UP: “Declines moderate in 4Q”

Union Pacific Corporation on Jan. 19 reported 2016 fourth-quarter net income of $1.1 billion, or $1.39 per diluted share compared to $1.31 per diluted share, in fourth-quarter 2015.

“While full-year volumes were down substantially year over year, we did see declines moderate in the fourth quarter,” said Lance Fritz, Union Pacific chairman, president and chief executive officer. “As we worked through the challenges of the year, we remained focused on the strategy we live each day through our six value tracks. Executing on these value tracks enables us to run a safe, efficient, and productive railroad while providing our customers an excellent value proposition.”

Operating revenue of $5.2 billion was down 1% in the fourth quarter 2016 compared to the fourth quarter 2015. Fourth quarter business volumes, as measured by total revenue carloads, declined 3% compared to 2015. While shipments of agricultural products grew 8%, volumes declined in the remaining five business groups.

Quarterly freight revenue decreased 1% compared to the fourth quarter 2015, as volume declines and lower fuel surcharge revenue more than offset core pricing gains.

Union Pacific’s 62.0% operating ratio improved 1.2 points compared to the fourth quarter 2015.

The $1.65 per gallon average quarterly diesel fuel price in the fourth quarter 2016 was 2% higher than the fourth quarter 2015.

Quarterly train speed, as reported to the Association of American Railroads, was 26.5 mph, 2% slower than the fourth quarter 2015.

The Company repurchased 9.6 million shares in the fourth quarter 2016 at an aggregate cost of nearly $940 million.

Summary of Fourth Quarter Freight Revenues: Agricultural Products up 7%; Chemicals flat; Intermodal flat; Industrial Products down 2%; Automotive down 6%; Coal down 6%

For the full year 2016, Union Pacific reported net income of $4.2 billion or $5.07 per diluted share versus $4.8 billion or $5.49 per diluted share in 2015, representing 11 and 8% decreases, respectively. Operating revenue totaled $19.9 billion as compared to $21.8 billion in 2015. Operating income totaled $7.3 billion, a 10% decrease compared to 2015. In addition:

Freight revenue totaled $18.6 billion, a 9% decrease when compared to 2015. Carloadings were down 7% versus 2015, with declines in the chemicals, coal, industrial products and intermodal business groups.

Average diesel fuel prices decreased 20% to $1.48 per gallon in 2016 from $1.84 per gallon in 2015.

Union Pacific’s operating ratio increased to 63.5%, 0.4 points higher than the full-year record set in 2015.

Train speed, as reported to the Association of American Railroads, was 26.6 mph, 5% faster compared to the full year 2015.

Union Pacific’s reportable personal injury rate of 0.75 incidents per 200,000 employee hours was a full-year record, improving 14% compared to 2015.

Union Pacific’s capital program in 2016 totaled just under $3.5 billion, a decrease of approximately $800 million compared to the full year 2015.

The Company repurchased 35.1 million shares in 2016 at an aggregate cost of $3.1 billion.

“Looking to 2017, we are fairly optimistic about some of the macro-economic indicators that drive our core business. Higher energy prices, favorable agricultural markets and improving business and consumer confidence all support a return to positive volume growth this year,” Fritz said. “We continue to have confidence in the strength and diversity of the Union Pacific franchise, which will position us well to safely and efficiently leverage stronger volumes as our markets begin to rebound. We will continue to execute on our strategic value tracks to provide our customers an excellent service experience while generating strong returns for our shareholders.”

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“UP beat our and Wall Street EPS expectations and offered a somewhat more positive tone about 2017 than on the 3Q16 call,” said Cowen and Company Managing Director and Wall Street Contributing Editor Jason Seidl. “We are raising our 2017 EPS estimate. We continue to view UP favorably longer term but maintain our Market Perform rating, as valuation is not compelling enough to warrant a more constructive opinion, even as we begin to value the shares on our newly established 2018 estimate.

“UP reported 4Q16 EPS of $1.39, up 6% y/y and above our and consensus estimates of $1.32 and $1.33, respectively. Operating income grew 2% to $1.97 Bn, also ahead of our and Street expectations of $1.91 Bn and $1.89 Bn, respectively. Revenue declined 1% to $5.17 Bn, compared to our and consensus estimates of $5.18 Bn and $5.13 Bn, respectively. The revenue decline occurred as lower volumes and fuel surcharges more than offset positive core pricing. The operating ratio (OR) improved 120 bps y/y to 62.0%, 110 bps better than our assumption and 100 bps better than the implied Street OR. Volumes declined roughly 3% in the quarter as an 8% rise in agricultural products traffic could not offset drops in all other carloading groups.

“We are modeling for 2017 volume growth of nearly 2%, not inconsistent with the company’s expectations for a low single-digit increase. Core pricing is likely to remain positive and could improve as the year progresses (investors however should not expect a step improvement in the next quarter or two). In 2016, UP achieved 1.5% core pricing, including 1% in the fourth quarter. However, excluding coal and international intermodal, pricing would have been in a 2-3% range. Fuel, which had a $0.03/sh negative impact in 4Q16, should continue to be a headwind in 1Q17 (tough comp with 1Q16) but should improve beyond that. Our forecast calls for 5% revenue growth in 2017, outpacing our estimate for a 3% increase in operating expenses. This results in a 2017 OR of 62.3%. For 2018 we are modeling for 5% revenue growth, a 4% increase in operating expenses, and 10% earnings growth. Our 2018 OR of 61.5% represents an 80 bps improvement over our 2017 estimate and is 150 bps shy of UP’s goal of a 60% OR in 2019. The company is maintaining its longer-term goal of achieving a 55% OR.

“We are raising our 2017 EPS estimate to $5.65, from $5.45, to reflect an improved outlook for several commodities, especially agricultural products, coal, industrial products, and domestic intermodal. We are also establishing our 2018 estimate of $6.20. Our price target rises from $98 to $109 as we begin valuing the shares based on our newly established 2018 EPS estimate while lowering the multiple by just half a point to 17.5x.”