Did Union Pacific Give Us the All Aboard Signal?

Omaha, Neb-based Union Pacific UNP reported third quarter earnings that beat Wall Street estimates, and with the strong growth in its different segments, this could be a sign the economy is nowhere close to falling off a cliff. The railroad operator reported third quarter earnings of $1.85 per share on $5.10 billion in revenues. Wall Street had been expecting earnings of $1.81 per share on $5 billion in revenues. "Union Pacific delivered top and bottom line record results in the third quarter," said Jim Young, Union Pacific chairman and chief executive officer. "We're clearly demonstrating how Union Pacific's diverse franchise and value-added service offerings are driving record free cash flow and improved financial returns for our shareholders." Union Pacific reported that all six of its business groups saw freight revenue growth, led by increased fuel cost recoveries, core pricing gains and volume growth. Volume growth is especially important, as it means more goods producing companies are shipping more of their products, which in turns means that the economy is picking up steam, not losing it. This morning, we saw a better than expected October Philadelphia Fed manufacturing index, coming in at 8.7, versus estimates of (9.4). If these trends continue, that could mean we could see even more volume growth in the railroad operators, and particularly, Union Pacific. Union Pacific said that industrial products revenues rose 24%, automotive rose 23%, energy rose 21%, chemicals was up 14%, agricultural was up 9%, and intermodal was up 8%. Union Pacific did not provide guidance in its press release, but did maintain confidence in the health of Union Pacific for the future. CEO Young said, "While the economic outlook is uncertain, we're optimistic about the future for Union Pacific. As we have shown in this weaker economy, the diversity of our business continues to deliver record results. We remain confident in the strength of our fundamental strategy to enhance our franchise, provide increased value for our customers, and generate improved financial returns for our shareholders." BMO Capital was also very positive on the quarter, reiterating its Outperform rating and $110 price target. In the research note, BMO wrote, "Trends in pricing and cost inflation are encouraging and should underpin margin expansion in 2012 even in the context of moderate volume growth. The company is distributing over 70% of net income to shareholders and we believe a greater level of distribution is likely given high cash balances and a strong balance sheet." Union Pacific currently trades at just over 12 times 2012 earnings, and sport a 2.1% dividend yield. With solid revenue growth, Union Pacific has confirmed what we have seen in recent economic data points. The economy is not falling off a cliff, it is growing, albeit not as fast as everyone would like. From ISM, to Chicago PMI, and to the latest Philly Fed, the economy appears to be stuck in first gear. It is moving, but it is not going above the speed limit. In fact, it is well below the speed limit, but it is still getting there. There are a number of things that need to happen for the U.S. economy to move into a higher gear, namely a resolution in Europe, but Union Pacific has signaled no recession, at least for now. It is not full speed ahead for the U.S. economy, but the engine keeps going, and will eventually get there. ACTION ITEMS:

Bullish:
Traders who believe that Union Pacific's strong results will lead to other strong earnings for the railroad operators might want to consider the following trades:

• CSX CSX was the first to report, and results were not as favorable. It could be better for Norfolk Southern NSC, and Berkshire Hathaway BRK, which owns Burlington Northern Santa Fe.

• This could also prove to do well for the smaller railroad companies, like Kansas City Southern KSU and Genesee & Wyoming Inc. GWR.

Bearish:
Traders who believe that the U.S. economy is in danger of slipping back into a recession despite the better than expected data may consider alternate positions:

• If the economy does slip back, earnings are likely to fall. Traders could short the S&P 500 ETF SPY to benefit.
  
  

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