The Rising Influence of Rising Affluence

[DewDiligence]

Union Pacific Is Coming 'Round the Bend

[This piece from the current issue of Barron’s is pedestrian, but I agree with the author’s contention that UNP is a fine company whose stock has a compelling stock valuation.

I consider UNP a core long-term play on The Global Demographic Tailwind insofar as its rails lines provide a key link in US exports of grain and coal to emerging markets and US imports of finished goods from emerging markets. Please see #msg-51248395, #msg-57643285, and #msg-53310057 for related material.]

http://online.barrons.com/article/SB50001424052970203793504576059952586701430.html

›The nation's No. 1 railroad has emerged from the recession leaner and meaner. It's grabbing market share from trucks and preparing to raise prices. All aboard!

JANUARY 8, 2011
By ROBIN GOLDWYN BLUMENTHAL

If you listen carefully, you can almost hear the whistle blowing. Union Pacific, the nation's largest railroad, is getting ready to barrel down the tracks.

With oil prices up, trucks are proving increasingly weak competition. With demand for commodities booming, there's plenty for Union Pacific to haul across its 33,000 miles of track. And the company has been cutting costs and preparing to raise prices.

As the economy picks up, there may be no stopping this train. Earnings per share are likely to come in at about $6.50 this year, up from $5.43 in 2010, says Lisa Dong, a portfolio manager and analyst at the Westwood Holdings Group in Dallas, which added to its position in Union Pacific in the third quarter. Dong sees the stock (ticker: UNP) at $117 by year end, up more than 25%. Within three years, she says, the shares could approach $140.

The company already is delivering the goods. It posted double-digit revenue gains throughout its freight operations in the third quarter, including a 36% jump in the automotive segment [#msg-55886742]. Union Pacific is now closing the books on what CEO James Young tells Barron's will be "one of the greatest years in our company's history."

Based in Omaha, Union Pacific dates back to 1862, when it and the Central Pacific were charged by President Abraham Lincoln with constructing the nation's first transcontinental railroad. These days, the company has a market value of about $46 billion and runs some 1,000 trains across its tracks every day, guided by increasingly high-tech logistics systems. The trains are getting longer, too—sometimes as long as two miles.

Union Pacific carries everything from coal and fertilizer to clothing and cars. All told, it has "the most compelling commodity mix and the best pricing opportunity on its book of business," says Jon A. Langenfeld, an analyst at investment firm Robert W. Baird.

In an industry that now can raise prices well in excess of inflation, Union Pacific has an added advantage: Over the next few years it is due to renegotiate long-term contracts amounting to 12% of its 2010 revenue.

The company is increasingly efficient, too. Union Pacific took advantage of the economic meltdown to sharply reduce costs and to "prove that costs are more variable than people thought," says Dong of Westwood Holdings. The company cut about 11,000 workers, or 21% of its staff, helping trim operating expenses to a record-low 68.2% of sales in the third quarter, down from 76% in all of 2009. Executives have set a target of 65% to 67% by 2015.

Moves like that have made Union Pacific a formidable competitor in the consolidating group of publicly traded railroads. (Warren Buffett's Berkshire-Hathaway (BRK-A) bought Burlington-Northern Santa Fe for $26.4 billion in February 2010). Union Pacific has a projected long-term earnings growth rate of 15%, second among U.S. railroads only to Kansas City Southern (KSU).

The next sign of the company's performance will come on Jan. 20, when it reports fourth-quarter earnings. Though the company did well in 2009's last three months, earnings per share are still seen rising 35%, to $1.46.

Some say that the terrific performance is already reflected in Union Pacific stock, up 42% in the past 12 months. But the shares still trade at just 14.4 times year-ahead earnings, not bad at all, given the railroad's projected earnings growth and well off the five-year-average price/earnings ratio of 17.7. It looks as if there's still room for the shares to run.

Young is cautious about the economic outlook, but he does see business trends moving in the right direction. He detects much more bullishness among customers than he did a year ago, and he has even begun to selectively hire.

He sees the greatest opportunity in "intermodal" transportation, or moving goods between shipping ports and inland destinations. It is here that Union Pacific and other railroads are grabbing market share from trucks, long the leaders in domestic freight. Union Pacific's own intermodal business jumped 34% in the third quarter. With oil breaching $90 a barrel, that trend shows no signs of slowing.

"We've got good momentum, and we're investing for growth," says Young, who this year is plowing some $3.2 billion into new tracks and other projects. Meanwhile, he expects to continue boosting the dividend [already done twice during 2010 (#msg-56867751)]—it now yields 1.6%—and share buybacks. Investors, all aboard.‹