UNION PACIFIC CORP annual report, FY2018

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Business context and reporting period

Union Pacific Corporation’s Form 10-K covers the fiscal year ended December 31, 2018. Its principal operating company, Union Pacific Railroad, operates 32,236 route miles across 23 states in the western two-thirds of the United States, with access to major ports and Mexican gateways. The railroad is reported as one operating segment.

The filing is annual, not a standalone fourth-quarter report. It provides quarterly figures for Q4 2018 and Q4 2017.

Key financial metrics

  • Revenue: 2018 operating revenue was $22.832 billion, up 7% from $21.240 billion. Freight revenue rose 8% to $21.384 billion, reflecting 4% volume growth, higher fuel surcharges and core pricing, partly offset by unfavorable traffic mix.
  • Profit and margins: Operating income was $8.517 billion, up 5% on a reported basis; management said it increased 8% versus adjusted 2017 results. Net income was $5.966 billion and diluted EPS was $7.91. The 2018 operating ratio was 62.7%, versus 61.8% reported and 62.8% adjusted in 2017.
  • Comparability: 2017 reported net income of $10.712 billion and diluted EPS of $13.36 included a $5.935 billion non-cash income-tax benefit from the Tax Cuts and Jobs Act (TCJA). Adjusted 2017 diluted EPS was $5.79; 2018 EPS increased 37% on that basis. The filing reports 2018 effective tax rate of 22.9%, compared with negative 40.4% in 2017.
  • Fourth quarter: Q4 2018 operating revenue was $5.757 billion, operating income $2.210 billion, net income $1.554 billion and diluted EPS $2.12. Q4 2017 net income of $7.278 billion and diluted EPS of $9.25 were heavily affected by the TCJA tax benefit.
  • Cash flow and investment: Cash from operations was $8.686 billion, investing cash outflow $3.411 billion and financing cash outflow $5.222 billion. Management’s non-GAAP free cash flow was $2.976 billion after capital investments and dividends. Cash capital investments were $3.437 billion; dividends paid were $2.299 billion.
  • Debt and liquidity: Total debt was $22.391 billion, up from $16.944 billion; debt due within one year was $1.466 billion. Cash and cash equivalents were $1.273 billion. The company had a $2.0 billion revolving credit facility with no borrowings and $400 million outstanding under a $650 million receivables facility. It reported a year-end working-capital deficit, primarily due to upcoming debt maturities, but said this was not an indication of inadequate liquidity. Adjusted debt/adjusted EBITDA, a non-GAAP measure, was 2.3x versus 1.9x.
  • Shareholder returns: The company repurchased 57.2 million shares and paid $2.3 billion in dividends, reporting $10.5 billion returned to shareholders. Shares outstanding declined 6% during the year.

Material changes versus the prior comparable period

  • Freight volume increased 4%; Premium and Industrial carloads each rose 6%, while Agricultural Products declined 1% and Energy declined 2%. Premium freight revenue rose 14% and Industrial rose 9%.
  • Operating expenses increased 9% to $14.315 billion. Fuel expense rose 34% to $2.531 billion as average diesel prices increased 27% to $2.29 per gallon; management also cited excess network costs, volume-related costs, depreciation and inflation.
  • Debt increased substantially, with $6.892 billion of debt issued and $1.736 billion repaid. Interest expense rose 21% to $870 million, partly reflecting a higher average debt balance.
  • Operating conditions improved during Q4 after congestion earlier in the year. Full-year average train speed declined 4% to 24.5 mph; average terminal dwell improved 2% to 29.6 hours. Management reported Q4 terminal dwell of 26.7 hours, 14% better than the first half of 2018.

Guidance, management commentary, risks and unusual items

  • Outlook: Management expected low-single-digit volume growth in 2019 and continued margin improvement from pricing, G55+0 productivity initiatives and Unified Plan 2020. It expected approximately $3.2 billion of 2019 capital spending, with 75%–80% directed to renewing and improving existing assets. These are forward-looking expectations, not guarantees.
  • Operating plan: Precision scheduled railroading principles began under Unified Plan 2020 on October 1, 2018; full rollout was expected by mid-2019. The company said it had removed more than 1,200 locomotives and about 30,000 freight cars from its network since August 1 to improve fluidity and capacity.
  • Safety and regulation: The reportable personal injury rate increased 4% to 0.82; derailment and crossing incident rates rose 12% and 5%, respectively. The FRA approved an alternative schedule for Positive Train Control implementation, testing and refinement during 2019–2020; approximately $2.8 billion had been invested through 2018.
  • Other unusual items: The company recorded an $85 million charge for early debt extinguishment in 2018. It disclosed an expected $78 million employer railroad-retirement-tax refund and about $30 million of interest, anticipated in 2019; no refund was recorded in 2018. Adoption of the new lease standard on January 1, 2019 was expected to increase assets and liabilities by about $2 billion, without affecting results or cash flows.
  • Risks and contingencies: Key risks include demand and capacity swings, fuel-price volatility, severe weather, competition, labor negotiations, hazardous-material incidents, environmental obligations, regulatory changes, cyber disruption and access to capital markets. Environmental remediation liabilities were $223 million across 334 identified sites. A California environmental settlement required $2 million in penalties, $313,000 in fees and costs, and three years of monitoring. An antitrust fuel-surcharge class-certification appeal was pending; the company also said it intended to appeal a newly certified ADA class action. Management did not expect known claims and contingencies to have a material adverse effect.
  • Controls and audit: Management and Deloitte & Touche reported effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

  • Compare 2018 performance with adjusted, not just reported, 2017 results because the TCJA created a large one-time tax benefit in 2017.
  • Track whether Unified Plan 2020 delivers the expected service, productivity and margin gains, and whether safety performance improves.
  • Review debt maturities, leverage, financing costs and renewal of the receivables facility, which matured in July 2019.
  • Assess cash generation against substantial capital needs, dividends and share repurchases, including the new authorization for up to 150 million shares through March 31, 2022.
  • Monitor fuel costs and surcharge recovery timing, commodity-specific demand, PTC implementation, environmental liabilities and material litigation developments.