Our rating is BUY on Union Pacific Corp. (NYSE: UNP). The shares are 6% below their 52-week highs and appear attractively valued. We think they are a suitable core holding in a diversified investment portfolio.
The beta on UNP is 1.02.
Management provided an updated outlook for 2021. Volume is expected to rise 4%-6%, with strength in export grain, biofuel, automotive and intermodal – as retailers restock inventories – offset by continued weakness in coal. Management expects the operating ratio to improve 150-200 basis points this year; the operating ratio for 2020 was 58.5%.
EARNINGS & GROWTH ANALYSIS
Bulk (31% of freight revenues), including grain, grain products, fertilizer, food & refrigerated products, and coal; Industrial (33%), including industrial chemicals and plastics, metals and minerals, forest products, and energy and specialized markets; and Premium (31%), including intermodal and finished vehicles.
Overall in the latest quarter, volume rose 3%, compared to a 4% drop in 3Q. By segment, volume fell 6% year-over-year in Industrial, was flat in Bulk, and rose 9% in Premium. The two largest subsegments were intermodal (up 12%) and grain (up 20%).
Union Pacific’s Unified Plan 2020 targeted a 60% operating ratio in 2020 on the way toward an eventual 55% ratio. In the latest quarter, UNP’s operating ratio improved 410 basis points to 55.6%. Quarterly fuel expense decreased 35% year-over-year.
Turning to our estimates, based on the latest volume trends, which are recovering, as well as management’s focus on costs, we are raising our 2021 EPS estimate to $9.60 from $9.30. Our estimate implies EPS growth of 17% for the year. We expect growth to continue for this well-managed company in 2022, and are establishing a preliminary EPS forecast of $10.55. Our long-term earnings growth rate forecast is 10%.
FINANCIAL STRENGTH & DIVIDEND
Union Pacific had $1.8 billion of cash on hand at the end of 2020. The cash flow conversion rate in 2020 was 101% of net income.
Union Pacific remains committed to maintaining a strong investment grade credit rating, ending 2020 with a BAA1 rating from Moody’s and an A- from S&P.
The company also pays a dividend. Management’s target payout ratio is 40%-45% of earnings.
MANAGEMENT & RISKS
Lance M. Fritz has been the company’s president, CEO and chairman since 2015. Mr. Fritz joined Union Pacific in 2000 and previously served as COO. Jennifer Hamann was appointed CFO in January 2020 and has worked at UNP since 1992.
UNP remains focused on improving its operating ratio, and while management stated that it is always looking for additional efficiencies, we think that the pace of ratio improvement may slow in the coming quarters. Still, UNP is an industry leader on this metric and has targeted an operating ratio of 55% over the long term.
Investors in UNP face risks.
Union Pacific’s main rival in the Western United States is BNSF Corp., which is owned by the deep-pocketed Berkshire Hathaway.
The company has a pension plan, which is not fully funded.
Union Pacific provides rail transportation services in North America. It has approximately 32,000 route miles and transports agricultural goods, automotive products, chemicals, coal, industrial products and other commodities between ports on the West Coast and Eastern gateways, as well to Mexico. Union Pacific was founded in 1862 and is based in Omaha, Nebraska. The company has 31,000 employees.
We think this comparison is important because UNP stock has outperformed peers in past periods. Based on our dividend discount model, we see fair value for UNP at more than $240 per share.