Real Client Managed Portfolio – FALL 2015

Analysts: Pien-Cheng (William) Wei, Sashikanth Yenika, Yue (Benjamin) Xu, Zeyu Chi, and Yuqing Zhang

Company: Union Pacific Corporation (NYSE:UNP)

Position: We own ? (100 shares) of an original position purchased in April 2013 at a split adjusted cost of $74.10

Recommendation : Buy 100 shares at the market ( $8 8 . 19 a s of Nov 5 th 2015)

RECOM MENDATION: BUY


Macroeconomic Outlook and Industry Overview

As the industrial leader of railroad transportation, Union Pacific Corporation outperforms the industry growth rate. Railroad industry has maintained a steady CAGR of 4.6% in the last five years, and is expected to grow at 3.0% in the next 5 years. Improved economic growth of Mexico and Canada, rising global consumption, and expected US job and wage growth partially offset by decreasing coal demand and low crude oil prices are the drivers of future growth. Though the power of suppliers and substitute products is high, medium power of buyers and low threat of new entrants and ability to pass on any increase in fuel prices makes the industry attractive.

Company Overview

Union Pacific Corporation is one of America’s premier railroad companies, linking 23 states across the western two-thirds of the United States. The railroad’s diversified business mix includes Agricultural Products, Automotive, Chemicals, Coal, Industrial Products and Intermodal. It is also the only railroad serving all six major Mexico getaways.

Financial Analysis

UNP has been improving its operating margins over the past five years from ~29% in 2011 to ~37% in 2014. This is expected to continue further as old and less efficient locomotives are being replaced by new and efficient locomotives. In addition, the legacy pricing contracts and the ability to pass on fuel prices as fuel surcharges helps UNP maintain such high margins. UNP originates and delivers 60% of traffic while it the peer average is 50%. This along with presence in all six Mexico getaways and diversified revenue streams help UNP outperform its peers in terms of profitability. UNP maintains a strong balance sheet with robust operating cash flow and low leverage levels.

Corporate Governance Analysis

Of the total 11 directors on UNP’s board, 10 of them are independent. No executive officers are on any of the board committees while the annual board elections use majority voting. In addition, issued options represented less than 1% of outstanding shares. These policies indicate that the agency problem is minimal at UNP and board makes sure that management works towards shareholder value maximization.

Valuation

DCF valuation gave us an intrinsic value of $103.26, using a discount rate of 8.78% and a terminal growth rate of 3%. Our comparable valuation gave us a value of $95.13 per share, using Trailing Price/Earnings, Forward Price/Earnings, Price/Book, and Price/Sales.

Recommendation

We recommend buying 100 Union Pacific at current market price. The company has shown strong financials and stable revenue stream over the past years and is projected to continue growing over the next 5 years.