Union Pacific Corp. (UNP) reported excellent financial results for the third quarter of 2011 despite facing several challenges, such as extreme heat, floods, late harvest, and reduced shipment of containers. Both revenue and EPS was well above the Zacks Consensus Estimates. Increased fuel cost recoveries, core pricing gain, and volume growth helped Union Pacific to perform fabulously. The freight railroads are gaining momentum over the truckers due to significant rise in fuel costs of truckers. The railroads are at present carrying more cargos, which is helping them to prosper even under a volatile U.S. economy. Union Pacific is also gaining.
Nevertheless, we remain concerned regarding the slowdown of intermodal volume and year-over-year increase in operating ratio. We also believe, if the global economic volatility persists for a long time, Union Pacific will be severely affected. We reaffirm our long-term Neutral recommendation on Union Pacific.
The Railroad industry is characterized as high barriers to entry. It is not easy to lay rail tracks and start shipments. The rail operators need to spend a significant amount of money as capital expenditures to maintain safety and technical improvements. Association of American Railroads (AAR), the main trade body of the industry, reported that the freight railroads together will spend a record high of $12 billion in 2011 for manpower recruitment, installation of new rail tracks and other capital projects.
Although, there are six large freight railroad operators in the U.S., they are actually enjoys a duopolistic situation. While the western part is controlled by Union Pacific and Burlington Northern Santa Fe Corp., the eastern part is dominated by CSX Corp. (CSX) and Norfolk Southern Corp. (NSC). On the other side, Canadian Pacific Railway Ltd. (CP) and Canadian National Railway Co. (CNI) controls inter country rail shipment between the U.S. and Canada. This duopolistic situation helps freight railroad operators to reap maximum benefit from rising prices as overall demand for the economy grows.
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