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Post Info TOPIC: Analysis: UP profits should set records even with slow economic growth


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Analysis: UP profits should set records even with slow economic growth
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Analysis: UP profits should set records even with slow economic growth

(The following analysis by Toby Kolstad appeared on the Gerson Lehman Group website on July 5, 2010.)

Summary

Like many of its North American railroad cousins, the UP reacted swiftly to the precipitous fall in traffic in 2009 by cutting costs and capital spending. With the help of some small rate increases, it maintained its hard won operating ratio of 76% and waited for traffic to increase. Traffic had fallen more than the economic contraction seemed to warrant, and it was a good bet that it would increase swiftly, even if it did not return to pre-recession levels.

Analysis

Notwithstanding the current concerns of a double dip recession, Union Pacific is poised to return to pre-recession profit levels (probably this year) long before traffic returns to the volumes handled in 2007/08. This diversified railroad company just keeps getting better, both at managing its costs very efficiently and wooing new customers to its lines through innovative and reliable service.

I was not a big fan of this company for many years. I had a more detailed knowledge of its operations than most observers, having worked for some of its merged companies, and I knew the management hype of past years was usually just that, a lot of self promotion to cover lackluster earnings. Even after Jim Young became president in 2004 and the company began to show some improvements, I reserved judgment to see if it was just rate hikes and a short term commodity boom that brought the higher earnings or real operational and service improvements.

The performance of the UP during the recession convinced me that their improvements were real and long lasting. Not only did they keep their operating ratio at the low level achieved before the recession, but they did so without relying heavily on rate increases to offset higher costs. A good example of the effects of their cost management can be seen in their fuel efficiencies of the past few years. The UP increased their net ton-miles per gallon more than any other railroad between 2004 and 2009, and suffered the smallest loss in efficiency of all the railroads when the traffic mix changed in early 2010 to more intermodal (less efficiently moved) and less coal (more efficiently handled) tonnage.

UP has a more diversified traffic base than it Western competitor, BNSF, with whom it shares the imported container traffic arriving at West coast ports and Powder River coal traffic. While traffic has risen in recent months in these sectors, the outlook is not that bright for either. UP on the other hand, also moves a lot of merchandize traffic from most of the industries that rely on rail transportation, including Auto, Paper, Chemical, Food, and Agricultural companies, and the outlook for these industries, while not spectacular, is brighter than those for coal and imports.

Tuesday, July 06, 2010



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