Union Pacific's stock is down around 10% year to date as a result of a string of downgrades by analysts and revised revenue guidance by its peers. Recently, Cowen and Company, Cleveland Research and Zacks downgraded the railroad to "market perform", "neutral" and "hold", respectively. Competing railroads Kansas City Southern and Genesee & Wyoming, revised their revenue guidance downwards, citing expectations of poor energy related volumes. In this article, we take a look at the factors responsible for these events and how they could impact Union Pacific.
See our complete analysis of Union Pacific here
Weak Coal Carloads
U.S. railroads have been suffering from weak metallurgical and thermal coal prices in the global market. Coal prices have slumped due to high exports from Australian coal suppliers and low demand from China. Additionally, the strong U.S. dollar has also presented headwinds. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. This has led to steep declines in railroads' export coal carloads.
The price of metallurgical coal is likely to decline to a six year low in the second quarter of the year as Australian coal producers have agreed to sell met coal at around $109.50 per metric ton to Japanese steel mills in the second quarter, compared to $117 in the first quarter. This will likely keep U.S. met coal producers at bay. Thermal coal traded at around $51 in the beginning of March, significantly lower than the cost of production at many U.S. mines, which is likely to lead to a decline in thermal coal shipments.
On the domestic front, the demand for coal at electric utilities seems to be declining. For the month of January, coal consumption at electric utilities declined 15% year-on-year, leading to a 16% rise in coal stock piles. The spot price for natural gas at Henry Hub has remained close to $3 per million btu in the past few months, a level at which utilities start to shift from coal to natural gas. This is also evident from the rise in natural gas consumption at electric utilities, which grew 6% year-on-year in January.
The low prices in the global coal markets and weak demand at utilities are the major reasons that railroads are predicting weak energy sector volumes and the primary reason behind lower revenue expectations by KCS and G&W. Union Pacific's coal carloads, which accounted for 17% of its revenues in 2014, have also been suffering due to these trends. Its coal carloads have declined 6% in the quarter to date ending March 21 and the weakness is likely to persist in the short term.
Crude Oil Price Declines
Another major reason behind the expectations of weak energy-related volumes is the declining price of crude oil. The price of Brent crude and U.S. crude have fallen way below the average breakeven price of $70-80 per barrel for U.S. shale, which means that at these levels, crude oil production from North American shale is unsustainable. This has had some impact on railroads’ crude oil volumes. In 2014, Union Pacific's crude oil volume declined 13% year-on-year. High crude oil production in the Petroleum Administration for Defense District 3 region and narrow spreads between the Western Texas Intermediate and Brent crude oil were also responsible for the decline.
Continued strength in the U.S. dollar and a possible nuclear deal with Iran will present headwinds to any oil price recovery. This should continue to impact Union Pacific's crude oil shipments. However, it is important to note that crude oil accounts for around 2% of Union Pacific's volumes. Therefore, the impact of a decline in crude oil shipments will not be significant enough to degrade Union Pacific's value.
Intermodal Headwinds
Union Pacific's intermodal volumes have suffered due to the labor disputes at west coast ports, which caused shutdowns and backlogs and also led to many shippers moving their merchandise to the East Coast. According to Union Pacific's carload report, its intermodal carloads are down 4% year-on-year in the quarter to date March 21. However, now that the labor contract negotiations between the ILWU and PMA have ended, Union Pacific's intermodal carloads have begun to recover. But the recovery will take some time, as operations at the west coast will take more than three months to return to normal. This should temper revenue growth of one of the most important segments for Union Pacific. Intermodal accounts for 19% of Union Pacific's revenue, the highest of all other reported segments.
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