The recent and continuing slump in the energy market has had an impact on the railway industry, with some companies warning of a fall in their revenues, and consequently in profits too. However, these warnings so far have been given by the smaller companies in the industry only, such as Kansas City Southern (KSU, Financial) and Genesee & Wyoming Inc. (GWR, Financial). It would seem the bigger players like Union Pacific Corporation (UNP, Financial) are not too worried, though, and the markets seem to agree somewhat, sending the UNP stock up by over 4% in the last weeks trading. Let us take a better look at this company.
The energy markets: a two-way street
Low fuel prices impact the rail industry both ways – positive and negative, the positives comes from the fuel costs that the company incurs for its operations. UNP saw a 10% drop in its overall fuel costs, worth $92 million, in the fourth quarter of 2014, and that money adds straight to the bottom line. Continuing low diesel prices should see further savings in the expenses this year, too. The other positive comes from the oil boom within the U.S. which has seen a lot of new players in the shale oil and gas industry who don’t have proper pipeline access and depend on rail transport to carry their products to refineries and other processing and distribution facilities.
The negative impact is also a two-pronged one. The first is the reduced oil production in light of depressed crude prices. Low prices lead to lesser oil production, which in turn means there is lesser oil for train companies to carry or low oil freight business, which means lesser income. UNP’s crude oil freight business declined 13% in 2014, in volume terms. But crude shipments form only about 2% of the total freight business volumes of the company. The second, more significant aspect is from the coal business, which has seen a decline in volumes for multiple reasons, both domestic and international. UNP’s coal carloads made up 17% of revenue in 2014, and its volume had reduced by 6% in the quarter to date ending March 21. The trend of weakness in this segment is likely to continue in the short-to-medium term.
Diversity of customers
Having a diversity of industries as customers is a smart move for any rail company, and UNP is no exception. Crude forms only a part of its overall Chemicals freight segment which, despite the reduction in crude volumes, increased by 5% in 2014. Both Industrial Products and Agricultural Products showed strong double-digit growths last year as well, making up for the slack in Chemicals and Coal. Even Intermodal transport, a segment designed to partially offset the competition from other modes of transport, grew by 11% in 2014.
A good company in a solid industry
The railroad industry is quite a solid one and in a sort of testimony to that, the only company bigger than UNP, in route miles, is BSNF which was wholly bought out by Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B) a few years ago. Without getting into legal matters and environmental regulations, just the money and time required to lay new tracks is a big deterrent for new players to enter the industry. Among the existing class 1 company in the industry, UNP ranks just below BSNF in terms of route miles though UNP’s revenue is higher than BSNF. And when compared to CSX Corporation (CSX, Financial), which is third in the list in both route miles and revenue terms, Union Pacific is significantly ahead on both the counts.
Conclusion
There are short-term concerns about the railroad industry in general, but things should get better in the medium-to-long term, especially for bigger players like UNP. The stock price has gone up during the last week but still makes for a very good BUY to hold for the medium to long term.
