Union Pacific is a stock I have been following for a while, and I plan on adding to my position, since I see a good upside potential (over the long term) and moderate risk, which I can evaluate better than most future developments in other sectors (tech, luxury, cars, oil…)
MY ASSUMPTIONS:
- The American economy will keep growing over the long term, (Buffet, “never bet against America”), since its fundamentals are incredibly solid (capital availability, population growth, stability and confiedence, skilled workforce, lots of value added industries, reserve currency status…)
- Increased Trade with Mexico and the re-industralisation of the US will cause an increased volume of goods and raw materials to be transported among the North American continent. I see no reason why the amount of good transported by rail (chemicals, cars, raw materials, fertilizer, coal and renewables materials…) should decrease in the future, and may even substitute some of the trade that currently takes place by shipping (shorter supply chains).
- Railroad companies have high profit margins (25-30%) and relatively law operating expenses, making them quite resilient to inflation (which may even allow them to increase their margins by charging higher price
- Distruptive innovation and new entries are unlikely because building other rail tracks next to UP's would be expensive and would not be profitable for other companies. I also don't beilieve that any new technology (drones, self driving trucks, hyperloops or whatever…) are going to be cost competitive over rail in the foreseable future.
Based on these assumptions, the business should grow based on favourable circumstances, without a need for strong investment and huge capital expenditures, which leaves lots of cash available for dividends and buybacks.
SOME NUMBERS
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The price-earning ratio for the company is around 18, which is in line with S&P 500. Thus, if current conditions persist I can expect a long term return of AT LEAST 5% (compounded), which is roughly the amount shareholders receive annualy (dividend plus buybacks).
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The amount of dividends has increased steadely year on year (https://www.macrotrends.net/stocks/charts/UNP/union-pacific/dividend-yield-history ),
while the numbers of outstanding shares is falling down (https://www.macrotrends.net/stocks/charts/unp/union-pacific/shares-outstanding)
- The company is becoming more and more efficent. I believe that operating expenses (employees paychecks and especially fuel costs (which accounted for 3.5bln last year) will decrease in the future, or at least grow at a slower rate than inflation, making the company even more profitable.
https://finance.yahoo.com/quote/UNP/financials?p=UNP
RELEVANT RISKS
- DEBT: The management seems to be really gready, and ahs been taking on more and more debt to increase dividends and buybacks. While I believe interest payments are manageble (1.2bln last year, likely to increase in the future…) , and this gamble is likely to payoff, this is a risk to be considered.
- LOSS OF MARKET SHARE: The management seems more focused on buybacks rather than re-investing into the business, and is losing market share to its only real competitor (BNSF, hold by Berkshire Hataway). While the trend is slow, and I didn't find data on the recent developments (https://finance.yahoo.com/news/comparing-results-unp-bnsf-162040284.html, is up to 2019) I find this to be the biggest risk faced by the company. I also have a position in Berkshire (B shares, the one for the plebs), which should mitigate this specific risk.
- UNIONS AND BAD PRESS: not a huge risk IMO, salaries expenses are low, and train incidents seems to be unconsequential for the company, it could lead to problems or higher cost in the future.
CONCLUSION
I believe Union Pacific is a company that will give me good returns over the long term, and that is now fairly priced. I see a lot of things going for them, and the problems they face (loss of competitiveness/ falling market share/ rising debt) don't seem that serious. I would like to hear other opinions, things I am missing, and your take on the company.
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