Business context and reporting period
Union Pacific Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016, compared with the same 2015 periods. Its railroad business is its sole reportable operating segment.
Financial and operating performance
Amounts are in millions except per-share data, percentages and operating statistics.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $5,174 | $5,562 | $14,773 | $16,605 |
| Operating income | $1,960 | $2,208 | $5,307 | $6,134 |
| Net income | $1,131 | $1,300 | $3,089 | $3,655 |
| Diluted EPS | $1.36 | $1.50 | $3.68 | $4.18 |
| Operating ratio | 62.1% | 60.3% | 64.1% | 63.1% |
| Cash from operations | Not separately presented for the quarter | $5,467 | $5,625 | |
| Capital investments | Not separately presented for the quarter | $2,604 | $3,323 | |
| Free cash flow | Not separately presented for the quarter | $1,266 | $498 |
Freight revenue fell 7% in Q3 and 11% year to date. Q3 carloads declined 6%; average revenue per car fell 2%, principally reflecting lower fuel surcharge revenue, partly offset by core pricing. Coal revenue declined 19% in Q3 and 30% year to date; industrial products fell 13% and 15%, respectively. Agricultural products revenue rose 6% in Q3, while other major commodity groups declined.
Operating expenses decreased 4% in Q3 and 10% year to date. Lower fuel prices, reduced volume-related costs and productivity savings were partly offset by inflation, higher depreciation and other expenses. Q3 locomotive diesel averaged $1.57 per gallon versus $1.81; year-to-date it averaged $1.42 versus $1.92. The operating ratio worsened by 1.8 points in Q3 and 1.0 point year to date as revenue and volume declines outweighed cost savings.
Liquidity, debt and capital allocation
At September 30, 2016, cash and cash equivalents were $1,909 and short-term investments were $330, versus cash of $1,391 and no short-term investments at year-end 2015. Current assets were $4,602 and current liabilities $3,257. Debt was $15,612, compared with $14,201 at December 31, 2015; debt to capital increased to 43.5% from 40.7%. Adjusted debt to capital, including operating leases and unfunded pension and OPEB obligations, was 47.7% versus 45.7%.
Operating cash flow was $5,467; investing activities used $2,819 and financing activities used $2,130 for the first nine months. Cash dividends paid were $1,382 and share repurchases were $2,100. The company had $1.7 billion available under its revolving credit facility, with no borrowings under it and no commercial paper outstanding. It reported compliance with its credit covenant.
Management reduced its 2016 capital plan by about $100 million because of anticipated locomotive delivery delays, to slightly below $3.6 billion, including Positive Train Control and excluding lease buyouts. The board’s repurchase authorization ran through December 31, 2017; 27.2 million shares remained authorized at quarter-end.
Management commentary, outlook and risks
Management said carload volume increased sequentially from Q2 but continued to align resources with demand. At quarter-end, about 3,200 employees were furloughed or in alternate work status and about 1,500 locomotives were stored. Train speed improved 2% and terminal dwell time improved 2% year over year in Q3, with management citing lower volumes and improved network operations; severe Southern Region weather caused disruptions.
No specific earnings or revenue guidance was provided. Management said it would continue to review the capital plan as business conditions or regulatory requirements warrant. It cited weak coal demand amid utility inventories and competitive natural gas, reduced shale-related shipments amid low energy prices, softer trade and domestic intermodal demand, and a customer bankruptcy as pressures. Core pricing, productivity and selected agricultural and automotive-parts volume provided offsets.
Unusual or notable items included $67 million of real-estate sale gains in the first half of 2016, versus a $113 million gain in the second quarter of 2015; an $8 million cost related to a debt exchange; and increased other expense associated with state and local taxes, bad debt, cancelled capital projects and environmental costs. In October 2016, after quarter-end, the company exchanged $1.006 billion of notes for $1.044 billion of 3.799% notes due 2051 and paid approximately $183 million plus accrued interest.
Contingencies include ongoing fuel-surcharge antitrust litigation: the class-certification hearing took place in September 2016 and a result was pending in the filing. Oxbow’s amended suit alleges more than $50 million in improper fuel surcharges; the company disputes the allegations. The company reported $208 million of environmental liabilities, $102 million of asbestos liabilities and a $288 million personal-injury liability; it estimated personal-injury settlement costs could range from $288 million to $315 million. Management did not expect known claims and contingencies, after recorded liabilities and insurance recoveries, to have a material adverse effect, but acknowledged estimation uncertainty.
Most important facts for investors to verify
- Whether freight volumes, fuel surcharge revenue and demand in coal, industrial products and intermodal continued to weaken or stabilize after the quarter.
- Whether cost reductions and service improvements can offset lower volume without further deterioration in the operating ratio.
- Execution of the revised capital plan, locomotive deliveries, and the company’s ongoing debt-funded capital allocation and share repurchases.
- Developments and potential exposure in fuel-surcharge litigation, environmental matters and personal-injury and asbestos claims.
- Debt growth, interest expense, liquidity and compliance with the revolving-credit covenant; also assess the post-quarter debt exchange’s cash and interest implications.