Thematic evaluation
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Union Pacific Corp. (UNP)

October 17, 2024

Compared to: Norfolk Southern Corp. (NSC) | CSX Corp. (CSX) | Industrial Select Sector SPDR Fund (XLI)

Our reasoning

Union Pacific appears moderately undervalued based on its strong financial performance, improving operational efficiency, and growth prospects in international intermodal and new markets. Despite facing risks such as demand fluctuations and cybersecurity threats, the company's valuation multiples are below industry averages, suggesting that the market has not fully priced in its potential for continued profitability and expansion.

Key takeaways
  • Union Pacific Corp. (UNP) is a financially strong company with a solid track record of profitability and cash flow generation, but faces challenges from declining revenue and a challenging economic environment.
  • UNP's operational efficiency is improving, but its liquidity position is decreasing, which could make it more difficult to meet its short-term obligations.
  • The company's growth opportunities in international intermodal and other emerging markets are promising, but it faces significant risks related to demand fluctuations, regulatory compliance, and macroeconomic conditions.
  • UNP's valuation metrics suggest that it may be undervalued, but its higher volatility and larger drawdowns indicate a higher risk profile.
  • Overall, UNP is a company with a strong financial foundation and growth potential, but investors should be aware of the associated risks.
Undervalued
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Evaluation summary

  1. Company Overview:

    • Union Pacific Corporation (UNP) is a leading Class I railroad operating in the U.S., with a network of 32,693 route miles connecting the Pacific Coast, Gulf Coast, Midwest, and Eastern U.S. gateways, as well as Mexico and Canada.
    • The company's operations are divided into three main commodity groups: Bulk (grain, fertilizer, coal, etc.), Industrial (chemicals, metals, forest products, etc.), and Premium (automotive, intermodal).
    • UNP serves a diverse customer base, including major industrial, agricultural, and consumer goods companies, and faces competition from other railroads, trucking, and maritime transportation.
    • For comparative analysis, we are using the Industrial Select Sector SPDR Fund (XLI) as a benchmark and Norfolk Southern Corp. (NSC) and CSX Corp. (CSX) as industry peers.

  2. Financial Performance:

    • UNP's revenue has been decreasing in recent quarters, driven by volume declines, mix changes, and lower fuel surcharge revenues.
    • Despite the revenue decline, the company has achieved strong profitability, with profitability ratios consistently above the industry average.
    • UNP's operating ratio has improved in recent quarters, indicating improved operational efficiency.
    • The company's return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC) are all significantly higher than the industry average, highlighting its strong profitability.
    • Compared to its peers, UNP has generally provided higher annualized returns, but it has also exhibited higher annualized volatility, suggesting a higher risk profile.

  3. Operational Efficiency:

    • UNP's working capital has been declining in recent quarters, potentially indicating a shift in working capital management strategies.
    • The company's cash flows from operations have been decreasing, potentially reflecting a decline in profitability or a change in working capital management.
    • UNP's capital expenditures have been decreasing, suggesting a potential slowdown in investment activity or a shift in strategic priorities.
    • The company's free cash flow has been trending upward, indicating its ability to generate cash flow despite the decline in operating cash flow.
    • UNP's dividend growth has been decreasing, suggesting a potential change in dividend policy or a focus on retaining cash for other purposes.
    • Compared to its peers, UNP has a lower debt-to-equity ratio and leverage ratio, indicating a lower level of financial leverage.
    • UNP's liquidity ratios are below the industry average, suggesting that the company may have a lower capacity to meet its short-term obligations compared to its peers.

  4. Growth Opportunities:

    • UNP is focused on expanding its international intermodal business, particularly in Mexico and Canada.
    • The company is investing in product development and business development to capture new opportunities in renewable diesel, petrochemicals, and other growing markets.
    • UNP is expanding its facilities and ramps to support growth, such as in Phoenix and the Gulf Coast region.
    • The company's capital allocation strategy is focused on maintaining a strong balance sheet, investing in growth opportunities, and returning capital to shareholders through dividends.
    • Management has demonstrated a track record of executing strategic plans, as evidenced by the company's consistent profitability and strong cash flow generation.

  5. Risks and Threats:

    • Fluctuations in demand for rail services and network capacity constraints pose significant risks to UNP's business.
    • The company is exposed to hazardous materials transportation and potential accidents/incidents, which could result in significant financial and reputational damage.
    • UNP's reliance on technology makes it vulnerable to cybersecurity threats, which could disrupt operations and compromise sensitive data.
    • Potential for labor disruptions and workforce availability challenges could impact the company's operations and profitability.
    • Compliance with extensive governmental regulations and environmental laws is a significant risk factor for UNP.
    • Macroeconomic conditions, such as inflation and interest rate changes, could impact the company's financial performance.

  6. Valuation Analysis:

    • UNP's valuation metrics, such as P/E ratio and EV/EBITDA, are currently below the industry average, suggesting that the company may be undervalued.
    • Compared to its peers, UNP's valuation metrics are generally lower, indicating a potential opportunity for investors seeking value.
    • Potential catalysts for UNP's stock price include continued improvement in operating efficiency, growth in international intermodal business, and a rebound in demand for rail services.

  7. Price Performance:

    • UNP's stock price has been volatile in recent months, but it has generally outperformed its peers and the broader industrial sector over the past three years.
    • The company's beta is below 1, indicating that it is less sensitive to market movements than the overall market.
    • However, UNP's higher volatility and larger drawdowns suggest that it still carries significant risk.

  8. Future Outlook:

    • Management expects continued uncertainty around the second-half recovery, with some markets showing growth while others, like coal, remain challenged.
    • The company remains confident in its ability to generate price dollars in excess of inflation and maintain freight revenue growth ahead of volume.
    • Analyst estimates for UNP's future earnings are generally positive, suggesting that the company is expected to continue to perform well.

  9. Summary:

    • UNP is a financially strong company with a solid track record of profitability and cash flow generation.
    • The company is navigating a challenging operating environment, but it has demonstrated its ability to adapt and improve its operational efficiency.
    • UNP's growth opportunities in international intermodal and other emerging markets are promising, but the company faces significant risks related to demand fluctuations, regulatory compliance, and macroeconomic conditions.
    • The company's valuation metrics suggest that it may be undervalued, but its higher volatility and larger drawdowns indicate a higher risk profile.
    • Overall, UNP is a company with a strong financial foundation and growth potential, but investors should be aware of the associated risks.
Peer fundamentals 
Fundamentals
Insights
  • Union Pacific Corp. (UNP) is a leading Class I railroad with a vast network connecting key markets across the U.S., Mexico, and Canada, serving a diverse customer base across the Bulk, Industrial, and Premium commodity groups.
  • The company is navigating industry challenges related to fluctuating demand, regulatory compliance, sustainability, and workforce availability, while investing in technology, operational improvements, and network resiliency to drive growth.
  • UNP's financial performance has been impacted by volume declines, inflationary pressures, and weather-related disruptions, but the company has demonstrated its ability to generate strong cash flow and maintain a healthy liquidity position.
  • UNP's revenue growth is decreasing, but its margins are increasing.
  • The company is controlling operating expenses, but they are increasing.
  • Overall profitability is decreasing.
  • The company's liquidity position is decreasing, which could make it more difficult to meet its short-term obligations.
  • The company's long-term solvency appears to be improving, as indicated by the reduction in debt and the increase in equity.
  • The company's cash flows from operations are decreasing, which could limit its ability to invest in growth opportunities or repay debt.
  • The company's dividend growth is decreasing, which could disappoint investors.
  • The company's future outlook is uncertain, as it faces a challenging economic environment.
  • Key balance sheet metrics to monitor in upcoming quarters include cash and short-term investments, total debt, and shareholders' equity.
  • Key cash flow metrics to monitor in upcoming quarters include cash flows from operations, free cash flow, and capital expenditures.
  • Key income statement metrics to monitor in upcoming quarters include revenue growth, operating expenses, and profitability margins.
Analysis
  • Revenue - Revenue is decreasing, potentially indicating a decline in demand or a change in pricing strategies. - The company's revenue growth is decreasing, suggesting a potential slowdown in demand or a change in pricing strategies. - The company's revenue growth is decreasing due to volume declines, mix changes, and lower fuel surcharge revenues. - The company's revenue growth is expected to continue to decrease, as the company navigates a challenging economic environment.
    • Profitability
      • The company's profitability ratios are all above the industry average, indicating that the company is generating a higher level of profit relative to its assets and equity compared to its peers.
      • The company's profitability ratios are trending slightly upward, suggesting that the company is improving its ability to generate profits.
      • The company's profitability ratios are significantly higher than its historical averages, indicating a strong performance in recent periods.
      • The company's overall profitability is decreasing, reflecting the combined impact of declining revenue and rising expenses.
      • The company's overall profitability is expected to continue to decrease, but its margins are expected to improve.
    • Liquidity
      • The company's liquidity ratios are below the industry average, suggesting that the company may have a lower capacity to meet its short-term obligations compared to its peers.
      • The company's liquidity position appears to be decreasing, as evidenced by the decline in cash and short-term investments.
      • The company's liquidity ratios are trending upward, indicating an improvement in the company's ability to meet its short-term obligations.
      • The company's liquidity ratios are lower than its historical averages, suggesting a potential decline in liquidity in recent periods.
      • The company's short-term liquidity position appears to be decreasing, as evidenced by the decline in operating cash flow.
    • Solvency
      • The company's solvency ratios are below the industry average, indicating that the company has a lower level of financial leverage compared to its peers.
      • The company's long-term solvency appears to be improving, as indicated by the reduction in debt and the increase in equity.
      • The company's solvency ratios are trending downward, suggesting a reduction in financial leverage and an improvement in the company's long-term solvency.
      • The company's solvency ratios are lower than its historical averages, indicating a significant reduction in leverage in recent periods.
      • The company's long-term solvency appears to be improving, as indicated by the reduction in debt and the increase in free cash flow.
    • Operational Efficiency
      • The company's efficiency ratios are all above the industry average, indicating that the company is effectively managing its costs and pricing strategies.
      • The company's efficiency ratios are trending upward, suggesting that the company is improving its ability to generate profits from its operations.
      • The company's efficiency ratios are significantly higher than its historical averages, indicating a strong performance in recent periods.
      • The company's asset utilization efficiency is likely improving, as evidenced by the increase in fixed assets and the decrease in working capital.
      • The company's focus on operational efficiency, as highlighted in the earnings call, could be driving the improvement in asset utilization efficiency.
    • Cash Flow Analysis
      • The company's cash flows from operations are decreasing, potentially indicating a decline in profitability or a change in working capital management.
      • The company's capital expenditures are decreasing, suggesting a potential slowdown in investment activity or a shift in strategic priorities.
      • The company's dividend growth is decreasing, suggesting a potential change in dividend policy or a focus on retaining cash for other purposes.
      • The company's cash flows from operations are likely to continue to decrease, as the company navigates a challenging economic environment.
      • The company's capital expenditures are likely to remain relatively low, as the company focuses on operational efficiency and cost management.
      • The company's dividend growth is likely to remain modest, as the company prioritizes retaining cash for other purposes.
    • Risk Factors
      • The company's liquidity position is decreasing, which could make it more difficult to meet its short-term obligations.
      • The company's revenue growth is decreasing, which could put pressure on profitability.
      • The company's operating expenses are increasing, which could further erode profitability.
      • The company's cash flows from operations are decreasing, which could limit its ability to invest in growth opportunities or repay debt.
      • The company's dividend growth is decreasing, which could disappoint investors.
    • Future Outlook
      • The company's future outlook is uncertain, as it faces a challenging economic environment.
      • The company's revenue growth is expected to continue to decrease.
      • The company's margins are expected to continue to increase.
      • The company's operating expenses are expected to continue to increase.
      • The company's overall profitability is expected to continue to decrease, but its margins are expected to improve.
      • The company's cash flows from operations are likely to continue to decrease.
      • The company's capital expenditures are likely to remain relatively low.
      • The company's dividend growth is likely to remain modest.
Most recent earnings report
Financial statements 
All public filings
Comparative Analysis
Benchmarks (as of 2024-10-15)
Industrial Select Sector SPDR Fund (XLI)
  • Performance Comparison:
    • UNP has consistently underperformed XLI over the past three years, with significant underperformance in the 2-year and 3-year periods. This suggests that UNP's performance has been weaker than the broader industrial sector.
  • Risk and Return Analysis:
    • UNP has provided lower annualized returns than XLI over the past three years. This indicates that UNP has not been as profitable as the broader industrial sector.
    • UNP has been more volatile than XLI, with consistently higher annualized volatility. This suggests that UNP's price movements have been more extreme than XLI's, making it a riskier investment.
    • UNP has experienced larger maximum drawdowns than XLI, indicating that it is more susceptible to significant price declines. This further reinforces its riskier profile.
  • Risk-Adjusted Performance:
    • XLI has consistently offered a better risk-adjusted return than UNP, as evidenced by its higher Sharpe ratio. This suggests that XLI has been more efficient in generating returns relative to its risk.
    • UNP's beta below 1 suggests that it is less sensitive to market movements than the overall market. However, its higher volatility and larger drawdowns indicate that it still carries significant risk.
  • Overall Assessment:
    • UNP has consistently underperformed XLI over the past three years, with lower annualized returns and higher volatility. This suggests that UNP is a riskier investment that has not been as profitable as the broader industrial sector. While its beta below 1 indicates a lower risk profile than the overall market, its higher volatility and larger drawdowns suggest that it still carries significant risk. Investors should carefully consider these factors before investing in UNP.
Peers Price History(as of 2024-10-15)
Norfolk Southern Corp. (NSC)CSX Corp. (CSX)
  • Performance Comparison:
    • UNP has shown a mixed performance history compared to its peers, NSC and CSX. While it has outperformed in the longer-term periods (2 years and 3 years), it has underperformed in the shorter-term periods (YTD, 1 week, 1 month, 3 months, and 1 year). This suggests that UNP's performance is more volatile and less consistent than its peers.
  • Risk and Return Analysis:
    • UNP has generally provided higher annualized returns than NSC and CSX, particularly in the longer-term periods. However, it has also exhibited higher annualized volatility, indicating a greater degree of price fluctuations.
    • The drawdown figures reveal that UNP has experienced larger maximum drawdowns than its peers, suggesting a higher risk profile. This is further supported by the higher frequency and duration of drawdowns observed for UNP.
  • Risk-Adjusted Performance:
    • UNP's Sharpe Ratio has been consistently lower than both NSC and CSX, indicating that UNP's risk-adjusted returns have been less favorable. This suggests that while UNP may offer higher returns, it comes with a higher level of risk.
    • UNP's beta has been consistently lower than both NSC and CSX, indicating that UNP is less sensitive to market movements and may be considered less risky. However, this lower beta is also associated with lower risk-adjusted returns, as evidenced by the lower Sharpe Ratio.
  • Overall Assessment:
    • UNP has shown a mixed performance history, with higher returns but also higher risk compared to its peers. Its higher volatility and larger drawdowns suggest a more volatile and less consistent performance. While its lower beta indicates a lower sensitivity to market movements, this is also associated with lower risk-adjusted returns.
    • Investors seeking higher returns may consider UNP, but they should be aware of the associated higher risk. Investors seeking a more stable and less risky investment may prefer NSC or CSX, despite their potentially lower returns.
Peers Fundamentals(as of 2024-06-30)
Norfolk Southern Corp. (NSC)CSX Corp. (CSX)
  1. Market Position and Size:
    • UNP is the largest company in the peer group, with a market cap more than twice the size of its closest competitor. This dominant position gives UNP a significant advantage in terms of scale and resources.
    • UNP's market cap is significantly larger than its peers, and this is reflected in its key financial metrics. UNP's revenue, EBITDA, and net income are all significantly higher than those of NSC and CSX. This suggests that UNP's size and market position give it a significant advantage in terms of revenue generation and profitability.
  2. Profitability and Efficiency:
    • UNP exhibits superior profitability compared to its peers and the industry average. Its Gross Profit Margin, EBITDA Margin, and Net Profit Margin are all significantly higher than those of NSC and CSX, exceeding the industry average by a considerable margin.
    • UNP demonstrates superior efficiency in generating returns compared to its peers and the industry average. Its Return on Average Assets, Return on Average Total Equity, Return on Average Total Capital, and Return On Average Invested Capital are all significantly higher than those of NSC and CSX, exceeding the industry average by a considerable margin.
  3. Financial Health and Stability:
    • UNP's liquidity position is generally healthy, with a Current Ratio and Quick Ratio that are comparable to its peers and the industry average. However, UNP's high level of debt, as reflected in its Total Debt to Total Equity Ratio and Debt / EBITDA ratio, is a notable concern.
    • UNP exhibits strong overall financial health, characterized by high profitability, efficient returns generation, and robust cash flow. However, its high debt levels are a potential risk factor that could impact its financial flexibility and profitability in the long term.
  4. Valuation and Market Perception:
    • UNP's valuation metrics are generally in line with its peers and industry averages, suggesting that the market perceives it as a fairly valued company. However, its high Price to Free Cash Flow ratio is a potential concern, indicating that investors may be paying a premium for its future cash flow potential.
    • UNP's valuation is generally in line with its peers and industry standards, but its high Price to Free Cash Flow ratio suggests that investors may be expecting strong future cash flow growth.
  5. Cash Flow and Capital Management:
    • UNP generates significantly more cash flow than its peers, considering their respective market caps. Its Net Operating Cash Flow, Total Capital Expenditure, and Free Cash Flow are all significantly higher than those of NSC and CSX.
    • UNP's strong cash flow generation is a significant advantage, allowing it to invest in growth opportunities, manage debt, and return value to shareholders.
  6. Growth and Future Prospects:
    • UNP exhibits a mixed growth profile, with strong growth in some areas and weaker growth in others. UNP's sales, EBITDA, and net income have shown consistently higher growth compared to the peer group average over the past 5 years. However, UNP's free cash flow and free cash flow margin have shown consistently lower growth compared to the peer group average.
    • UNP's growth trends suggest that it is maintaining a strong competitive position in the railroad industry. Its superior growth in sales, EBITDA, and net income indicates that it is effectively capturing market share and expanding its operations. However, its weaker growth in free cash flow and free cash flow margin is a potential concern, suggesting that the company may be facing challenges in converting its revenue growth into cash flow.
  7. Potential for Investment:
    • UNP presents an attractive investment opportunity due to its strong profitability, efficiency, and cash flow generation. Its dominant market position and growth potential are further advantages. However, its high debt levels and weaker free cash flow growth are potential risks that investors should consider.
    • UNP's strong financial performance and dominant market position make it an attractive investment. However, investors should be aware of its high debt levels and monitor its free cash flow growth.
  8. Key Risks and Considerations:
    • UNP's high debt levels are a potential risk factor that could impact its financial flexibility and profitability in the long term.
    • UNP's weaker free cash flow growth is a potential concern, suggesting that the company may be facing challenges in converting its revenue growth into cash flow.
  9. Overall Assessment:
    • UNP exhibits strong overall financial health, characterized by high profitability, efficient returns generation, and robust cash flow. However, its high debt levels are a potential risk factor that could impact its financial flexibility and profitability in the long term.
    • UNP's financial performance is generally positive, with strong profitability and efficiency metrics. However, its high debt levels are a concern that requires monitoring.