16 Jul

What Could Hurt Union Pacific and Its Peers in Q2?

WRITTEN BY Anirudha Bhagat

On Thursday, Union Pacific Railroad (UNP) is scheduled to report its second-quarter results. Analysts expect the company’s earnings growth rate to slow down more in the second quarter. Union Pacific is expected to report an adjusted EPS of $2.14—an increase of 8.2% YoY (year-over-year).

What Could Hurt Union Pacific and Its Peers in Q2?

The company’s second-quarter earnings growth projections are lower than the 15% YoY increase in the first quarter. The expectations are lower than the company’s increase of over 30% YoY recorded in all four quarters in 2018.

Union Pacific’s slower growth

Analysts expect lower revenue growth to hurt Union Pacific’s bottom-line results. They expect the company to report revenues of $5.63 billion—a YoY decrease of approximately 1%. In the first quarter, the company reported a 1.7% YoY decline in its revenues.

The first-quarter results and second-quarter projections are in contrast with the company’s performance throughout last year. Union Pacific reported high-single-digit revenue growth in all four quarters of 2018.

Analysts think that dismal rail traffic volumes could weigh on the company’s second-quarter top and bottom-line results. On July 3, Union Pacific reported a 4% YoY decline in its second-quarter rail traffic. The company’s intermodal volume fell 6%, while the carload traffic fell 2% during the quarter.

For the US, ongoing trade disputes with European countries and China had a negative impact on the freight rail traffic volume. Cheap natural gas prices and floods across several North American regions might have also contributed to the lower volume.

Will the operating ratio improve?

Despite dismal top-line projections, analysts expect Union Pacific’s bottom-line results to benefit from its cost-saving initiatives. The company is implementing the PSR (Precision Scheduled Railroading) system to improve operational efficiency and reduce network complexity.

Notably, Union Pacific has targeted to bring its operating ratio below 60% by 2020 with the help of the PSR system. The ratio signifies operating expenses as a percentage of total revenues. Therefore, a lower rate is better for the company.

Management appointed Jim Vena as the new executive vice president and COO to attain its long-term target. Vena is a well-known railroad industry veteran. Under his leadership, Canadian National Railway (CNI) achieved its best safety and operating ratio in the North American rail industry.

Trying to determine how the PSR system is helping the company improve its operating ratio is difficult. However, in the first quarter, the company’s operating rate contracted by 100 basis points. In the first quarter, Union Pacific’s operating rate was 63.6% compared to 64.6% in the first quarter of 2018

Peers’ expectations

Analysts expect Union Pacific’s peers to report sluggish top-line and bottom-line growth due to weak volumes in the second quarter. In the last quarter, Norfolk Southern’s (NSC) rail traffic volume fell 3.8% YoY, while CSX (CSX) registered a 4% YoY decline.

Analysts expect CSX’s revenues to increase 1.2% YoY compared to 4.8% growth in the first quarter. The company reported double-digit top-line growth in the last two quarters of 2018. CSX’s EPS is expected to increase 9.4% YoY compared to over 30% growth recorded in the previous five quarters.

Analysts’ top-line and bottom-line estimates for Norfolk Southern suggest an increase of 1.8% and 11.6%, respectively. The company reported revenues and EPS growth of 4.5% and 30%, respectively, in the first quarter.

Analysts expect Kansas City Southern’s (KSU) revenues to grow 3.5% YoY. The growth expectations are significantly lower than the mid-single-digit increase in the previous three quarters. Analysts expect Kansas City Southern’s earnings to rise 4.6%, which is much lower than the high-double-digit rise in the last four quarters.

Stock performance

So far, Union Pacific stock has made a remarkable run this year. Despite dismal top-line expectations, investors seemed confident about Union Pacific’s ability to deliver impressive bottom-line results. The company’s cost-cutting measures and operational efficiency improvement initiatives will likely drive its bottom-line results in the near term. The company’s aggressive shareholder return policy made investors confident.

With a YTD (year-to-date) return of 25%, Union Pacific has outperformed the broader market. The Dow Jones and the S&P 500 have gained 17.3% and 20.2%, respectively. The stock has also outpaced the iShares Transportation Average ETF’s (IYT) returns. IYT, which invests in US transportation stocks listed on the Dow Jones, has risen 15.5% YTD.

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