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Union Pacific: Why Its Operating Margins Improved in 2Q17

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UNP’s operating margins in 2Q17

In this article, we’ll focus on Union Pacific’s (UNP) operating margins in 2Q17. The company reported 10% growth in total operating revenues in 2Q17. Its operating expenses totaled $3.2 billion, up 4% from $3.1 billion in 2Q16. The growth in revenues outpaced the rise in operating expenses by a huge margin.

Union Pacific recorded a rise of 340 basis points in its 2Q17 operating margin. Its operating margin was 38.2%, up from 34.8% in 2Q16.

In 2016, Union Pacific kicked off a G55 + 0 operational efficiency drive. The company aims to reduce its operating ratio to 55% with zero injuries. Under the same program, it achieved $110.0 million in efficiency gains in 2Q17. 

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Compensation and benefits

UNP’s compensation and benefits expenses totaled $1.2 billion, up 3% in 2Q17. Higher wages coupled with higher volumes resulted in higher employee costs. Plus, the company’s overall workforce declined 2% in 2Q17 on a year-over-year basis.

Fuel charges

The company’s fuel expenses totaled $434.0 million, up 25% compared to 2Q16. Increased diesel prices along with a 10% rise in gross ton-miles pushed the hike in fuel expenses. 

Compared to 2Q16, Union Pacific reported a 3% improvement in its fuel consumption rate. However, its average fuel price jumped 17% to ~$1.70 per gallon. 

The second quarter of 2017 purchased services and materials expenses grew 5% to $597.0 million. The 5% rise was mainly fueled by increased volume-triggered costs, although it was subsidized by reduced joint facility expenses.

The increase in UNP’s depreciation expenses was offset by reduced equipment and other rental expenses and lower Other operating expenses.

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Management outlook

Union Pacific expects labor inflation to be ~5% in fiscal 2017. The company expects to achieve pricing above rail inflation costs. UNP expects its depreciation expenses to rise 4%–5% for fiscal 2017. 

Higher usage of Positive Train Control assets could result in higher depreciation expenses in the rest of 2017. The company anticipates slightly higher other operating expenses in 2H17.

Peers’ operating margins

Norfolk Southern (NSC) and Canadian National Railway (CNI) have not yet reported their 2Q17 earnings. Among those who have reported, CSX (CSX) recorded a 1.6% rise in operating margins. Kansas City Southern’s (KSU) 2Q17 margins fell 2.2%. Calgary-based Canadian Pacific’s (CP) margins expanded 3.3% during the same period.

All US-originated Class I railroads are included in the portfolio holdings of the Industrial Select Sector SPDR ETF (XLI).

In the final part of this series, we’ll discuss analysts’ recommendations on Union Pacific after its 2Q17 earnings.

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