Union Pacific Confident In Its March Towards A Lower Operating Ratio

Union Pacific UNP still expects to reach a previously stated goal of an annual operating ratio of below 61 percent for 2019 despite lower rail volumes in the first half of this year.

Operating ratio can gauge the financial health of a company, with a lower operating ratio implying more profitability. The railroad, which operates in the western U.S., reported an all-time record operating ratio of 59.6 percent for the second quarter of 2019, compared with 63 percent for the same period in 2018, and it has had a goal of reaching an operating ratio of below 60 percent by 2020.  

"We have to play the hand that we are dealt when it comes to volumes, but rest assured our commitment to achieving our financial targets is unwavering and has never been stronger," UNP chief financial officer Rob Knight said during his company's second quarter earnings call on July 18.

Union Pacific attributed the all-time record operating ratio in part to its deployment of Unified Plan 2020, its version of precision scheduled railroading (PSR). PSR is an operating model that seeks to streamline operations and schedules. 

Company officials said the productivity gains reached because of Unified Plan 2020 enabled the railroad to adjust to lower second quarter volumes and adverse flooding conditions.

"When volumes get softer, we know how to adjust our resources to match what volume represents. But I would have to say, the lion's share of what you saw was about Unified Plan 2020 and productivity. And you can see that kind of across the board," said UNP chief executive officer Lance Fritz. 

He continued, "We had to adjust the amount of resources we put at locomotives as we parked about a quarter of the locomotive fleet if not more. And you can see that directly related to the headcount, to the manpower that we have attached to maintaining locomotives. The same is true on maintaining cars. The same is true on the TE&Y [train, engine and yard] workforce. We've taken a lot of work out of the network and it's being reflected now on our manpower… There are more of those adjustments to be made as the network continues to stabilize and as we continue to find opportunity."

UNP expects to maintain its guidance on net productivity of at least $500 million for 2019 as the company seeks to lower costs, improve operations and better utilize its locomotive fleet. The productivity target should be reachable because during the second half of the year the railroad's management doesn't believe it will face the same level of flooding and other weather-related events that resulted in operational inefficiencies in the first half of the year, Knight said.

"You've heard me say this many, many times – we're not going to use the lack of volume as an excuse not to make aggressive achievements on our productivity. And I think with Jim and his team and the implementation of Unified Plan 2020, I feel stronger about that than I ever have, frankly," Knight said.

Union Pacific's net profit grew 4 percent to $1.57 billion, or $2.22 per diluted share, in the second quarter of 2019, compared with $1.51 billion, or $1.98 per diluted share, in the second quarter of 2018. 

Of that, operating revenues fell 1 percent to $5.6 billion amid a 4 percent decrease in total revenue carloads and a drop in overall volume. But operating expenses dropped 7 percent to $3.3 billion, compared with $3.6 billion in the second quarter of 2018.

Outlook for the second half of 2019

Union Pacific outlined a number of headwinds the railroad could face in the second half of 2019, all of which could pressure rail volumes to fall compared with the same period in 2018.

Uncertainty about trade and tariffs between the U.S. and China could weigh on several segments, including intermodal volumes and the U.S. grain volumes. Domestic intermodal volumes could also face pressure from increased competition from trucks, which could limit over-the-road conversions in the short-term, and from "tough" comparisons in the fourth quarter because the fourth quarter of 2018 saw a pull ahead of international intermodal shipments because of anticipated tariffs, said Kenny Rocker, UNP executive vice president of sales and marketing.

For energy, the systemic decline in U.S. coal consumption continues to weigh on UNP's energy volumes, as well as a decline in frac sand volumes. For forest products, a forecasted decline in housing starts could put pressure on lumber volumes.

But other factors could support UNP's volumes, including "stronger" light truck and sport utility vehicle sales that could offset slumping car demand, higher demand for biofuels and beer, and higher shipments of plastics products because of new plant expansions coming online.

"Some of the challenges will be what they are. We'll see what happens with the domestic trucking market. We'll see what happens with trade. We still feel very good, again, about the construction business that we have, the crude oil that we have. And the plastics business, we expect that to continue to grow," Rocker said.

"Everything that Jim is doing on the operating side, again allows us to compete. It allows us to get after rail-centric business that we lost during the floods, which allows us to increase a lot of the truck-centric business moving forward. So we feel positive about that," Rocker said.

Union Pacific said declines in energy and premium volumes, as well as flat volumes for agricultural products, weighed on overall second quarter volumes, although industrial volumes rose for the company. 

But in terms of freight revenue, agricultural products were actually up 4 percent to $1.16 billion, while industrial revenue was up 4 percent to $1.5 billion. Energy revenue was down 13 percent to $966 million while premium revenues were down 2 percent to $1.6 billion. 

Meanwhile, some service metrics improved. Quarterly freight car velocity totaled 195 daily miles per car, up 4 percent from the second quarter of 2018, although average train speed slowed 6 percent to 23.1 miles per hour compared with 24.7 miles per hour in the second quarter of 2018. But average terminal dwell time fell 14 percent to 25.5 hours from 29.5 hours in the second quarter of 2018. Terminal dwell time is the amount of time a train spends at a terminal.

Chief operating officer Jim Vena said the decrease in train speed can be attributed to two factors, continued flooding in the Midwest, which affected network fluidity, and daily work events that were required to implement Unified Plan 2020.

"While these work events are helping us increase train size and drive asset utilization, the team is still working to execute these work events even more efficiently and drive faster train speeds," Vena said.

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