Navigating Forward, A Journey To Stronger Margins And Shareholder Value

Key Takeaways

• Union Pacific's efficiency improvements, such as reduced fuel costs and longer trains, are enhancing financial performance despite volume declines.
  
• Strategic pricing and a focus on profitable mixes, along with a commitment to service excellence, are key drivers for revenue growth and margin expansion.
  
• Challenges in coal markets, fuel surcharge reductions, volatility in intermodal demand, inflation, and competition from trucking risk impacting volumes, revenue, and margins.

Catalysts

Through its subsidiary, Union Pacific Railroad Company, operates in the railroad business in the United States.

• Union Pacific is establishing a more efficient and productive network, which positively impacts margins by reducing fuel costs, increasing train lengths, and improving locomotive productivity. This improved efficiency translates directly into better financial performance, particularly in the face of volume declines in certain segments.
  
• Solid core pricing gains in combination with favorable business mix changes are expected to continue, boosting freight revenue growth ahead of volume growth. This strategic pricing and focus on more profitable mix could enhance overall revenue quality and contribute to margin expansion.
  
• The focus on safety, service, and operational excellence is fostering a more reliable and attractive service offering, potentially increasing customer retention and attracting new business, leading to revenue growth opportunities in various market segments.
  
• Initiatives to generate productivity improvements across the board are expected to further reduce expenses, directly benefitting the operating ratio. Continuous improvement in this area, even in a challenging environment, indicates strong management execution that could unlock shareholder value.
  
• The planned restart of share repurchases in the second quarter signals management confidence in the company’s financial health and strategy. This action could support earnings per share growth and reflect positively on the company's valuation.

Assumptions

• Analysts are assuming Union Pacific's revenue will grow by 4.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 26.5% today to 29.6% in 3 years time.
• Analysts expect earnings to reach $8.1 billion (and earnings per share of $14.42) by about July 2027, up from $6.4 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $8.4 billion in earnings, and the most bearish expecting $6.6 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 24.2x on those 2027 earnings, up from 23.3x today. This future PE is lower than the current PE for the US Transportation industry at 24.6x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.38%, as per the Simply Wall St company report.

Risks

• Persistent challenges and uncertainty in key markets such as coal, which faces difficult market conditions due to record low natural gas prices, could negatively impact volumes and pressure revenue.
  
• The reduction in fuel surcharge revenue, influenced by lower fuel prices, if prolonged, could continue to negatively affect freight revenue, despite gains in core pricing and positive business mix.
  
• Volatility in international intermodal demand, as highlighted by soft market conditions and the loss of an international contract, poses a risk to volume growth and revenue in this segment.
  
• Elevated inflation and the costs associated with new labor agreements could outpace productivity gains and negatively affect net margins.
  
• Competition from other transportation modes, especially trucking in the domestic intermodal and automotive segments, could impact Union Pacific's ability to grow volumes and maintain or increase its market share, potentially affecting earnings.

Valuation

• The analysts have a consensus price target of $261.71 for Union Pacific based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $290.0, and the most bearish reporting a price target of just $210.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $27.5 billion, earnings will come to $8.1 billion, and it would be trading on a PE ratio of 24.2x, assuming you use a discount rate of 7.4%.
  
• Given the current share price of $243.89, the analyst's price target of $261.71 is 6.8% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.