2023-10-12 16:38:13 ET
Summary
- Union Pacific gets a Buy rating today.
- The bullish sentiment is driven by dividend growth, positive cash flow, share price trading below average, and a reasonable P/E ratio.
- It is offset by YoY earnings declines in the top and bottom line, underperformance vs S&P500, and overvaluation on price-to-book value.
- The forward risk of declining freight volumes has been discussed.
Research Note Summary
In today's research note, I covered a rail company, Union Pacific ( UNP ), which I gave a buy rating.
This Omaha-based company with roots going back to the 1800s, and trading on the NYSE, has shown strength in the category of dividends and free cashflow, as well as being reasonably valued on price-to-earnings.
Some of its headwinds remain the downside risk of decreasing freight volume in certain freight segments, as well as underperformance vs the S&P500 index and also being last in YoY revenue growth among its railroad peers.
Methodology Used
I will utilize my WholeScore Rating methodology which looks at this stock holistically across 7 categories including potential downside risks, and assigns a rating score.
Industry Outlook
This stock is part of the rail transportation segment, which I like to call part of the critical infrastructure of North America, necessary to move a variety of goods from one point to another when it is more economical than using trucks or ships.
UNP has several large peers in this space including CSX ( CSX ) and Norfolk Southern ( NSC ) which are common sights to those of us who have traveled by rail in the US, often seeing freight trains on the railway, something I have done many times over the years. In fact, a common issue that occurs is passenger trains like Amtrak sometimes get delayed due to freight traffic, as those companies typically own the rail lines themselves.
The nature of making money in this industry is important to mention, because these rail companies depend on volume, and the demand for transporting a variety of goods such as grains, chemicals, automobiles, and other items.
If you compare UNP against 5 of its peers, it actually came in last place in terms of YoY revenue growth, a metric I believe is an indicator of somewhat lower demand for its services.
The average among these peers for YoY revenue growth has been 19.65% as of this article, and my goal is for UNP to be at least 5% above average.
Unfortunately, it is not there yet, so I gave it a score of 0 in this category. In addition, my outlook going into Q3 is that it will continue to be below average as it has quite a ways to go to overcome some of its peers.
Financial Statements
When combing through its financial statements, the metrics I think are relevant to myself as an investor would be top-line and bottom-line earnings growth on a YoY basis, cashflow, and equity growth.
If you look at the table I created below, UNP has not met my goal of 5% YoY growth on revenue and net income, according to its Q2 income statement , and my sentiment for Q3 is another YoY drop, driven by headwinds to rail volume.
While the company's equity remains positive and has seen YoY growth, according to its balance sheet , it is below my goal of 5% YoY growth, so I would like to see some more strength there, and I believe Q3 should see some improvement there.
The one area where the firm has impressed is in free cashflow per share, with a 7.18% YoY growth of free cash flow per share, beating my target of 5%. I estimate for Q3 this will continue to improve, as you can see in the cashflow statement for recent quarters the free cash flow per share has consistently been above $1.75.
For these reasons, I gave this stock a total score of 1 in this category.
Dividends
When it comes to investing, I am first thinking about cashflow , so I turn to the dividends to tell me a story of what kind of cashflow I can generate on this stock.
If you look at my table below, this stock scored well in the dividends category, exceeding my goals for 3 year dividend growth and dividend yield vs its sector.
For example, it achieved a 34% dividend growth in 3 years, and its yield is almost 57% above average, according to its dividend data .
Based on these strong numbers, I estimate Q3 to continue to see growth and close to above-average yields. However, if the share price goes up significantly it could reduce the yield somewhat, which I don't think will happen just yet until they start seeing improvement to earnings.
The cashflow scenario I created is to hold 100 shares of UNP stock and with a goal of earning at least $100 in dividend income per year, which I can achieve with this stock, and it appears for Q3 it will be the same case. This means I am looking for stocks that pay at least $0.25 per share in dividends, which this one does.
For these reasons, I gave this stock a total score of 3 in this category.
Share Price
The next question I have for this stock is whether the current share price presents a buying opportunity right now, and I say it does.
If you look at the price chart, as of the writing of this article, you can see the share price of $207.92 is just 0.72% above the 200-day simple moving average, a long-term trend I am tracking as it is a good way to smooth out the price trend over time, avoiding trying to "time" short-term daily price jumps and dips.
I created the following table to compare the share price to the moving average, with a goal of finding a share price no more than 5% above the average, and this stock fits that goal.
Though I don't think there is a perfect buy price or a perfect sell price either, my portfolio goal is typically to avoid buying at more than 5% above the moving average. In my opinion, buying at close to or below the 200-day moving average increases my upside potential and limits my downside potential, although it does not guarantee a specific future result.
I am estimating a 1-year price target of 10% above the current 200-day SMA, which would be a price of $227.07. If that estimate proves correct, I can realize a $19 per share capital gain on this stock if it was in my portfolio.
For these reasons, I gave this stock a total score of 1 in this category.
Performance vs S&P500 Index
Another factor to consider is the market momentum of this stock, as it tells a story of market sentiment and whether this stock was able to outperform a major index like the S&P500.
The table I created below shows that this stock's price performance over the prior 1 year is 60% below that of the S&P500 index, so it did not meet my goal of outperforming the S&P by 5% or better.
I think the below-average market momentum on this stock could be tied to earlier mentioned factors such as a weaker revenue growth position among its peers, and I believe many investors and analysts like to focus on consistent "top line growth".
In this case, I gave it a score of 0 in this category.
Valuation
I prefer to use the following two metrics to talk about valuation, and that is the forward price-to-earnings and price-to-book value, as they tell a data story of what the market's sentiment is in relation to this firm's earnings and book value.
In this case, the valuation metrics show that the stock is valued in line with its sector average on price to earnings but is severely overvalued on price to book value:
My target was a max 5% above the sector average, as I think above that and it gets into overvaluation territory. I am estimating for Q3 that it will be somewhat undervalued on price to earnings but will continue to show overvaluation vs book value.
I think the market is being just lukewarm on its company's earnings, but a high P/B ratio could indicate a positive market sentiment on forward book value of this company. However, I don't see the justification for such a high P/B ratio when the sector is closer to 3x book value.
In this category, I gave the stock a score of 1.
Forward-Looking Risks
I am incorporating any forward risk estimates into my overall review, and the key risk to mention for this stock is a downside risk of continued headwinds to rail volume in certain segments, which can have a business impact to a company like this that depends on volume.
The following graphics were taken from the company's Q2 presentation .
In Q2, its bulk segment suffered YoY drops in the fertilizer and food sub-segments. The remaining segments of grain and coal saw meager or flat growth YoY, which is not much to write home about.
In the industrial segment, the notable to mention is a 13% YoY drop in forest products, which is a significant drop I think, whereas the other three areas were flat or meager growth.
Although in the premium segment the intermodal category took a growth hit in volume, what saved this segment is the shipping of cars, which saw an 11% YoY growth.
The company's own outlook for 2023H2 is mixed, estimating volume growth in biofuels, construction, and automotive, while the rest remain flat or down.
Based on this, I created the following table which creates a total risk score based on adding the risk impact and risk probability, with a total risk score of 8 considered tolerable.
In this example, we know there is a high probability of decreasing freight volume, but we also know some of the segments such as automotive will be positive, so I would say the business impact is moderate.
In this category, the stock earned a score of 1.
WholeScore Rating
Here is a recap of my research note today on this stock, showing how it did in the various categories reviewed and why I gave it a buy rating.
UNP - WholeScore Rating (author analysis)
Be sure to keep track of this company's upcoming Q3 earnings release scheduled for Oct. 19th.
For further details see:
Union Pacific Chugs Along With Solid Dividend Growth And Cashflow Strength