This Company Will Excel
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Market-beating returns over the long-term come from staying invested in companies that meet the following criteria: 1) high barriers to entry, giving a company the ability to raise prices and still keep business; 2) “repeat purchase business,” meaning people use the product/service perpetually; and 3) a competitive edge.
Union Pacific (NYSE: UNP), a railroad company operating mainly in the west, possesses all three of these qualities:
1) Union Pacific owns a huge amount of expensive infrastructure such as railroads, bridges, and locomotives, making it expensive for other companies to enter the business.
2) Anytime someone needs movement of goods, especially in the west, only two companies, Union Pacific and Burlington Northern Santa Fe, get the call.
3) Union Pacific’s even exposure to various revenue streams gives it the competitive edge that others lack.
The company's latest earnings announcement, released on Oct. 18, reaffirms Union Pacific’s standing as a superior investment.
Diverse revenue stream
Union Pacific’s advantage over competitors in other parts of the country comes from even exposure among its various business segments: Automotive, Agricultural, Chemical, Coal, Intermodal and Industrial. Robust growth in the chemicals segment (+17%), automotive segment (+15%), and intermodal segment (+8%) made up for the declines in the coal segment (-5%) and agricultural segment (-4%).
The recipe for investment success comes from owning companies that make, distribute, and transport essential items. Crude oil and plastics, much needed resources for modern civilization, drove the chemicals segment. Oil, used to make gasoline and other products, literally fuels our society. Plastics can be found in everything from bottles to electronics to furniture.
Macroeconomic supply and demand drove the automotive segment. Consumers keep cars for ten years on average, but there comes a point when the cost of maintaining an old car exceeds the cost of simply buying a new one. Improving credit ratings of the average consumer encourage the purchase of new vehicles, driving the automotive freight segment. This unexpected example shows that parts of the economy show signs of recovery.
Union Pacific’s intermodal (cargo freight) segment rides the slow economic recovery with an 8% increase in quarterly revenue, and overall revenue increased 5%.
Other companies lack the diverse exposure that Union Pacific enjoys. CSX (NYSE: CSX), a railroad company operating in the east whose revenue streams depend heavily on coal, experienced a 2% decline in revenue. Positive revenue growth in certain CSX segments, such as 18% growth in automotive, was not enough to offset the decline in negative segments.
Norfolk Southern’s (NYSE: NSC) revenue comes from intermodal transportation (46%) and coal (20%). I expect a sharp drop in the coal segment, and maybe a modest increase in the intermodal segment at the next earnings announcement.
If natural gas prices increase making coal more competitive in the marketplace coal volume should pick up. Low prices could compel natural gas drillers to exit the market due to the low profitability of extracting the gas.
Price Increases
Despite overall volume decrease, Union Pacific still managed a 5% expansion in revenue due to core price increases. The “toll bridge” nature of this company puts it in a position to raise prices. Companies can either pay the prices to have their freight hauled or try to find another means of transportation, such as another train company that may not possess the infrastructure to carry out the job, or a less fuel-efficient means of transportation like trucking.
Looking ahead
Union Pacific possesses a huge barrier to entry. Transporting goods to the west coast means the use of Union Pacific or its only main competitor, Burlington Northern Santa Fe. Declines in one or two revenue segments won’t hurt Union Pacific thanks to its diverse revenue streams. Chances are this company will be around in ten years and will continue to give investors market beating returns. I’m giving this company a thumbs-up on the Motley Fool Caps.
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