Union Pacific Drops Most in 7 Years as Pricing Power Wanes

  • Railroad sees freight volume dropping 6% to 8% this year
  • Cowen analyst cuts rating because of minimal rate increase

Union Pacific Corp. tumbled the most since 2009 as the largest publicly traded railroad signaled that pricing power has eroded with a decline in freight demand.

Rates rose just 1.5 percent in the third quarter, having declined steadily from 4 percent in last year’s second quarter, Union Pacific reported, sparking investors to doubt whether the carrier can continue to boost prices above inflation. 

The shares plunged 6.7 percent to close at $90.64 in New York, marking the sharpest decline since March 2009. The stock has gained 16 percent this year, outpacing a 4.8 percent increase for the Standard & Poor’s 500 Index.

Union Pacific’s cost index is up about 1.5 percent this year and will likely accelerate to 2.5 percent next year, Chief Financial Officer Rob Knight said on a conference call with analysts Thursday. Cargo volume will drop 6 percent to 8 percent this year and decline in the “low single digits” this quarter, the Omaha, Nebraska-based company said in a presentation accompanying its quarterly results.

Railroads over the past decade have relied on price increases, as opposed to volume gains, to boost profits. Investors are concerned that earnings growth could stall if Union Pacific can’t raise rates and traffic remains weak. 

‘Walk Away’

The carrier won’t pursue freight at any price to gain market share, Chief Executive Officer Lance Fritz said on the call, explaining that cargo rates must remain profitable.

“If we can’t find that, we walk away from it,” he said.

The throttled price increases are the main reason Jason Seidl, an analyst at Cowen & Co., lowered his rating on Union Pacific to market perform from outperform and cut his 2017 earnings estimate by 50 cents to $5.35 a share. 

Union Pacific’s struggle to charge customers more “was due to competitive pressure and overall market demand weakness,” he said in a note to clients. “The factors that led to the moderation thus far this year are likely to persist going forward.”

Carloads Tumble

Union Pacific isn’t the only railroad grappling with weak freight. U.S. carriers’ carloads slid 6.3 percent in the quarter from a year earlier, pulled down by coal, oil and metals, according to the Association of American Railroads trade group. Coal, one of the largest single commodities the railroads haul, plummeted 25 percent this year through September from the same period in 2015. Demand for the fossil fuel has been hurt as power companies switch to cheaper, cleaner natural gas.

Union Pacific reported that third-quarter adjusted earnings dropped to $1.36 a share. That fell short of the $1.40 average estimate of analysts surveyed Bloomberg. Sales slid 7 percent to $5.17 billion, matching predictions.

Coal revenue plummeted 19 percent to $728 million, while sales for hauling containers fell 8.6 percent to $957 million. Revenue for industrial cargo dropped 13 percent to $855 million.

Bottoming Out

The cargo decline may end next year, CEO Fritz said in an interview. Rising prices for natural gas could help check the steep drop in coal. The railroad also has opportunities to gain freight volume in automotive parts, Mexican chemicals and as truck cargo converts to rail, he said. 

“I think there’s more catalyst for improvement than decline,” Fritz said. “In the medium term, it’s hard to imagine that coal retreats significantly from where it is.”

The company’s operating ratio, a measure of efficiency in which a lower figure is better, rose to 62.1 percent from 60.3 percent a year earlier. Union Pacific no longer expects to improve its operating ratio from last year, citing the magnitude of the cargo decline.

A bumper grain harvest has been one of the few bright spots for U.S. carriers, pushing up carloads 17 percent in the third quarter. Union Pacific said its grain carloads jumped 27 percent, helping drive a 6.5 percent gain in agriculture revenue to $937 million.

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