UNION PACIFIC CORP quarterly report, Q2 FY2017

Business context and reporting period

Union Pacific Corporation’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2017. The Railroad and its affiliates are the company’s sole reportable operating segment. Dollar amounts below are in millions unless stated otherwise.

Financial and operating performance

• Q2 freight revenue rose 11%, with carloads up 5% and average revenue per car up 6%. For the first half, freight revenue rose 9%, carloads 3%, and average revenue per car 5%.
• Q2 commodity revenue gains were strongest in coal (+25%) and industrial products (+24%); first-half gains were also led by coal (+25%) and industrial products (+16%). Chemicals and automotive had weaker volume trends, including continued declines in crude oil shipments.
• Q2 operating expenses increased 4%; first-half expenses increased 5%. Higher fuel prices, volume-related costs, inflation and depreciation were partly offset by productivity gains and resource alignment. Q2 fuel expense rose 25%; first-half fuel expense rose 34%.
• Cash provided by operations was $3,459 for the first half, versus $3,525 a year earlier. Cash capital investments were $1,589, approximately flat year over year. Free cash flow, as defined by the company, was $915 versus $762.
• Cash and cash equivalents were $1,286 at June 30. Current assets were $3,869 and current liabilities $3,406. Debt was $15,760; debt to capital was 44.6%, compared with 43.0% at year-end 2016. Adjusted debt to capital, including lease and pension adjustments, was 48.5%, versus 47.3%.
• The company had $1.7 billion available under its revolving credit facility and no commercial paper outstanding. It issued $1.0 billion of notes in April; $200 million was outstanding under its receivables facility at quarter-end.

Material changes and management commentary

Q2 revenue increased 10%, operating income 21%, net income 19% and diluted EPS 24% year over year. The improved operating ratio reflected volume growth, pricing, productivity and a modest benefit from fuel-surcharge recovery timing. Share repurchases reduced average diluted shares to 807.2 million from 840.1 million in Q2 2016. The company repurchased 15.3 million shares in the first half and declared dividends of $1.21 per share, up from $1.10.

Management reported network disruptions: Q2 average train speed fell 5% to 25.4 miles per hour and terminal dwell time increased 4% to 28.3 hours. Average workforce declined 2%; about 1,100 employees were furloughed or in alternate work status and approximately 1,400 locomotives were in storage at quarter-end.

Outlook, risks and unusual items

• The company expected its 2017 capital plan to be approximately $3.1 billion, subject to business conditions and the regulatory environment. The filing provides no specific earnings or revenue guidance.
• A settlement effective July 19, 2017, resolved pipeline-easement rent litigation; the confidential back-rent payment was to be recognized in Q3 other income and expected to add approximately $0.05 to diluted EPS.
• Following an Illinois tax-rate increase effective July 1, the company expected to record approximately $33 million of additional deferred tax expense in Q3.
• Recorded contingencies included personal-injury liabilities of $285 million, with estimated settlement costs potentially ranging from $285 million to $310 million; asbestos liabilities of $102 million; and environmental liabilities of $204 million. Management did not expect known claims and contingencies, after recorded liabilities and insurance recoveries, to materially adversely affect results, financial condition or liquidity.
• UPRR had identified 304 sites where it may be liable for environmental remediation, including 20 currently on the Superfund National Priorities List. The company also disclosed pending antitrust matters, including rail-shipper litigation awaiting a class-certification decision, and said it believed the cases were without merit.
• Future accounting changes include lease accounting expected to significantly increase reported assets and liabilities. The company expected no material financial-statement impact from the other standards discussed, including revenue recognition.

Important facts for investors to verify

• Whether network fluidity recovers and service disruptions reverse the declines in train speed and increases in dwell time.
• How much revenue and margin growth persists if fuel prices, fuel-surcharge timing, coal demand, frac-sand activity or traffic mix change.
• Progress against the approximately $3.1 billion capital plan and the effect of investment, buybacks and debt issuance on leverage and free cash flow.
• The final financial and legal effects of the pipeline settlement, Illinois tax change, antitrust proceedings and environmental and personal-injury claims.
• Whether the disclosed debt-to-net-worth covenant and available revolving credit remain adequate as obligations and financing needs evolve.