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Does Union Pacific’s Free Cash Flow Suggest a Rise in 2018?

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Factors favoring railroad stocks

Transportation stocks seem to be back on track in 2018, resulting from two factors. The first factor is the passage of the Tax Cuts and Jobs Act. The provision of deduction capital expenditures for tax calculation purposes in the year incurred has favored transportation (XTN) stocks—specifically the railroads.

Secondly, Brent crude oil price edged close to $80.00 amid global turmoil on May 16. Rising energy-related commodity prices are expected to benefit US railroad stocks. Canadian Pacific Railway (CP) noted that it sees an opportunity for crude-by-rail.

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Union Pacific’s cash flow

The extent of FCF (free cash flow) is a deciding factor in dividend payments, stock buybacks, and reinvestment in the business. FCF is the excess of OCF (operating cash flow) over a company’s capital expenditure (or capex). If a company’s OCF is high and its capex is low, then the FCF will be higher. We’ll look at Union Pacific’s (UNP) operating cash flow levels and the extent of its capex.

Union Pacific’s capex-to-revenue ratio was ~16.0% in 2017, which was the lowest among all class I railroads in that year. The company’s operating cash flow was $7.2 billion in that year, down 4.0% compared with $7.5 billion in 2016. Its capital expenditure was down 7.0% to $3.2 billion in 2017 from $3.5 billion in 2016. As a result, UNP’s free cash flow declined 1.2% YoY (year-over-year) to $3.9 billion.

For fiscal 2018, analysts expect Union Pacific to report $8.5 billion in operating cash flow, indicating 17.5% growth YoY. The company has guided for capex of $3.3 billion this year, which is 2.5% lower YoY. This should take the railroad’s free cash flow to $4.7 billion in 2018, representing a 20.3% increase YoY. The levels of capex and the tax savings due to the lower tax rates should leave sufficient scope for UNP to pay higher dividends in 2018.

Railroads’ cash distributions

Prominent Eastern US railroads Norfolk Southern (NSC) and CSX (CSX) announced increased stock buybacks in 2018. Genesee & Wyoming (GWR) also initiated share repurchases in the first quarter. Kansas City Southern (KSU) also started stock buybacks in mid-2015. 

A solid rise in top-line results appears elusive for these major US railroads. However, the recent events detailed in this article have acted as a catalyst for railroad stocks’ momentum. 

Next, we’ll compare Union Pacific’s dividend payout with its peer group.

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