Union Pacific Corporation — FY 2016 Form 10-K
Reporting period: Year ended December 31, 2016; filed February 3, 2017. This is an annual filing, not a standalone fourth-quarter report. Union Pacific operates an integrated freight railroad across 23 states, with 32,070 route miles and one reportable operating segment.
Financial and operating performance
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Operating revenue | $19.941 billion | $21.813 billion | Down 9% |
| Freight revenue | $18.601 billion | $20.397 billion | Down 9% |
| Operating income | $7.272 billion | $8.052 billion | Down 10% |
| Net income | $4.233 billion | $4.772 billion | Down 11% |
| Diluted EPS | $5.07 | $5.49 | Down 8% |
| Operating ratio | 63.5% | 63.1% | Worsened 0.4 percentage points |
| Cash from operations | $7.525 billion | $7.344 billion | Up 2% |
| Cash capital investments | $3.505 billion | $4.650 billion | Down $1.145 billion |
| Total debt | $15.007 billion | $14.201 billion | Up $806 million |
Free cash flow, as defined by the company as operating cash flow less investing cash use and dividends paid, was $2.253 billion, versus $524 million in 2015. Cash and cash equivalents were $1.277 billion at year-end. The company had $1.7 billion available under its revolving credit facility, with no borrowings, and its $650 million receivables facility was unused. A year-end working-capital deficit was attributed chiefly to lower other current assets and higher payables and upcoming debt maturities; management said this did not indicate inadequate liquidity.
Debt to capital increased to 43.0% from 40.7%; adjusted debt to capital, including lease and benefit obligations, increased to 47.3% from 45.7%. Return on invested capital, an adjusted non-GAAP measure, fell to 12.7% from 14.3%. The company declared $1.879 billion of dividends and repurchased approximately 35 million shares for $3.105 billion, returning about $5 billion to shareholders through dividends and repurchases.
Material changes and business drivers
- Carloads fell 7%, to 8.442 million, the second-lowest volume level since 1998. Management cited soft energy markets, the strong U.S. dollar’s effect on exports, and sluggish domestic consumer demand.
- Coal freight revenue declined 25%, with coal carloads down 20%; weak utility demand, high inventories, and competition from natural gas were key factors. Industrial Products revenue declined 12% and Intermodal 9%.
- Agricultural Products revenue rose 1%, supported by a large U.S. harvest and strong grain export demand late in the year. Automotive revenue fell 7%; volume was flat as growth in parts shipments offset lower finished-vehicle shipments.
- Fuel expense fell 26%, reflecting a 20% decline in average diesel price and lower traffic. Compensation and benefits expense declined 8%, aided by lower volume and productivity initiatives.
- Train speed improved 5% and terminal dwell improved 4%, partly reflecting lower volumes and better network fluidity. The reportable employee injury rate reached a record low of 0.75.
Outlook, risks and unusual items
For 2017, management expected low-single-digit volume growth, subject to economic and market conditions, and anticipated continued margin improvement through pricing, productivity, and resource utilization. The planned 2017 capital program was approximately $3.1 billion, including about $300 million for Positive Train Control (PTC). The filing gives no specific earnings or EPS guidance.
Key risks include continued volume weakness or sharp demand changes; competition and commodity substitution, particularly coal and natural gas; fuel-price volatility and the roughly two-month lag in fuel surcharges; service disruption from severe weather or capacity constraints; hazardous-material incidents; labor negotiations (then in mediation); expanded rail regulation; cybersecurity; environmental obligations; and reliance on a small number of locomotive and rail suppliers. PTC remained in implementation, with a statutory deadline of December 31, 2018, potentially extendable to 2020; cumulative investment through 2016 was approximately $2.3 billion.
Environmental remediation liabilities were $212 million at year-end, compared with $190 million in 2015, across 292 identified sites. Personal-injury and asbestos liabilities were $290 million and $111 million, respectively. The company said it did not expect known claims and contingencies to have a material adverse effect, while noting that ultimate costs and outcomes remain uncertain. Fuel-surcharge antitrust litigation and an Oxbow lawsuit remained pending; management denied the allegations and considered the cases without merit. A pipeline-easement rent dispute was treated as a gain contingency, with no recovery recognized.
Other notable items included $67 million of real-estate-sale gains in 2016, compared with $113 million in 2015; higher other expense from environmental costs, a customer bankruptcy, and canceled capital-project write-offs; and a 2016 debt exchange with no gain or loss recognized. The independent auditor gave an unqualified opinion on the financial statements, and management and the auditor concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether the expected 2017 low-single-digit volume growth and margin improvement materialized, especially in coal, intermodal, and industrial markets.
- Whether core pricing and productivity can offset volume pressure, inflation, and higher depreciation while improving the operating ratio.
- Debt maturities, interest costs, leverage, and continued access to capital markets; debt was $15.007 billion and $1.195 billion was scheduled to mature in 2017.
- Progress, cost, and deadlines for PTC and the expected return on the approximately $3.1 billion 2017 capital plan.
- Updates to environmental and casualty reserves, antitrust litigation, labor negotiations, and other contingencies, including any changes to management’s assessments.