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Union Pacific Earnings: Fuel, Coal, Intermodal Temper Top Line

Union Pacific (NYSE:UNP) announced its first quarter results on April 23, reporting relatively stagnant revenues at $5.6 billion, missing market expectations of $5.7 billion. The railroad’s top line suffered due to coal, intermodal and fuel surcharge headwinds. Low fuel prices helped Union Pacific’s operating ratio (operating expenses expressed as a percentage of revenue), leading to a 7% rise in operating income. This also helped boost the railroad’s earnings per share by 9%, to reach $1.30. However, Union Pacific missed market expectations of earnings of $1.37 per share, which sent its stock plummeting 3.6% during pre-market trading.

In a time of weak volumes, Union Pacific seems to be operating at overcapacity. In order to better balance its resources with the current demand, the railroad has decided to cut back on its fleet and employees strength. Union Pacific has already furloughed around 500 of its train, engine and yard employees, while having reduced its hiring plans by 400. It has put 475 locomotives into storage and will be purchasing 218 efficient ones. Union Pacific has also reduced its capital expenditure plan for the year by $100 million, to around $4.2 billion.

Fuel Prices: Boon And Bane

The declining fuel prices, along with low volumes, have taken its toll on Union Pacific’s top line. For the quarter, Union Pacific’s fuel surcharge revenues declined 4% and volume declined 2%, more than offsetting benefits from pricing and favorable mix. However, the declining fuel prices have led to a net positive benefit for the railroad. This is because fuel surcharge is based on two month lagged values of highway diesel, while fuel expenses are based on spot prices. Since fuel prices have declined continuously, spot prices are lower than prices two months back, leading to lower fuel expenses than fuel surcharge revenues.

The average price of the U.S. on-highway diesel fuel declined 26% year-on-year in the first quarter.  This led to a 39% decline in Union Pacific’s fuel expense. The lower fuel bill helped reduce Union Pacific’s operating expense, which declined $147 million, leading to a 2.3% improvement in the railroad’s operating ratio.

As long as fuel prices keep on declining, Union Pacific is likely to see a net positive benefit, which should continue to help improve its operating ratio and earnings. Since fuel prices are not likely to increase anytime soon, the benefit should continue through 2015.

Weak Coal Carloads

U.S. railroads have been suffering from weak metallurgical and thermal coal prices in the global market. Coal prices have slumped due to high exports from Australian coal suppliers and low demand from China. Additionally, the strong U.S. dollar has also presented headwinds. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. Union Pacific’s coal carloads, which accounted for 17% of its revenues in 2014, have also been suffering due to these trends. Its coal volumes declined 7% in the first quarter and the weakness is likely to persist in the short term.

The price of metallurgical coal is likely to decline to a six year low in the second quarter of the year as Australian coal producers have agreed to sell met coal at around $109.50 per metric ton to Japanese steel mills in the second quarter, compared to $117 in the first quarter.  This will likely keep U.S. met coal producers at bay. Thermal coal traded at around $54 in the beginning of April, significantly lower than the cost of production at many U.S. mines, which is likely to lead to a decline in Union Pacific’s thermal coal shipments.

On the domestic front, the demand for coal at electric utilities seems to be declining, which should have an impact on Union Pacific’s domestic coal shipments. For the month of January, coal consumption at electric utilities declined 15% year-on-year, leading to a 16% rise in coal stock piles.The spot price for natural gas at Henry Hub has remained lower to $3 per million btu in the past few months, a level at which utilities start to shift from coal to natural gas. This is also evident from the rise in natural gas consumption at electric utilities, which grew 6% year-on-year in January.

ntermodal Headwinds

In the first quarter, Union Pacific’s intermodal carloads declined 3% year-on-year due to labor disputes at west coast ports, which caused shutdowns and backlogs and also led to many shippers moving their merchandise to the east coast. [1] However, now that the labor contract negotiations between the International Longshore and Warehouse Union (ILWU) and the Pacific Maritime Association (PMA) have ended, Union Pacific’s intermodal carloads have begun to recover. But the recovery will take some time, as operations on the west coast will take more than three months to return to normal. [8] This should continue to temper revenue growth of one of the most important segments for Union Pacific. Intermodal accounts for 19% of Union Pacific’s revenue, the highest of all other reported segments.

source: http://www.trefis.com