UPDATED: UP earnings up despite crew shortage

Written by Stuart Chirls, Senior Editor
Union Pacific freight train

Photo: Spencer Hughes/YouTube

The largest U.S. Class I railroad posted a net gain after wrestling with infrastructure and crew issues in the second quarter.

Union Pacific Corporation reported second quarter net income of $1.5 billion, or a second quarter record $1.98 per diluted share. This compares to $1.2 billion, or $1.45 per diluted share, in the second quarter 2017.

Operating income totaled $2.1 billion, up 5%, while the Omaha-based company’s operating ratio reached 63.0%, up 1.1 basis points.

“Overall, I am pleased with the effort put forth by the entire Union Pacific team; however, I recognize the results could have been better,” said Lance Fritz, Union Pacific chairman, president and chief executive, in a statement. “Network performance improved significantly coming out of the first quarter, but a tunnel outage and train-crew shortages created a headwind in June. I am confident we have the right plans in place to drive improvement in our operations and a better service experience for our customers.”

Operating revenue of $5.7 billion was up 8% on-year. Carloads increased 4%, while volume increases in industrial and premium freight more than offset declines in agricultural products and energy.

Quarterly freight revenue improved 8% as volume growth, increased fuel surcharge revenue, and core pricing gains were partially offset by a negative mix of traffic.

The $2.30 per gallon average quarterly diesel fuel price in the second quarter 2018 was 36% higher than second quarter 2017.

Quarterly train speed, as reported to the Association of American Railroads, was 24.7 mph, 3% slower than a year ago.

The company repurchased 33.2 million shares in the second quarter 2018, including 19.9 million shares received as part of an accelerated share repurchase program.

By category, shipments of Agricultural Products was up 5%; Energy, 5%; Industrial, 8%, and Premium, 14%.

“Looking to the remainder of the year, we expect the strong business environment to continue as we regain our productivity momentum and improve the value proposition for all of our stakeholders,” Fritz said.

Cowen and Co. Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl in a note to investors wrote, “UNP reported a miss compared to our operating income estimates, but a lower than anticipated tax rate led to a slight EPS beat vs. our and consensus estimates. Core pricing remained the same, as it continued to be held back by pressures in coal and international intermodal. We are slightly lowering our price target to $151, and maintaining our Market Perform rating.

UNP reported 2Q18 EPS of $1.98, up 37% y/y and slightly above our and consensus estimates of $1.97 and $1.95, respectively. Reported operating income of nearly $2.1B was $63M below our expectations. The modest beat was the result of a lower interest expense than expected and tax (240bps more favorable).

Revenue increased 8% to $5.67B, below our estimate of $5.76B and just above consensus forecasts of $5.66B. The top-line miss was the result of lackluster pricing, which came in at 2% this quarter. Ex-coal and international intermodal, pricing was up 3% for the quarter, which compares favorably to the 2.75% mark posted in 1Q. Although the overall 2% pricing number is above current rail cost inflation, inflationary pressures are likely to rise going forward, leaving us concerned that UNP has not been able to fully capitalize on what appears to be a strong pricing environment for transportation carriers across the supply chain.

Unlike their international intermodal business where contracts renew every 3-5 years, UNP’s domestic market tends to reprice annually. With tightening truck capacity and UNP calling out the impact of ELDs [Electronic Logging Devices] on trucks, it is UNP’s domestic intermodal market that is more truck-competitive and could be a source of future price improvements that can help offset the aforementioned weakness in coal and international intermodal. Indeed, results from our quarterly rail shipper survey showed pricing expectation up 90 bps on a sequential basis which marked the second largest gain in a 10 year period.

On the volume front, management did raise guidance and now expects full-year car loadings in the low to mid-single digit range (up from low single digits). While intermodal gains should come UNP’s way their outlook for autos shifted from negative in 1Q to neutral in 2Q. We are cautiously optimistic about the economy but will remain focused on any impacts seen from the ongoing trade wars.

The western giant’s operating ratio (OR) deteriorated 120bps y/y to 63% and was 50bps worse than our estimate. Management noted that rising fuel prices (investors may recall that railroad fuel surcharges typically operate on a two-month+ lag) hurt the OR by 110 bps. UNP stated it believes it should see full-year improvement in its operating ratio in the back half of the year as productivity gains take hold. Excluding one-time items in the prior year, our model now calls for a 10bps improvement in OR year-on-year.

We are lowering our 2018 and 2019 EPS estimates by $0.10 each to $7.80 and $8.90, respectively. We continue to use a 2019 EPS multiple of 17x, and as a result, our new price target falls $2 to $151. While we would remain on the sidelines it should be noted that an improvement in the company’s pricing outlook could cause us to reexamine our investment opinion.

Categories: Class I, Freight, Intermodal, News Tags: ,