Reflections on UNP's Q2/3rd Degree
July 20, 2018
The rail world turned upside down? I have been a railroads analyst for….some time now. I sometimes reflect on all of the changes since shortly after deregulation (the “railroad renaissance” and all that!) – but I don’t think I would have ever, ever anticipated a time when the mighty Union Pacific would be taken sharply to task for the crime of not being….CSX. After reporting consensus-beatings Q2/18 results (by 2% or so; but 37% above Q2/17), good volume growth (+4%) and increasing their volume guidance for the full year (to about Q2 levels, with 7 of the 11 categories rated “+” for H2) – not to mention essentially just coming off of an Investor Conference only last month promising a whopping $20B share buyback – one would expect some softballs in webcast Q&A. But, to my surprise, the analysts (driven it was said by one, by investor feedback) came out firing like the All Star pitchers Tuesday night (average pitch speed over 95mph). For a second, I thought I was listening to an Australian earnings webcast (try that sometime – it makes “Prime Minister’s Questions” seem like a grade-school Xmas pageant)- there were the series of questions I will label “Chessie Envy”, the usual lot about the OR – and ten (10!) on price – but, not that many on….service, which ties it all together. So let’s dive in….
Service metrics retreated in June, with an estimated $65mm cost from the now-famous tunnel collapse and from the costs of re-routing, etc – and of crew shortages. Capex will not be raised (from $3.3B). No correlation? Safety was flattish, but quarterly velocity (-3%) and dwell (+4%) worse. The outage did hurt the metrics, clearly., but velocity was running flat YOY, and dwell still worse, at the time of the incident….
UNP’s OR of 63% was an increase of 110bps – and the cause of much angst, starting with whether UNP could improve their OR in H2/18 – much less reach their targets of 60% in 2020 (and G55 at some point….)
Price – the big one. UNP reported, vaguely, of course, pricing gains of 2%, but 3% without coal (which saw a volume drop of XX%) and international intermodal (which grew 7% with the addition of new business – leading to the valid question of – if it’s a bad price environment why are you adding volumes?). Both the 2%/5% levels will show to be quite below their peers, and seem to not reflect this tight-capacity environment. As this has been a recurring issue, it was suggested that perhaps it was a systemic one, that UP would always trail its peers (management was very cool on the call – only to this last challenge did CEO Lance Fritz show a tiny bit of what I expect was his rather immense frustration: “What I am saying is what I said!”).
CSX – the surprising one! Several folks, ears likely still ringing from the party in Jax, asked how CSX could come from behind to pass UP in OR so quickly, and whether or not there was any sense of urgency in Omaha (this off of a record quarter), and, frankly, whether it was time to install PSR on the UP, not just bits of it. CSX, after all, was reducing crews and rolling stock while growing (to be far, growing at half the rate of UP in the last quarter).
These questions, whilst tough (and verging on impolite) weren’t unfair. The sense of urgency, real or perceived, is exactly the issue – while UNP has done fine in this cycle, it is widely acknowledged to have the “best franchise”; it is in great financial condition (aided by the tax cut, of course, which, as with CSX, was even lower in Q2 than expected), yet….always seems to strive for a podium finish rather than for the gold. The Investor Conference in Omaha in June suggested that was an incorrect assumption. The quarterly results – the reaction to them – seemed to bring that issue back, But, not all was wrong in the quarter, of course – it was a record, after all, and I was particularly impressed with the domestic intermodal growth rate for example, and overall marketing seems to be gaining momentum. But the other carriers on the higher podium steps are taking up a lot of investor attention, and throwing some shade on Union Pacific.
So – if this is the reception UNP got – what will next week be like?
Anthony B. Hatch