When you compare the company to its peers, and find that they are the best at many performance metrics, it’s a good bet the stock will perform well. Unless the whole industry is in decline, a company that outperforms its peers, gives an investor some comfort when the market’s waters get rough. If you are looking for the leader in the railroad industry, look no further than Union Pacific Corporation (NYSE:UNP).
I honestly don’t understand why more investors don’t read railroad earnings. Many times I’ve gotten some of my best stock tips from these quarterly reports. Railroads transport both raw and finished goods for multiple industries. It’s a good bet if the big three railroads, Union Pacific Corporation (NYSE:UNP), CSX Corporation (NYSE:CSX), and Norfolk Southern Corp. (NYSE:NSC), all see volumes increasing, that the industry is doing well. On the flip side, you can also get a sense of industries that may run into problems.
For instance, when Union Pacific Corporation (NYSE:UNP) reported earnings, they said that chemical volumes were up 14%, and CSX Corporation (NYSE:CSX) reported an increase of 11%. Though Norfolk Southern Corp. (NYSE:NSC) has yet to report, it’s a good bet that chemical performance will be a positive in their earnings as well. CSX Corporation (NYSE:CSX) suggested that this increase in volume was due to energy-related crude demand, as well as gas and frac sand. A smart investor might use this information to investigate companies involved in these industries.
By the same token, investors had multiple notices that the coal industry was going to have a rough patch because shipment volumes have been dropping across the board. When CSX Corporation (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC) report better than 10% declines in coal volumes and Union Pacific Corporation (NYSE:UNP) reports a 6% decrease, it’s hard to imagine a pure coal play that would do well. Even with all of this free information about the economy, investors need to like the railroad itself to put their hard earned money into the shares. The great news for Union Pacific Corporation (NYSE:UNP) investors is, their railroad is outperforming their peers in multiple ways.
4 ways better than the competition
The first reason to consider Union Pacific Corporation (NYSE:UNP) is the company has consistently weathered the coal storm better than its peers. In past quarters, CSX Corporation (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC) have reported a 15% or 20% decline in coal volumes. By comparison, Union Pacific would report a decline of 10% or less. The same relationship held true this quarter, where CSX Corporation (NYSE:CSX) saw a decline of 10%, and Union Pacific saw a decline of 6%. When an industry is struggling, the railroad that can limit the effects of this challenge should outperform.
Second, Union Pacific is the most efficient railroad based on their operating margin. In the last three months, the company reported a margin of 30.87% versus 29.58% at CSX and 26.6% at Norfolk Southern Corp. (NYSE:NSC). A higher margin theoretically should produce more cash flow, which in turn can be used for dividends or share repurchases.
Third, Union Pacific has the lowest free cash flow payout ratio of their peer group. However, investors need to be careful of how they calculate this ratio. It used to be that the cash flow statement was an easier way to tell how a company was really doing. While earnings could be manipulated, cash flow is less easy to change. The problem is many times companies are recording huge changes to their assets and liabilities that may or may not be real cash. To avoid this issue, I use something I call core free cash flow.
Core free cash flow is simply a company’s net income, plus depreciation, minus capital expenditures. Using this measure, CSX’s core free cash flow payout was 60.08% in the last quarter. By comparison, Norfolk Southern Corp. (NYSE:NSC) actually had a negative core free cash flow payout, and Union Pacific used 53.04% of their core free cash flow. With the lowest payout ratio, Union Pacific may be able to increase their dividend more easily than their peers.
Last but not least, investors should consider Union Pacific’s stronger balance sheet as a potential reason to buy the stock. While in some measures the company barely beats their competition, if we look at Union Pacific’s debt-to-equity ratio, this is no contest. The company’s debt-to-equity ratio of 0.46 is significantly less than Norfolk Southern Corp. (NYSE:NSC) at 0.86, or CSX at 0.95. With relatively less debt versus their peers, Union Pacific has more flexibility to increase the dividend, buy back shares, or make earnings accretive acquisitions.
As you can see, whether it’s better margins, free cash flow, or a stronger balance sheet, Union Pacific beats them all. Investors are being paid a yield of just under 2%, and analysts expect strong earnings growth of over 14% in the next few years. What better way to keep up with the economy, than to buy shares in the railroad that is at the top of its class?
The article There Is No One Better in This Industry originally appeared on Fool.com and is written by Chad Henage.
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