Two Blue-Chips I Bought This Week:
Union Pacific and General Electric
Whitney Tilson
Kase Capital Management
12th Annual Value Investing Seminar
Trani, Italy
July 10, 2015
Kase Capital Management
Manages Three Hedge Funds and is a
Registered Investment Advisor
Carnegie Hall Tower
152 West 57th Street, 46th Floor
New York, NY 10019
(212) 277-5606
Disclaimer
THIS PRESENTATION IS FOR INFORMATIONAL AND EDUCATIONAL PURPOSES ONLY AND SHALL NOT BE CONSTRUED TO CONSTITUTE INVESTMENT ADVICE. NOTHING CONTAINED HEREIN SHALL CONSTITUTE A SOLICITATION, RECOMMENDATION OR ENDORSEMENT TO BUY OR SELL ANY SECURITY OR OTHER FINANCIAL INSTRUMENT.
INVESTMENT FUNDS MANAGED BY WHITNEY TILSON OWN SHARES IN UNION PACIFIC AND GENERAL ELECTRIC. HE HAS NO OBLIGATION TO UPDATE THE INFORMATION CONTAINED HEREIN AND MAY MAKE INVESTMENT DECISIONS THAT ARE INCONSISTENT WITH THE VIEWS EXPRESSED IN THIS PRESENTATION.
WE MAKE NO REPRESENTATION OR WARRANTIES AS TO THE ACCURACY, COMPLETENESS OR TIMELINESS OF THE INFORMATION, TEXT, GRAPHICS OR OTHER ITEMS CONTAINED IN THIS PRESENTATION. WE EXPRESSLY DISCLAIM ALL LIABILITY FOR ERRORS OR OMISSIONS IN, OR THE MISUSE OR MISINTERPRETATION OF, ANY INFORMATION CONTAINED IN THIS PRESENTATION.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND FUTURE RETURNS ARE NOT GUARANTEED.
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The Railroad Industry: What Can Happen
When an Industry Consolidates
• The semiconductor, U.S. airline, and auto rental industries today remind me of
the railroads a decade or so ago: a lousy, capital-intensive industry –
characterized by cut-throat competition, low margins, low returns on capital, and
high debt levels – consolidates and slowly turns into a much better industry
• When this happens, there can be a decade-long tailwind of strong top-time
growth combined with improved pricing, margins, and returns on capital, leading
to rapidly rising earnings
• This, combined with investors awarding these earnings a higher multiple, can
lead to tremendous long-term stock returns (the worst performer is up 7x!):
Norfolk Southern
CSX
Union Pacific
Canadian Pacific
KC Southern
Canadian Nat’l
S&P 500
A slide I’ve presented over the past few years
-6-
Overview
• 153-year-old Union Pacific is the largest railroad in North
America, with revenue of $24 billion in 2014
• UP and Berkshire Hathaway’s Burlington Northern Santa Fe
($23.2 billion in revenue) dominate the western U.S.
• With a $95 billion enterprise value, it is the most valuable
transportation company in the world, just ahead of UPS ($93
billion)
• Headquartered in Omaha, UP’s network stretches across 23
states and 32,000 miles of track, from Los Angeles and Seattle
to Chicago and New Orleans
• UP offers gateways to the nation’s busiest ports, and ultra-long
routes from origin to destination greatly lower the cost per mile
of transport
-10-
Union Pacific Is a Spectacular Business
• A duopoly with an extremely rational competitor
• There will no new competitors
• A ~5x cost advantage over trucking
– Trucks ship a ton of freight an average of 120 miles on a gallon of
diesel fuel; railroads can move the same cargo 600 miles on that
gallon
• Strong revenue growth
• Substantial pricing power, leading to rising margins over time
• Net margin: 22%
• Return on equity: 25%
-11-
Union Pacific’s Revenue Has Doubled in
the Past Decade
$0
$5
$10
$15
$20
$25
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
$B
-12-
Union Pacific’s Profit Margin and ROE
Have Soared as Well
0%
5%
10%
15%
20%
25%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Return on Equity %
Net Income Margin %
UP’s net margin of 21.9% rivals Apple (22.5%)
and exceeds Goldman Sachs (21.1%), Intel
(20.9%), Google (20.2%) and Pfizer (18.4%)
-13-
Valuation
• Stock price (7/9/15): $95.85
• Market cap: $84.2 billion
• EV: $94.9 billion
• P/E (trailing and 2015): 16.4x
• P/E (2016): 14.4%
• EV/EBITDA: 8.8x
• Dividend yield: 2.3%
-14-
Why Has the Stock Been Weak?
• Thanks to coal, shale oil, grain and autos, Union Pacific’s
volumes soared 7% in 2014, ~4-5x the 1.5% or so that’s normal
in a good economy
• Two of UP’s major growth engines, coal and shale oil, are
currently under pressure
• Labor strife at the ports in Los Angeles and Long Beach caused
a big drop in shipments of imports from Asia
• The sudden pullback in these businesses, following a big
buildup in 2014, has temporarily saddled Union Pacific with too
many people and too much equipment, so it has idled some
locomotives and furloughed 600 workers (1.3% of 47,200)
• Revenue is expected to fall ~3% in 2015 and EPS will only rise
~2%
-15-
Reasons for Optimism
• Railroads enjoy a big, and growing, cost advantage over trucks for
long-haul shipments, so the shift of cargoes from trucks to trains
will continue and be UP’s principal growth engine in the future
• The Long Beach and LA ports are returning to normal
• The logjams from the surge in business in 2014 are now easing
• The oil business (sand, drilling pipe and crude oil), even at its
peak in 2014, was only 4.5% of revenue
• Four major franchises — intermodal freight, chemicals,
automotive, and agricultural products — are all showing strong
gains
– More than a dozen big chemical companies are building tens of
billions of dollars in petrochemical plants along the Gulf Coast, where
UP has the best rail network
– Virtually all the world’s major automakers have announced or
completed major manufacturing hubs in Mexico, and UP transports
two out of three of the new cars that Mexico exports to the U.S.
-16-
Target Stock Price
• Revenue and EPS are expected to rise ~7% and ~14%,
respectively in 2016
• At 18-20x consensus analysts’ estimates of 2016 EPS of $6.72
results in a share price of $121-$134, 26-40% above today’s
levels
-18-
Overview
• Founded in 1889, GE is the only one of the original 12
companies still in the Dow Jones Industrial Average
• The 17th largest business in the world by revenue in 2014, with
$148 billion
• GE is shedding most of GE Capital and its appliance business,
so revenue is expected to decline by ~15% to $125 billion in
2015
• Earnings are expected to decline from $1.51 in 2014 to $1.38 in
2015 (excluding one-time charges)
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
$200
-19-
General Electric’s Revenue Is Flat
Over the Past Eight Years
$B
-20-
General Electric’s Profit Margin Has Been Flat
and ROE Has Declined Over Two Decades
0%
5%
10%
15%
20%
25%
30%Return on Equity %
Net Income Margin %
-22-
General Electric’s Remaining
Businesses Are of Exceptional Quality
Note: Revenue estimates for GE Capital and Appliances & Lighting are for 2016 to reflect pending sales
2015 2015 Est.
Estimated Operating
Segment Revenue Margin
Power & Water $35.4 15.9%
Aviation $25.8 21.5%
Healthcare $18.3 17.2%
Oil & Gas $16.5 13.1%
Energy Management $9.7 5.2%
GE Capital $9.5 15.0%
Transportation $6.1 21.1%
Appliances & Lighting $1.5 5.5%
-23-
Valuation
• Stock price (7/9/15): $26.26
• Market cap: $261 billion
• P/E (2015 adjusted): 19.0x
• P/E (2016 adjusted): 16.6%
• Dividend yield: 3.5%
-24-
Why Is the Stock Interesting?
• GE is selling assets more rapidly than expected and getting
better-than-expected prices
• When GE is finished shedding assets next year, what remains
will be one of the premier global industrial businesses with high
margins, solid growth and strong backlogs
• The stock will likely command a premium multiple (P/E of 16-20)
• Analysts project earnings of ~$2.00 in 2018, but I believe
earnings will be $2.50, assuming:
– The Alstom deal goes through
– Power & Water margins rebound to 2009-13 levels (20%) by 2018
– Share repurchases average ~6% annually in 2016-18
• At 16-20x $2.50 results in a share price of $40-$50 in 2018, 54-
93% above today’s levels – and you get paid a 3.5% dividend
while you wait
-25-
General Electric Today Reminds Me of Microsoft 2½ Years
Ago – It Had Been Flat for ~15 Years and Is Up 60% Since
+60%
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