Business context and reporting period
Union Pacific Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018, compared with the same 2017 periods. Its railroad and related subsidiaries constitute one reportable operating segment.
Financial and operating performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Operating revenue | $5.928B | $5.408B | $17.075B | $15.790B |
| Operating income | $2.269B | $2.073B | $6.307B | $5.859B |
| Net income | $1.593B | $1.194B | $4.412B | $3.434B |
| Diluted EPS | $2.15 | $1.50 | $5.79 | $4.26 |
| Operating ratio | 61.7% | 61.7% | 63.1% | 62.9% |
- Q3 revenue rose 10%, including freight revenue growth of 10%, with carloads up 6% and average revenue per car up 4%. Nine-month revenue grew 8% and freight carloads 4%.
- Q3 net income increased 33%; nine-month net income increased 28%. Lower federal tax rates following the Tax Act materially supported earnings: effective tax rates were 23.3% versus 39.8% in Q3 and 22.9% versus 38.0% year to date.
- Fuel expense increased 46% in Q3 and 41% year to date, reflecting higher fuel prices and consumption. Q3 fuel price averaged $2.38 per gallon versus $1.77; the fuel consumption rate also rose 4%.
- For the first nine months, cash from operations was $6.374B; investing used $2.434B, including $2.428B of capital investments; financing used $3.405B. Company-reported free cash flow, a non-GAAP measure, was $2.224B after dividends.
- At September 30, cash and equivalents were $1.810B and short-term investments were $90M. Debt was $22.411B ($1.468B due within one year). The company had $2.0B available on its revolving facility and $200M of commercial paper outstanding.
- Adjusted debt to adjusted EBITDA was 2.3x at September 30, versus 1.9x at December 31, 2017. The company repurchased 44.7M shares for approximately $7.0B during the nine months and paid $1.716B in dividends.
Material changes versus the prior comparable period
- Revenue and operating income grew, but higher fuel, volume-related, inflationary, and network-challenge costs limited operating leverage; Q3 operating ratio was unchanged and the nine-month ratio worsened by 0.2 percentage points.
- Debt rose from $16.944B at December 31, 2017, alongside substantial share repurchases. The company issued $6.992B of debt and repaid $1.807B during the nine months.
- Other income fell to $48M for the nine months from $212M. The 2017 comparison included litigation and real-estate gains; 2018 included an $85M first-quarter early debt-extinguishment charge.
- Q3 freight growth was led by Premium and Industrial shipments. Energy volume declined 2% in Q3, including lower frac sand and coal shipments; Mexico freight revenue rose 15% in Q3.
Outlook, management commentary, risks and unusual items
- Management said network performance had stabilized, with modest sequential improvement in some measures, but ongoing congestion, high freight-car inventories, higher labor and equipment costs, locomotive maintenance, and fuel consumption continued to challenge operations. Q3 average train speed fell 6% year over year to 24.0 mph; terminal dwell improved 2% to 29.3 hours. Positive Train Control implementation also affected speed.
- The company announced Unified Plan 2020 to improve service reliability, reduce operating variability, and improve resource utilization. It expected 2018 capital expenditures of approximately $3.2B, about $100M below its prior expectation; timing of projects and equipment receipts drove the reduction. No specific earnings or revenue guidance is provided in the filing.
- On October 23, 2018, the company announced elimination of one operating region and five service units and a reduction of approximately 475 employees and 200 contractors, expected to be substantially completed in Q4 2018. Management continued to evaluate further cost-reduction opportunities.
- Environmental liabilities were $217M and personal-injury liabilities $273M at September 30. Management did not expect known claims and contingencies to materially harm results, financial condition, or liquidity. Antitrust litigation remained pending; the company said it would vigorously defend the claims.
- Potential railroad-retirement tax refunds for 1991–2017 were not recognized because they are gain contingencies; any eventual recognition could significantly affect results in the period received. The IRS was examining the 2016 return, and state tax examinations covered 2010–2016.
- The company expected adoption of the new lease standard to increase assets and liabilities by more than $2B, with the ultimate impact dependent on its lease portfolio at adoption. It reported no material change in risk factors or market-risk disclosures.
Important facts for investors to verify
- Whether Unified Plan 2020 produces sustained improvement in train speed, terminal dwell, service reliability, and operating costs.
- Whether fuel prices and consumption, congestion, and traffic mix continue to pressure margins and cash generation.
- How higher borrowing and share repurchases affect leverage, interest expense, and future capital allocation.
- Whether the $3.2B capital-spending expectation, announced workforce reductions, and lease-standard impact change.
- Developments in antitrust, environmental, personal-injury, tax-refund, and tax-examination matters, including any material change in estimated exposure.