower volumes, negative business mix and decreased fuel surcharge revenue.
  • UP’s 61% operating ratio increased 140 basis points compared to 2Q19.
  • UP recognized a $69 million gain from a real estate sale to the Illinois State Toll Highway Authority.
  • The $1.26 per gallon average quarterly diesel fuel price in 2Q20 was 43% lower than 2Q19.
  • UP’s first-half reportable personal injury rate of 0.83 incidents per 200,000 employee hours improved 5% compared to first half 2019.
  • Quarterly freight car velocity was 225 daily miles per car, an 11% improvement compared to 2Q19.
  • Quarterly locomotive productivity was 136 GTMs (gross ton-miles) per horsepower day, a 12% improvement compared to 2Q19.
  • Average maximum train length was 8,664 feet, a 13% increase compared to 2Q19.

Summary of 2Q Freight Revenues

  • Bulk down 17%.
  • Industrial down 23%.
  • Premium down 33%.

“The second quarter proved very challenging as we faced a volume decline of 20% due to the economic impact of the COVID-19 pandemic,” said Lance Fritz, UP Chairman, President and CEO. “Demonstrating the transformation our company is experiencing through the implementation of Unified Plan 2020, we were able to largely mitigate the impact of that volume loss. Our dedicated employees are feeling a very real impact from this pandemic, making tangible sacrifices. Despite this adversity, they continue to make strides to improve the safety of our railroad, while providing our customers an uninterrupted, enhanced service product.

“Our first priority continues to be the health and safety of our employees during the pandemic, as they perform critical service to support economic recovery. Our ability to be nimble and flexible in adjusting our resources to rapidly changing volumes, while providing a high level service product, demonstrates the strength of our service model. We remain focused on providing our customers with a safe, reliable and efficient service product.”

THE COWEN INSIGHT

Jason Seidl

“UNP is one of the best-managed North American Class I railroads and the only western one that is publicly traded,” said Cowen and Company analysts Jason Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Adam Kramer. “With the hire of Jim Vena as COO, we believe the company is on its way to OR improvement through adoption of Precision Scheduled Railroading.”

“Cost reduction efforts led to a 2Q EPS beat even after removing a real estate sale, though revenues in the quarter were soft,” the analysts noted. “3QTD automotive and intermodal volumes have us feeling more constructive on the 2H top line, and we view the 10% full-year carload decline guidance as likely conservative.

“UNP’s reported first-quarter EPS of $1.60 was above our and consensus’ $1.56 expectation. We note that this EPS figure excludes a ~$69MM real estate sale to the Illinois State Toll Highway Authority that would have contributed an additional ~$0.07 to the quarter.

“The operating income’s y/y fall to $1.65B was above our $1.64B estimate but slightly below the Street’s $1.66B expectation. The Operating Ratio (OR) in the quarter was 61.0%, roughly 140 BPS worse than last year, ~260 BPS better than our estimate, and approximately 130 BPS better than consensus’ expectation. The aforementioned real estate sale did not contribute to the OR, as it was reported below the line.

“UNP’s quarterly revenue declined of 24% to $4.24B was below our and consensus estimates of $4.50B and $4.40B, respectively. By carload type relative to consensus, Industrial and Other revenues missed, while Bulk and Premium beat.

“UNP expects full-year 2020 carloads to decline by ~10% y/y. With significant unknowns still in the freight market, including questions around West Coast imports, the pace of the auto recovery, and the decline in coal, we’re not surprised to see this somewhat conservative figure from UNP. We do note that UNP has the easiest 3Q and 4Q comparisons in the industry.

“UNP continues to price above rail cost inflation, but noted that the market is still very competitive on price, with this competition coming from fellow railroads and trucking. Though trucking spot rates have recovered in recent months from steep declines, UNP described the trucking market as still fairly soft. With auto inventories the lowest they’ve been in 9 years, we believe that the momentous recovery in carloads for that segment won’t evaporate, and we are modeling for carload growth y/y in 4Q (a quarter with much easier y/y comparisons).

“We are adjusting our 2020 and 2021 EPS estimates to $7.85 and $9.65 from $7.80 and $9.40, respectively. We are increasing our multiple to 20x from 18x, which we believe is warranted, given the company’s PSR success thus far, including significant cost-cutting in a challenged quarter (registering a near 60% OR), with further cost reductions, train lengthening and yard rationalization potentially still to come. With this new 20x multiple and our new 2021 EPS estimate, our price target goes to $193 from $169. We rate UNP Outperform.”

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