Weather, Inflation Impact UP 1Q23 Results (Updated, TD Cowen and SFG Analysis)

(Photograph Courtesy of UP, via Twitter)

“We delivered greater network fluidity and resiliency in the first quarter even as we faced a series of significant weather events,” Union Pacific Chairman, President and CEO Lance Fritz said during the Class I’s financial report on April 20. “In addition to the impact of weather on carload volumes and costs, higher inflation also reduced our operating income and more than offset our record first quarter operating revenue.”

“Despite a continued challenging environment, our strengthening service product, bolstered by a strong pipeline of new employees, gives us confidence we can capture available demand and improve efficiency the remainder of the year,” Fritz concluded.

For the three months ending March 31, 2023, UP posted:

• Net income of $1.630 billion, or $2.67 per diluted share, which included $107 in other income from a one-time real estate transaction. These results compare with first-quarter 2022’s $1.630 billion, or $2.57 per diluted share.

• Operating revenue of $6.056 billion was up 3% from the prior-year quarter’s $5.860 billion, “driven by higher fuel surcharge revenue and core pricing gains, partially offset by a negative business mix and volume declines,” the railroad reported.

• Freight revenue of $5.656 billion was up 4% from first-quarter 2022’s $5.440 billion.

• Business volumes, as measured by total revenue carloads, were down 1% from first-quarter 2022. Bulk revenue reached $1.897 billion, up 4% from the same period last year, with volumes of 507K, down 3%; industrial revenue was $2.017 billion, up 5% from 2022, with volumes flat at 536K; and premium revenue was $1.742 billion, up 3% from 2022, with volumes of 934K, down 1%.

• A 62.1% operating ratio, which deteriorated 270 basis points from first-quarter 2022’s 59.4%. “Falling fuel prices in the quarter positively impacted the operating ratio by 190 basis points,” UP said.

• Operating income of $2.294 billion declined 3% from the prior-year quarter’s $2.377 billion.

Among UP’s operating performance results for first-quarter 2023:

• Quarterly freight car velocity came in at 196 daily miles per car, a 1% decline.
• Quarterly locomotive productivity was 123 gross ton-miles (GTMs) per horsepower day, a 5% fall-off.
• Average maximum train length of 9,159 feet was flat.
• Quarterly workforce productivity decreased 6% to 991 car miles per employee.
• Fuel consumption rate (measured in gallons of fuel per thousand GTMs) was 1.123, a deterioration of 1%.
• Reportable derailment rate improved 10% to 2.21 per million train miles vs. 2.46 for 2022.

2023 Outlook

UP reported that it is maintaining its full-year guidance of:

• Carloads to exceed Industrial Production. According to UP, the current Industrial Production forecast is -0.7%.
• Operating ratio improvement.
• Pricing dollars in excess of inflation dollars.
• Capital spending of less than 15% of revenue; a capital plan of $3.6 billion.

TD Cowen Insight: ‘Trudging Through the Snow’

“UNP fell short of our estimate and consensus expectations in 1Q when adjusting for its real estate sale,” notes TD Cowen Managing Director, Industrials and Railway Age Wall Street Contributing Editor Jason Seidl. “1Q results and QTD trends make full-year guidance more reliant on 2H recovery, in our view. We acknowledge the severe weather out West was a contributor to network challenges but note 1Q volumes still outpaced Western peer BNSF. We lower our price target to $218 and reiterate Outperform.

“UNP reported 1Q results of $2.67 including an unanticipated real estate transaction that added $0.14 cents to the bottom line. Excluding this one-time item, results missed our estimate of $2.58 and the consensus forecast of $2.56. Top line growth of 3.3% was roughly in-line with our estimates, though OR of 62.1% (down 270bps y/y) missed our and consensus projections as inflationary cost pressures and severe weather affected results.

“Carloadings were down 1.4% y/y in 1Q as harsh weather conditions added to pockets of demand weakness (though still better than West Coast competitor BNSF). Coal volumes in particular were hit by weather, dropping 4%, and UNP expects volumes to remain subdued due to lower natural gas prices. Management reiterated guidance of growing volumes in excess of industrial production while noting that this forecast has shifted from -0.5% in 1Q to -0.7%. Carloadings in 2Q should receive some support from improved weather as well as increased construction activity, as we heard at our recent conference visit and on our quarterly roundtable.

“Intermodal volumes were down 3% y/y, about in-line with our expectations. The domestic side saw some strength from inland moves. Domestic intermodal is, however, seeing stiff competition from low OTR rates as UNP acknowledged loose trucking capacity. We believe this will likely pressure rates to some extent. Management confirmed that some freight is moving back to West Coast ports though refrained from disclosing how quick this shift might occur once a labor deal is reached. We believe intermodal volumes will continue to be pressured in 2Q and a recovery may be pushed out further into 2H even as pricing comes under pressure from OTR transport.”

SFG: ‘The Great Freight (Macro) Debate.’

“UNP and the broader rail bull/bear thesis is increasingly dependent on how macro recovery (bull!) or deterioration (bear!) trends in 2H23 and early 2024, as outgoing CEO Lance Fritz caveated, ‘We have not planned in a recession, so a recession would be a problem for us,’” say Susquehanna Financial Group analysts Bascome Majors, Harrison Bauer and Alex Dorfman. “Elsewhere, management reiterated guidance, anchored to variable volume trends with their volume anchor (‘IP-plus’) moving slightly (consensus industrial production shared by UP now –0.7%, 20bps below January). Our sense is investors generally have more conservative views here. Despite Y/Y OR deterioration in 1Q, the reiterated full year OR improvement guide will be helped in percent terms by falling fuel prices (190bps tailwind in 1Q), though falling fuel is likely dilutive to the bottom line in net dollar terms. In the ‘plus’ column, 1Q23 endured an estimated $50MM-plus in weather-related lost revenue/cost increase that should provide a sequential OR tailwind into 2Q. Still, we remain conservative on the volume outlook for UNP and the broader rail industry into spring (our UNP 2023E revenue forecast is –4% Y/Y vs. pre-earnings consensus of flat Y/Y).

“What Else We’re Watching. 1) Pending CEO search to succeed Lance Fritz, with no update today (reiterated 2/26 plan, and our initial thoughts); 2) Cadence of share repurchases (repurchased 2.9MM shares for $0.6B in 1Q23; no explicit target for 2023 but we model no net debt increase); 3) Weekly reported operating stats (velocity/dwell/cars on line) to measure service performance and network fluidity, as STB likely extends expanded service reporting beyond May.

“Stock Action: Trimming 2023 ($10.60) by $0.10 on yield, with a modestly larger cut to 2024 ($11.75) by $0.30 as slower buybacks compound. Target price –$1 to $202 with 2023 estimate cut and unchanged methodology (~19x SFG 2023 EPS), which capitalizes a 4.6% FCF yield.”