Union Pacific Corporation UNP
May 10, 2004 - 6:23am EST by
2004 2005
Price: 57.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 14,000 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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  • Railroad


Union Pacific Corporation’s shares have been depressed by a temporary problem. Once the problem is solved, the shares should rebound. Then, over the next few years, because the railroad should benefit from a number of positive trends, we expect further appreciation.

In our opinion, the Union Pacific and the Burlington Northern Santa Fe are the two strongest railroads in the United States. Both operate in the western half of the country, where hauls tend to be longer and more efficient than in the more eastern half. During the recent recession, both railroads’ earnings held up quite well, partially because both reduced costs, especially the number of employees. In the middle of 2003, Union Pacific started to benefit from the stronger economy. However, commencing late in the year, the railroad’s traffic turned too strong – and the company started to suffer from congestion and resulting expensive inefficiencies. One cause of the congestion was insufficient capacity, partially stemming from the reduction in employment levels. A second cause was the particularly severe winter weather, which resulted in abnormally high occurrences of blocked (because of snow drifts and slides) and broken tracks, frozen switches, etc. The capacity problem is being solved by the addition of equipment and personnel – and the weather problem is, of course, self-correcting. It may take several additional quarters for the railroad to regain its former efficiencies – but it is logical that the problems can and will be solved

Looking ahead, we believe that the Union Pacific will benefit from a number of trends. Coal traffic should be strong as electric utilities try to burn more coal and less natural gas, which is in short supply. The high cost of gasoline should cause some traffic to shift from trucks to railroads, which are more energy efficient. Shipments to and from the West Coast ports should benefit from increased trade with China and several other rapidly growing Asian countries. Western states should continue to gain population at the expense of a number of northeastern and mid-western states. And, because of the strong demand, Union Pacific should be able to increase its rates (pricing had been soft during the recession). Given all of the above, our best guess is that Union Pacific’s revenues will increase by about 6% this year and then at about a 4% rate for the next several years (assuming a normal economy) – and that the company’s operating margins will increase to the 22 or so % level. If these projections prove true, Union Pacific’s 2006 EPS will exceed $6.00 – and at 15X earnings the shares would be “worth” in excess of $90. I note that in eight of the last ten years the PE ratio of the shares has exceeded 15X for at least part of the year – and in the mid-1990s the PE ratio often exceed 20X. Thus, we are looking for the shares to appreciate by more than 55% over the next two years.

Furthermore, Union Pacific’s book value currently is about $48 per share. Even if the company’s earnings moderately lag our projections, two years from now the company’s book value should be about equal to the current price of the shares. This is one reason we believe that the shares are a low risk investment. Other reasons include the high quality of the company’s management, balance sheet, and assets. I note that the company’s current net debt – to – cap ratio is about 44% (including leases and other obligations that are off the balance sheet), which is a low ratio for a railroad.


Union Pacific's shares have been depressed by a temporary problem. Once the problem is solved, the shares should rebound.
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