Thesis Intact. Key takeaways:
UNP met consensus numbers thanks to a combination of moderate volume growth and price increases, and kept costs under control. Operating Ratio (OR) was 64.6%, but productivity gains of $35M were well below management’s expectations. The shortfall was related to the network issues the company experienced during the quarter, mostly in the Southern region.
The management team is scratching its 2019 OR target of 60% (with consensus already above that numbers ~61%, so sell-side numbers shouldn’t come down too much) and its $300-350M in productivity gains guidance. The reasons are:
· Productivity initiatives affected by problems in implementing an automated train stopping and collision avoidance system (Positive Train Control), affecting the flow of operations. PTC implementation was initially targeted to end in 2018, but now pushed towards 2020. The company has reactivated 650 locomotives (250 since February) and still has 250 still in storage. To improve its service, the company is also offering signing bonuses to attract new labor and has recalled all employees on furlough
· Price inflation less than expected (something the street had been questioning the company for a while)
It long-term OR target of 55% is remains untouched at this time. The company still benefits from high barriers to entry, supporting pricing power and margins. For 2018, management remains positive on the top line possibilities, guiding to positive full year volumes and core price gains. They are also evaluating its capital structure, and could see some debt funded buyback to be announced at its Analyst Day on May 30th. We see this quarter as a one-time blip in the company’s strong operational history. We remain positive on the name.
Valuation: price target $145 unchanged
· The company continues to return capital to shareholders, buying back $4B shares in 2017 (4% reduction in share count), and distributing ~$2B in dividends (2% yield)
· The balance sheet is still solid, with leverage below 2x
Investment Thesis:
1. Pricing power: Railroads offer 4x the fuel efficiency of trucking per ton-mile of freight – a secular tailwind
2. History of compelling long term shareholder returns
3. Industry leading operating ratio and improving ROIC driving returns to shareholders via dividends/buybacks. Real shareholder yield of 6.5% (2.5% dividend yield, 4% buyback)
$UNP.US
[tag UNP]
Julie S. Praline
Director, Equity Analyst
Direct: 617.226.0025
Fax: 617.523.8118
Crestwood Advisors
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Boston, MA 02109
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