The Kansas Fed’s survey: The Union Pacific’s earnings implications

The Kansas City Fed’s monthly survey

The Federal Reserve Bank of Kansas City will announce the results of April’s survey on Thursday, April 24. Unlike the Chicago Fed National Activity Index, which covers the whole country, the Kansas City Fed’s monthly Survey of Tenth District Manufacturers provides information on current manufacturing activity in the Tenth Federal Reserve District, which includes the western third of Missouri; all of Kansas, Colorado, Nebraska, Oklahoma, and Wyoming; and the northern half of New Mexico. The survey monitors factories selected according to geographic distribution, industry mix and size. Survey results are indicative of changes in manufacturing activity, including production and shipments, and monitor both changes in prices of raw materials and finished products.

The Kansas Fed’s survey: The Union Pacific’s earnings implications

 Highlights from March’s report

  • The Survey’s composite index consisting of sub-indices (production, new orders, employment, supplier delivery times, and raw materials inventory) rose to 10 in March from 4 in January.
  • The production jumped to a 3-year high of 22 in March, from 3 in February, due to increases in both durable and non-durable goods.
  • Other indices like the new orders, new export orders, capital expenditures, and order backlogs indices, all climbed higher.
  • The employment index was flat at 7, while shipments and inventories were lower though still in positive territory.
  • Inflationary pressures made their presence felt slightly as most price indices showed moderate increases, the highest being the raw materials index which increased from 37 to 57 on a year-on-year basis.

What investors can expect from the April release

  • Continued strength in the manufacturing sector albeit at a slower pace, due to increases in the future production and orders indices in March.
  • Slight improvement in the employment indices as a result of the above and also due to relatively high additions to non-farm payrolls in March.

What do manufacturing surveys mean for investors?
Three important manufacturing surveys are due to be released this week: by the Chicago, Richmond, and Kansas City Feds respectively. Last month, the Chicago and Kansas City Fed surveys reported an increase in manufacturing activity, while the Richmond Fed’s survey reported a contraction due to mostly weather-related issues.

An expansion in manufacturing activity is likely to benefit industrial firms, especially the larger ones at this stage of the recovery. Higher manufacturing output and sales is also likely to benefit companies in the transportation sector like Union Pacific Corporation (UNP) and FedEx (FDX). Both companies are part of the S&P 500 Index (IVV) which includes the 500 largest companies in the US by market capitalization. Both UNP and FDX are also part of the iShares Transportation Average ETF (IYT) which tracks the Dow Jones Transportation Average Index. The Index measures the performance of the transportation sector of the U.S. equity market.

An example of how higher industrial output and shipments have impacted returns for transportation companies, is the record results posted by Union Pacific (UNP) in Q1 2014. The company reported net income of $1.1 billion up from $957 million for the comparable quarter last year. Freight revenues for industrial products were up 10% in the quarter to ~$1.0 billion, despite weather-related challenges which impacted deliveries. Earnings were also helped by a 3% fall in diesel prices compared to Q1 2013.

Manufacturing upticks also imply that the economy is growing and the low interest rate environment that has persisted over ~six years would soon come to an end, all else constant. As bond prices move inversely with interest rates, this would imply that prices of bonds and the ETF funds investing in them, would be impacted negatively. Investors can benefit from rising rates by investing in floating rate funds like the iShares Floating Rate Bond (FLOT), where interest rates are not fixed but reset periodically.