UNP Union Pacific Corporation Sector: Industrials BUY · Union Pacific NYSE: UNP Intermodal, 20%...
Transcript of UNP Union Pacific Corporation Sector: Industrials BUY · Union Pacific NYSE: UNP Intermodal, 20%...
AppliedPortfolioManagement Analysts:BobbyFlorence,XiaoyunYu
Report Date: 5/12/2014
Market Cap (mm) $77,834 Annual Dividend $3.18 2‐Yr Beta (S&P 500 Index) 0.98
Return on Capital 10.3% Dividend Yield 1.7% Annualized Alpha 28.8% Compared With:
EPS (ttm) $9.83 Price/Earnings (ttm) 19.1 Institutional Ownership 9.4% CSX Corp.
Current Price $188.00 Economic Value‐Added (ttm) $974 Short Interest (% of Shares) 1.0% Norfolk Southern Corporation
12‐mo. Target Price $205.00 Free Cash Flow Margin 15.1% Days to Cover Short 2.0 and the S&P 500 Index
Business Description
Total Revenue 9.0% Free Cash Flow ‐1.1%
EBIT 14.0% Total Invested Capital 4.9%
NOPAT 13.7% Total Assets 4.9%
Earnings Per Share 19.3% Economic Value‐Added 0.6%
Dividends Per Share 31.2% Market Value‐Added 25.9%
2009 2010 2011 2012 2013
23.9% 29.6% 29.3% 32.2% 33.9%
6.0% 9.6% 13.8% 11.6% 15.1%
5.9% 6.0% 6.4% 6.6% 5.6%1.7% 1.4% 1.8% 2.0% 1.8%
2009 2010 2011 2012 2013
3.76 5.58 6.78 8.33 9.47
1.08 1.31 1.93 2.49 2.96
4.27 6.33 7.37 8.90 10.01(0.24) 5.15 3.23 4.85 5.36
Datasource: Capital IQ
Margins and Yields
Operating Margin
Per Share Metrics
Earnings
NOPATFree Cash Flow
Dividends
Free Cash Flow Margin
Earnings YieldDividend Yield
Union Pacific Corporation, through its subsidiary, Union Pacific
Railroad Company, provides rail transportation services in the United
States. The company offers freight transportation services for
agricultural products, including grains, commodities produced from
grains, food, and beverage products; automotive products, such as
imported and exported shipments, finished vehicles, and automotive
parts; and chemicals consisting of industrial chemicals, plastics, crude
oil, liquid petroleum gases, fertilizers, soda ash, sodium products, and
phosphorus rock and sulfur products. It also provides transportation
Investment Thesis
ANNUALIZED 3‐YEAR CAGR
As the US economy recovers, the increasing demand of freight will boom
the industry.With our portfolio underweighted in Industrials, as analyts
previously studying the railroad industry, we became intrigued as we
studied UNP’s ability to create value for the portfolio With historic growth
that beats the S&P and still maintians a Beta of 1.Union Pacific’s 3‐Year
CAGR’s shows Total Revenue growth of 9.0%, EBIT growth of 14.0%,
Earning Per Share growth of 19.3%, Dividends Per Share growth of 31.2%,
and Total Invested Captial growth of 4.9%. With these numbers Union
Pacific shows continuous growth and efficiency while already solidifying
itself as the central and midwest leader in the railroad industry.We are
convinced the company's stock undervaluation presented the student
investment fund with a long‐term potencial opportunity.
Union Pacific Corporation Sector: Industrials BUY UNP
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UNP CSX NSC
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Price/Earnings Price/Free Cash Flow
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EBIT Net Operating Profit After Tax
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Economic Value‐Added Market Valued‐Added
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ROA ROE ROIC
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Recommendation: BUY Market Cap: $85.05 billion Current Price: $188.00
Sector: Industrial Dividend Yield: 1.9% 12-month target price: $206.66
Sub-Sector: Railroad P/E Ratio: 19.2 Beta: 1
Investment Thesis
As the US economy recovers, the demand for consumption increases year over year, which booms
the demand of freight and benefits the railroad industry. As the leading company in the industry,
Union Pacific has huge opportunities to gain profit in the future decade.
With our portfolio underweighted in Industrials, as analyts previously studying the railroad
industry, we became intrigued as we studied UNP’s ability to create value for the portfolio with
historic growth that beats the S&P and still maintians a Beta of 1 to the S&P 500.
Looking deeper at the major players in the railroad industry, Union Pacific impressued us with its
solid performance to bounce back from the recession and produce constant stable returns
thereafter.
While already being the nations leader in the railroad industry, the company’s high degree of
management throughout the company as it pursues its strategy to increase efficiency, rather than
focus on revenues, promises well for future gains in profits, margins, and stock stabability.
Union Pacific’s 3-Year CAGR’s shows Total Revenue growth of 9.0%, EBIT growth of 14.0%, Earning
Per Share growth of 19.3%, Dividends Per Share growth of 31.2%, and Total Invested Captial growth
of 4.9%. With these numbers Union Pacific shows continuous growth and efficiency while already
solidifying itself as the central and midwest leader in the railroad industry.
Union Pacific, a United States based company, diversifies our position into industrias while keeping
risk low in the Student Investment Fund.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Macroeconomic Thesis
As the economy has come back, many cyclical sectors have seen impressive strength. This is especially true in the transportation industry, as surging demand has greatly helped this key market sector, which also forms the backbone of the development of economy. In the modern economy, as the most efficient and affordable freight service, the railroad industry plays a very important role in U.S. economy, and also is representing as a barometer of US economic health. As statistics, almost 40% of the US intercity freight is served by railroad. As the US economy recovers, the demand for consumption increases year over year, which booms the demand of freight.
In consideration of a growing U.S. population and in recognition of the need for fuel efficient solutions, the US Department of Transportation estimates that the U.S. population alone is expected to increase freight demand by 30% over the next 20 years as U.S. highways are further crowded.
Positive outlook for the US agricultural trade will increase the demand of railroad freight rapidly, which contributes to 20% of UN’s revenue.
As the recovery of Economy in US, the continuing strength in housing and constructive market increases the demand of freight dramatically.
In the short run, rapid expansion of oil production in the Bakken with volumes increased nearly ten-fold between 2005 and 2013,which are expected growing more, strained the capacity of existing pipelines and of refiners able to process the oil. Rail as a means of transporting crude supplies in U.S. markets will be benefit from the booming demand of transportation.
Union Pacific
NYSE: UNP
Intermodal,
20%
Industrial Products,
18%
Engry Including coal, 19%
Agricultural, 16%
Automotive, 10%
Chemicals, 17%
FREIGHT REVENUE (2013)
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Business Segments
UNP has 6 main Freight Segments
Intermodal – $4,392.6M (20%) consists of a jumble of container and trailer shipments as well as time-sensitive business delivery requirements. UNP’s intermodal business includes both domestic and international clients.
Industrial Products - $3,953.3M (18%) includes several categories such as lumber, minerals, steel construction products, paper, consumer goods, metals and other miscellaneous products. Transportation services for government entitles and waste companies are also included.
Energy including coal - $4,173M (19%) primarily comprises coal and petroleum coke shipment to utilities, factories, and water terminals. Water terminals allow the railroad to move western U.S. coal east. And through interchange gateways and ports, UNP’s reach extends to eastern U.S. utilities, Mexico, Europe, and Asia.
Agricultural - $3,514M (16%) contains whole grains, commodities produced from grains, and food and beverage products including fresh and frozen fruits and vegetables, dairy products. UNP accessed to most of the United States’ major markets, linking Midwest and Western U.S. to export terminals in the Pacific Northwest and Gulf Coast ports, as well as Mexico.
Automotive - $2,196.3M (10%) are shipped for seven vehicles assembly plants and distrusted imported vehicles from six West Coast ports and Houston. UNP is the largest automotive carrier west of Mississippi River and access over 40 vehicle distribution centers. It also transports automotive parts.
Chemicals – $3,733.7M (17%) comprehends four broad categories: Petrochemicals, Fertilizer, Soda Ash, and Other. Petrochemicals include industrial chemicals, plastics and petroleum products, including crude oil and liquid petroleum gases at chemical-producing areas along the Gulf Coast and in the Rocky Mountain region
Union Pacific
NYSE: UNP
BNSF
UN
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Peers & Industry Analysis
The chart allow investors to compare UNP versus its industry peers and S&P 500 Railrads Index regarding to the return on stock price in the past five years. Since the beginning of 2012, UNP has started outperformance and still has a clear uptrend of its EPS, apparently beating the other leading railroad companies’.
The graphics shows the comparison of UNP and its industry peers by Argus Universe of Coverage. The long-term growth and value as two critical characteristics indicates that UNP is more growth-oriented.
This bar chart indicates the EBITDA of UNP and the strong competitor BNSF Railway for Western US feright, owned by Warren Buffett’s Berkshire Hathaway (BRK.B) in the past five years. UNP’s EBITDA grows much faster than BNSF’s since the middle of 2010. And the strength is expected to increase in the future.
Union Pacific
NYSE: UNP
Pic: Restoring locomotive: “Big Boy” 4014
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
UNP’s Sustainable Competitive Advantage
• Largest railroad company
UNP operates 8,300 locomotives over 31,800 route-miles in 23 states in the Midwest and western part of USA, occupying the largest market share in the industry. Moreover, UNP is the only one railroad company serving all 6 major gateways to Mexico.
• Strong operational network
UNP’s capital investments on network play a critical role in meeting the long-term demand for freight transportation in the U.S. UNP has invested $21.6 billion in the past 6 years on network ad operation to support American Transportation infrastructure. Over half was spent on replacing and hardening the infrastructure to further enhance safety and reliability.
By 2015, mandatory (and costly) installation of positive train control systems (PTC) will finally be complete. Completing PTC system installation could reduce CapEx by as much as 10%.
• Diversified revenue streams
With diversified six segments, UNP benefits year over year even though experiencing cyclical industry. In the past few years, the increasing revenue from the expanding sectors like automotive, construction, chemical products and agriculture somehow offset the decreasing profit from the coal consumptions.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Model Assumptions
Our analysis for UNP was based on conservative model assumptions. Our Free Cash Flows
valuation model estimates UNP’s intrinsic value at $192.18 per share for 2014 and a 12-month
target price of $206.66. Even with conservative modeling forecasts for margin expansion and
cost structure, the model indicates Union Pacific is undervalued at the current price of $188.00.
Income Statement Assumptions
Historical Growth and Margins:
Revenue Growth: Despite having a solid five-year historical growth rate of 4.1%, UNP faced a
negative revenue growth of -21.3% in 2009. This was due to the effects of the recession and
declining manufacturing orders. However, UNP was able to respond quickly earning revenues at
an increasing rate. Our forecasted income model indicates year-by-year revenue growth: starting
at a rate of 7% in 2014 and then continuing with a rate of 6% until 2017. In perpetuity, the model
forecasts a long-term growth rate of 3.5% while tapering down to our long-term growth rate of
3.5% in 2018. The growth rate was determined by Union Pacific’s position in the market equally
with increases in new manufacturing orders and consumer spending.
Forecasted Growth and Margins
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Gross Margin: UNP has seen a
consistent increase in efficiency
concerning their gross margin.
From 2008 through 2013,
Union Pacific has been able to
increase their Gross Margin
from 38.8% to 45.9%. UNP was
able to accomplish this with
superior pricing power below
inflation from contracts and
their suppliers. Starting in 2014, the model forecasts an increase in margins of 46.3%. Based on
conservative modeling forecasts, an increase of 0.3% every year is noted until perpetuity.
Management aims to improve efficiency across all aspects of the company. We will notice the
effects throughout the assumption.
Operating Margin: Historically, UNP has increased their operating margin consistently from
23.9% in 2009 to 33.9% in 2013. This is an example of incredible income statement efficiency as
the model anticipates the trend to continue. In the model, the operating margin increases to a
moderate value of 34.3%.
Thereafter, a 0.3% increase
year by year is applied until
perpetuity. This is due to
Union Pacific increasing
revenue relative to expenses,
improving costs along the
railroad, improving fuel
efficiency, and increasing
railroad delivery times.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Net Margin: Union Pacific has
realized improving income
statement efficiency from 13.4%
in 2009 and improving to 20.0%
in 2013. The model implies a
steady increase in margin
expansion, starting at 20.3% in
2014 and increasing by 0.3%
year by year until 21.5% in
perpetuity. The model suggests
the trend will continue because
of improved efficiency and costs savings.
Common Shares: UNP has historically repurchased common shares at an average rate of 1.9%.
Union Pacific has continued the trend by announcing a 60 million share repurchase plan in 2013
that expires 2017. Therefore, with respect to common share the model states a 2.5% rate of
repurchase until 2017, then reverting back to the average of 1.9% in perpetuity.
Dividend: The growing profitability of Union Pacific has allowed them to increase their dividends
at an average of 24.7%. We are confident UNP will keep returning cash to investors, therefore
the models shows an increase in dividends at a rate of 14% in 2014 and staggering down to a 5%
growth rate in perpetuity.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Balance Sheet Assumptions
Cash and Equivalents: Union Pacific has historically kept below a 6.5% cash and equivalents ratio
to sales. However, in 2009 UNP held 13.1% of cash and equivalents due to reduced debt
payments and a lower repurchase of shares. In 2014 and into perpetuity, the model suggest a
7.0% cash ratio to sales based on improving net margins and UNP’s intention to improve their
liquidity position.
Net PP&E to Sales: Union Pacific invests heavily each year in replacement, improvement, and
expansion in their railways. However, despite massive investments UNP’s property plant and
equipment ratio to sales shows a
decrease from 261.1% in 2009 to a
value of 197.3% in 2013. The model
implies a continued pattern of
decreasing PP&E relative to sales.
The 2014 forecast will hold a 194%
PP&E to sales while conservatively
declining by 2% year by year until a
value of 186% in perpetuity.
Total Debt: UNP has decreased their debt to sales from 68.1% in 2009 to 40.4% in 2013.
Compared to sales, Union Pacific has decided to refinance their position in their debt. Therefore,
the model gives a bump to 43% as the standard value.
Cost of Capital
Cost of Equity: The cost of equity 7.8% was calculated using a risk-free rate of 4.25%, market risk
premium of 6% and a beta of 1. Evaluating UNP’s 5-year beta of 1.078 and 2-year beta of .98, a
value of 1.0 was considered.
Weighted Average Cost of Capital: The W.A.C.C. was calculated using the costs of 5% for total
debt with a weight of 10.2%. The cost of equity was calculated at 8.7% with a weight of 89.8%.
The calculation came to a weighted average cost of capital of 8.1%.
Long-Term Growth Rate: A value of 3.5% was applied for the long-term indicating a conservative
growth rate while maintaining the sector’s leader in railroads.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Financial Analysis
ROA & ROE: UNP has sustained
an increase of ROE from 11.2%
to 20.7% since the recession.
The same trends can be seen in
the ROA increasing from a
value of 4.5% to 8.8%. The
forecasted ROA and ROE will
continue a modest increase
even considering the
conservative forecasts. These are signs of increased efficiency and value within the organization.
EPS & DPS: Relative to the
recession, Union Pacific’s
earnings per share is
historically stable. The EPS has
increased from $3.76 per
share in 2009 to $9.47 per
share in 2013. UNP has also
increased dividends at an
average rate of 24.7% even
through the recession. With
conservative rates for the forecast, Union Pacific is able to maintain a stable increase in both
earnings per share and dividends per share.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Value Creation Metrics
NOPAT and Free Cash Flow: Over
the past five years, UNP has
grown NOPAT at an average rate
of 12.2%. The historic growth in
NOPAT has sustained UNP’s
ability to return on invested
capital. Also since 2011 Union
Pacific has been growing their
free cash flow with their NOPAT.
The forecast anticipates an
increasing trend into the future.
Even though Union Pacific is a capital-intensive company, they have been able to generate a free
cash flow relative to their investments
EVA & MVA: Recession and post-recession, Union Pacific’s EVA remained negative through the
years 2008-2010. However in
2011, UNP’s economic value
added jumped from a negative
value of $18 million to a positive
$247 million. Leading with a
strong return on capital, Union
Pacific continues to produce EVA
to the current value of $974
million. Relative to conservative
assumptions the model forecasts
UNP to continue to add value.
The historic and future Market Value Added is stable correcting after the recession and more
recently becoming stable with EVA. The future MVA is projected to remain steady with EVA.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Value Spread
ROIC: Union Pacific’s average five-year return on invested capital is 8.3%. Considering the
negative impact of the recession, UNP recovered well, delivering current values of 10.3% A value
aboev 10% for the railroad industry is astonishing. For the forecast, the ROIC is projected to
increase based on their ability to grow
NOPAT relative to capital.
W.A.C.C.: The Weighted-average cost
of captial was calculated to 8.1%. As
mentioned above, a conseravtive basis
was considered when determing the
alternative beta.
Value Spread (ROIC – W.A.C.C.):
During the recessionary period the
return on investment dipped below the 8.1% value spread. The negative spread continued into
2009 because of declining cunsumer confidence. However, Union Pacific was able to sharply
bounce back in 2010 and began building a positive spread. Due to their focus on income
statement efficiency and contiunued effort of investing, UNP is forecasted to keep improving
their value spread.
Valuation
Present Value of Free Cash Flows: Since 2008, Union Pacifc has an increasing fiscal year-end
stock price starting at $118.80 to the current price of $188.00. The value creation model
forecastes an intrinsic value of $192.18 compared to the current value of $188.00. The twelve
month target price sits at a
relative value of $206.66. In
the model, conservative
forecats were taken into
account. For example, the
adjustments in the income
statement were small
compared to Union Pacific’s
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
goals of increasing margins. Also, a beta of 1.0 was used instead of a .98 two-year beta. Values
generated by the model suggest Union Pacific to be undervalued by $4.18. UNP being the
leading railway system in the west and central region of the United States a long-term growth
rate of 3.5% was applied. With Union Pacific’s focus on efficiency and historical metics to back up
their improving management system, provides conficdence the model provides conservative
values for the future.
Dividend Discount Model: Union Pacific has grown their dividend every year even through 2009
where they suffered a drop in earnings per share. With UNP’s current rate of dividend growth at
an average of 24.7% per year the model forecasts a conservative increase of 14% in 2014 to a
perpetual growth of 5%. Based on their current dividend of $2.96, the expect growth and an
equity required rate of return of 8.7%, UNP is worth $102.85 per share, vs. a current stock price
of $188.00. Over half of the frims value is recorded in dividends alone.
Risks to Investment
If the U.S. economy were to slow down, pertaining to the recession in 2008, new manufacturing
orders would slow down and consumer confidence would drastically decrease. The slowdown of
the economy would decrease the demand for supplies to be transported along the railway
system. Due to Union Pacific’s high dependence on suppliers, if one or more of their suppliers
suffer bankruptcy, this could have a drastic impact on their competitive advantage of pricing.
Union Pacific also is at the risk of inflating oil prices. If diesel oil prices rise unexpectidly, this
would negatively impact UNP’s margins. Weather is also a conern for the company. If there is
severe weather in a region of the country, then efficiency along the railway system will be
slowed.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Other Analyst Recommendations
According to the world-wide data gathering company Reuters, Union Pacific has a strong Buy,
Outperform, and Hold positions while not a single analyst recommending an Underperform or
Sell option. The analysts positions align with the recommendations from our forecasts, which
only adds to the conviction Union Pacific is a strong buy and hold for any portfolio.
Union Pacific
NYSE: UNP
Analysts: Bobby Florence, Xiaoyun Yu Student Investment Fund Portfolio
Recommendation Summary
As the US economy recovers, the demand for
consumption increases year over year, which
booms the demand of freight and benefit the
railroad industry. As the leading company in the
industry, Union Pacific has huge opportunities to
gain profit in the future decade.
Union Pacific’s 3-Year CAGR’s shows Total Revenue growth of 9.0%, EBIT growth of 14.0%,
Earning Per Share growth of 19.3%, Dividends Per Share growth of 31.2%, and Total Invested
Captial growth of 4.9%. With these numbers Union Pacific shows continuous growth and
efficiency while already solidifying itself as the central and midwest leader in the railroad
industry.
From the intrinsic value estimates, we can see that UNP’s current stock price is slightly undervalued in every category, except the dividend disount model. UNP has a low dividend yield of 1.9% but the intrinsic value of the dividend discount model is still valueing over half of the current stock price in the form of dividends.
Despite the low dividend yield UNP has been growing dividends per share at a rate of 31.2% over the last three years. This again shows Union Pacifics ability to create value for the portfolio.
Ultimately the present value of FCFs model states Union Pacific stock is slightly undervalued even with reduced margin growth rates and a beta of 1.0 to the market. This results also suggest continued growth into the future with appreciation of capital, economic-value added, free cash flow, NOPAT, earnings per share, dividends per share, and with the intrinsic value of the firm.
The macroeconomic outlook created by the Apllied Portfolio Management class indicated a moderate upturn expected to occur within the next year. This indicated by an increase in new manufacturing orders and an increase in consumer confidence. All these varaibles signify an increase in the demand to move more good across the United States. There is no better way to move goods than the railway system.
For all of these reasons, we rate UNP as a BUY.