Union Pacific Earnings: Winter Weather Constrains Velocity Gains, but Firm Maintains Guidance

Wide-moat Class-I railroad Union Pacific’s UNP top line grew 3% year over year on core pricing gains and higher fuel surcharges. Total yield (revenue per carload) grew 5.5%, while total volume fell 1%, which came in shy of our forecast due to winter weather disruption. Intermodal activity is facing retail sector inventory destocking and loose capacity in the competing truckload sector, and industrial end markets softened by the end of last year. Additionally, network service was a material volume headwind (across the board) in the quarter because of weather, which offset underlying productivity gains from hiring progress. Recall that productivity and velocity had been improving throughout much of 2022 before the onset of winter. On the positive side, automotive volumes expanded on recovering production, and metals and minerals were up on healthy nonhousing construction demand and new business wins.

UP’s operating ratio (expenses/revenue), or OR, deteriorated 270 basis points year over year to 62.1%, slightly worse than we were expecting due to weather headwinds. The OR worsened because of significant wage inflation from the new labor agreement (secured in December), general cost inflation, and winter-related network inefficiencies. Encouragingly, service rebounded nicely as winter eased, and management still expects OR improvement for full-year 2023. This implies to us that the firm has high confidence that service will prove solid in the quarters ahead and that overall volumes can show sequential improvement from current levels, despite sluggish industrial production. Nonetheless, macroeconomic risk remains elevated, especially in terms of the consumer.

Overall, we do not expect to materially alter our DCF-derived $203 per share fair value estimate. The shares are trading close to our fair value estimate, placing UP in fairly valued territory. Generally speaking, the market seems to be agreeing with our longer-term outlook and model assumptions.