Real Client Managed Portfolio – Spring 2016
Analysts: Fang Liu, Madina Yunussova, Sashikanth (Sash) Yenika, Tanvi Rotkar, Vanditha M Ravindranath
Company/Position: Union Pacific Corporation (NYSE:UNP) We own 200, one lot at $74.10 cost, the other lot at $84.71 cost
Recommendation: HOLD
RECOMMENDATION: HOLD
Macroeconomic Outlook and Industry Overview
As the industrial leader of railroad transportation, Union Pacific Corporation outperforms the industry growth rate. Railroad industry revenue has maintained a steady CAGR of 2.7% in the last five years, and is expected to grow at 2.3% in the next 5 years. Improved economic growth of Mexico and Canada, rising global consumption, and expected US population and job growth partially offset by decreasing coal demand and low crude oil prices are the drivers of future growth. Though the power of suppliers and rivalry among competitors is high, medium power of buyers, threat of substitute products 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
A 6% decline in shipment volumes, and a decline in fuel surcharge revenue due to lower oil prices, negatively impacted Union Pacific’s revenue in 2015. However, this decline in fuel expenses due to lower prices and volumes partially offset the impact of wage inflation, higher depreciation and property taxes on margins, translating into a 40 basis points improvement in the operating ratio. UNP has been improving its operating margins over the past five years to a new record of 36.9% in 2015. This is expected to continue further as new and efficient locomotives are replacing old and less efficient locomotives. In 2015, railroad performance has been improved as average train speed has increased by 6% and average dwell time has decreased by 3%. Also, these investments enhance safety and support the transportation needs of customers. According to Federal Railroad Administration (FRA), Union Pacific is the safest railroad in the United States in 2015. 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. Regardless of the 5% increase in debt to capital ratios as a result of a $2.8 billion increase in debt from December 31, 2014, UNP maintains a strong balance sheet with strong cash flow position and other sources of liquidity.
Valuation
DCF valuation gave us an intrinsic value of $81.65, using a discount rate of 8.3% and a terminal growth rate of 3%. Keeping in mind the speculations of rising interest rates, we have grown the discount rate and estimate it to be 10.8% by FY2020 which was used to discount the terminal value. Our comparable valuation gave us a value of $83.10 per share, using Trailing Price/Earnings, Forward Price/Earnings, Price/Book, and Enterprise Value/EBITDA. Hence, we estimate the Company to be fairly valued.
Recommendation
We recommend to HOLD the shares of 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.