We came across a bullish thesis on Union Pacific Corporation (UNP) on ValueInvestorsClub by Ideafactory. VIC is our preferred site because the ideas there are generally posted by aspiring analysts who tend to think out of the box. We find the ideas presented on the site well thought out and worthy of a serious look. Click here for the full article. The article was posted in September 2020 when UNP was trading at $190. Below we summarized the UNP bullish thesis:
The Union Pacific Corporation is a publicly traded railroad holding company. It was incorporated in Utah in 1969 and is headquartered in Omaha, Nebraska. With over 42,000 employees, it is the parent company of the current, Delaware-registered, form of the Union Pacific Railroad.
UNP recently announced its O.R. (operating ratio) target of 55, which would probably be second to only CNI, which had nearly achieved this target. And even that too was possible after decades of PSR (Precision Scheduled Railroading) experience. UNP’s structural edge of longer LOH (length of haul), high exposure to merchandise traffic, and easier geographic footprint should help the company move heavier cargos over longer distances, optimizing the fixed-cost output. A potential successful PSR implementation could improve its O.R. to even ~50. The company’s employee productivity is improving, productivity gains are beating targets, average dwell time (the time train stands idle between stops to load/unload the freight) has dropped by 27% since 2018, and the trip plan compliance (percentage of cars on time) have improved 75-82% from 67% in 2018. This has made UNP’s operations increasingly fuel-efficient. Contrary to CSX’s PSR implementation in a short time resulting in service disruptions, UNP is doing it in stages with a O.R. target of 60 by 2020 and 55 with no time line. With two decades of PSR experience at CNI, the UNP’s COO – Jim Vena is probably the best man for the job to help UNP steer in the PSR turnaround.
Strong entry barriers
Railroads have strong entry barriers with duopoly market structure. Since the 1980s’ Stagger Act, the 40+ railroads have merged into seven with four railroads taking the largest share. The Berkshire Hathaway-owned BNSF and UNP have the duopoly on transcontinental freight rail lines in the west. Starting a new railroad is not viable for a new player. Additionally, UNP also has unique franchise of being the only railroad to serve all six major rail gateways between the U.S. and Mexico. UNP also has a 26% minority ownership interest in Ferromex (FXE), a rail network covering ~70% of Mexico. The company’s 10% revenues come from Mexico corridor.
Being more fuel-efficient than trucks, railroads have a competitive advantage over trucks, and are now poised to recapture the lost ground due to the unreliable and inconsistent rail service in the past few years.
UNP has adopted the best capital allocation in company’s history by leveraging at manageable credit (2.9x net debt/EBITDA). The $20 billion (15% of market cap) worth of share buy-back program is expected to yield handsome reward for shareholders. With a base case of O.R. of 55 and bull case of 50 the analyst is calling for a 40-60% upside in the stock. UNP trades at a 22x PE of 2021 estimates, which deserves a re-rating.
Foot notes:
- Jim Vena has moved within the company as the Special Advisor effective 1 January, 2021 through June, 2021.
- The stock has since risen to $206 from $190 on 3 September, 2020.
