The value case for railroad stocks is a pretty simple one, that’s been around forever. It goes like this: railways have a stranglehold on some aspects of ground transportation such as bulk haulage in many areas. Therefore they make money by effectively charging a toll on certain goods and raw material.
This toll-charging aspect is why value gurus like Warren Buffett and his bridge buddy Bill Gates love railways. Berkshire Hathaway (NYSE: BRK.B) famously ones one transcontinental railway; the Burlington North Santa Fe (BNSF), and gates owns a large chunk of the Canadian National (NYSE: CNI) a competing transcontinental.
Is thesis true, can transcontinental railroads make a lot of money these days? After all, they do control the freight conveyer between America’s population centers in the Midwest and East Coast, and the West Coast ports where all the consumer goods from China get offloaded. To answer that question I took a look at the oldest and famous transcontinental the Union Pacific (NYSE: UNP).
Does the Union Pacific Make Money?
The UP’s financial numbers prove that running a toll booth is still profitable but not necessarily lucrative. The Union Pacific (UP) reported revenues of $20.96 billion and a net income of $4.578 billion on 30 September 2017.
The income is pretty good at the UP, the railroad reported $4.578 billion in net income. That figure was up slightly from $4.578 billion in September 2016, but still below the $5.086 billion reported in September 2015.
The income is good because the UP’s revenues have dropped dramatically in recent years. Union Pacific reported $22.76 billion in revenues in September 2015 and $19.98 billion in revenues in September 2016. That number recovered slightly to $20.96 billion in revenues in September 2017.
The Union Pacific is definitely making money off those revenues with a quarterly profit margin of 22.08% on September 30, 2017, but is it keeping that money. The answer is yes, Union Pacific is doing a better job keeping cash than some of its competitors.
The Union Pacific has a lot of Cash for a Railroad
The UP reported $1.937 billion in cash and short-term investments on 30 September 2017. That was better than the CSX (NASDAQ: CSX); which reported $704 million in cash and short-term investments, and the Kansas City Southern (NYSE: KSU) which reported just $88.40 million in cash and short-term investments on the same day.
Since the UP reported $7.456 billion in cash from operations on September 30, 2017, that means it managed to save over one-seventh of its cash. That’s good enough to make Union Pacific a value investment contender.
It is also worth noting that Union Pacific’s cash from operations was more than double those of CSX and the Norfolk Southern (NYSE: CSX) on September 30. Norfolk Southern reported $3.187 billion cash from operations and CSX reported $3.414 billion in cash from operations on 30 September, 3017.
The Union Pacific has more assets than some of its peer. The UP reported $57.40 billion in assets on September 30, 2017. CSX reported $35.57 billion in assets and Norfolk Southern reported $35.15 billion in assets on the same day.
All this makes Union Pacific a definite value investment in railroads because it has more cash and value than its peers. The UP also had a free cash flow of $1.149 billion on September 30, in contrast to $788 million at the CSX and $457 million at the Norfolk Southern.
Is Union Pacific a Value Investment?
This makes Union Pacific a good company but is it a good investment? If you are looking for a railroad that rewards shareholders the answer is yes.
The Union Pacific provided investors with a 23.19% return on equity on September 30, 2017. It also paid a really nice dividend of 66.5¢ on November 29, 2017. That payout marked a five cent increase over May 2017 when UP shareholders received a 60.5¢ dividend. More importantly, the dividend has grown by 10.5¢ in the past year, it was 55¢ in May 2016.
Therefore Union Pacific is a good stock to own because it pays a nice growing dividend, and offers a decent return on equity. More importantly, it has a growing business and a lot of value.
Can Union Pacific Survive
The Union Pacific has a pretty bright future because it owns four rail lines that connect the Great Plains to the West Coast.
They include the original transcontinental rail line from Omaha, Nebraska to Oakland, California and the Southern Pacific line from Los Angeles to Houston. Shorter routes include the line from Salt Lake City to Los Angeles, and the Oregon shortcut from Pocatello, Idaho, to Portland, Oregon, and Seattle. Other key routes include a line from El Paso to Chicago, the line from Houston to Chicago, and the line from Denver to Salt Lake City.
These tracks put the Union Pacific in a great position to cash in on all the raw materials shipped from the West and Midwest to Pacific and Gulf Coast Ports. It is also in a good position to haul all the consumer goods shipped from China to U.S. ports.
Is the Tesla Semi a Threat to Union Pacific?
“It’s not just economic suicide to use one diesel truck, its economic suicide for rail,” Musk said. “This beats rail.”
There are some threats to rail including Elon Musk’s electric-powered Tesla Semi. Musk predicted that the Tesla Semi is suicide for rail because it would be cheaper to operate, Vox reported. At Tesla Motors (NASDAQ: TSLA) semi unveiling circus Musk claimed his semi is 20% cheaper to operate than diesel trucks.
Fortunately for Union Pacific mass adoption of the Tesla Semi is still a few years away. The Tesla Semi faces other problems such as crowded and poorly maintained Interstate highways. What good is Musk’s high-tech truck if it ends up stuck in traffic, while the Union Pacific train is cruising by on the tracks?
An opportunity for Union Pacific would be for somebody to use the Semi Technology to create a battery-powered electric locomotive. Perhaps Musk should be working on a Tesla locomotive as well as Semi. That way he could have Union Pacific as a customer rather than a competitor.
A huge advantage to the Tesla locomotive is that would be able to pull large amounts of additional power in the form of cars filled with Tesla Power Packs of lithium-ion batteries. One use for those trains would be to haul Tesla batteries from the Gigafactory in Storey County, Nevada, near Union Pacific’s mainline to the Tesla factory in Freemont, California. Another would be to haul Tesla vehicles to the East Coast and the Gulf Coast for export.
Musk needs to stop bad mouthing rail and start working with it. There might be a huge market for a Tesla locomotive as a well as a Semi. The Union Pacific would be a logical customer for Tesla locomotives.