(Originally posted January 30, 2025)
Before I share my comments on Union Pacific’s full-year results, let’s start with a quote from Warren Buffett explaining why Berkshire Hathaway acquired Burlington Northern Santa Fe back in 2009…
OK, now to my thoughts on Union Pacific…
Union Pacific’s (NYSE: UNP) full-year 2024 operating revenue increased 1% and diluted EPS grew 6%. It generated a full-year operating ratio (OR) of 59.9%, return on equity (ROE) of 43%, and return on invested capital (ROIC) of 15.8%. ROIC improved slightly from 2023. It generated nearly $6 billion in free cash flow (FCF) before dividends, which equates to a FCF-to-net income ratio (FCF conversion) of 87% and a FCF margin of 24%. But growing the dividend every year is so sacrosanct at UNP that it prefers to calculate FCF after dividends. In that case, it paid out $3.2 billion in dividends and generated FCF (after dividends paid) of $2.8 billion. This measure of FCF increased 82% year-over-year because of higher net income, lower capex and working capital, as well as the easy comp relative to the 2023 labor agreement payments.
Six percent EPS growth in 2024 is below the company’s medium-term guidance of high-single digits to low-double digits (which I interpret to mean 7%- 12%, but I’m conservative and put UNP in my 7%-10% growth basket). But remember that it is currently facing fierce business mix headwinds in two ways…
First, coal and industrial carloads are its highest revenue-per-carload and highest-margin businesses, but volumes in both are currently weak. Coal volumes are weak because of high inventories (so little need to move more coal) and competition from low natural gas prices, and industrial shipments are weak because of the shallow, but very real industrial recession in the U.S. (ISM PMI has been below 50 for 24 of the last 25 months, which is the longest industrial contraction on record).
So, it is experiencing slower-than-normal volume growth in its two highest yielding, highest-margin businesses. Once industrial demand improves, I expect UNP to exhibit powerful operating leverage as it drives higher-margin volumes across its fixed cost rail network (and any sustainable increase in nat gas prices would be an added bonus because that would accelerate the high-margin coal volumes again as well). To be clear, if I’m right about the eventual operating leverage from an improved industrial economy, I think the incremental margins could be quite high and that EPS growth could surprise to the upside (end up higher than its medium-term guidance).
Secondly, at the same time that its two most profitable businesses are seeing slow demand, its low-margin international intermodal business (mainly lower margin consumer goods) is growing like gangbusters (surging 26% in the fourth quarter driven partly by East Coast port strikes which redirected that volume to the West Coast where Union Pacific operates). So, its fastest growing business (currently) also carries some of its lowest margins. This is a double-whammy business mix headwind, but everything is cyclical, and this too shall pass.
In the meantime, Union Pacific is laser focused on using its pricing power to offset inflation (price in accordance with the improving value/service it is delivering) and being the best at the fundamentals of running a railroad. For example, in 2024 Union Pacific’s fuel consumption improved 1%, its freight car velocity improved 2%, its locomotive productivity improved 5%, and its workforce productivity improved 6%. Impressively, in the fourth quarter, it was able to move 5% more volume with 3% fewer employees. It is on the back of these efficiency/productivity gains, that it was able to generate such an impressive OR (under 60%) in such a low volume (total freight revenue grew only 1% in 2024) environment.
For 2025 Union Pacific is guiding for EPS growth “consistent with attaining our three-year Investor Day CAGR of high single to low double-digit growth” (which I’m once again interpreting as 7%-10% growth). It is expecting to once again generate an “industry-leading operating ratio and return on invested capital.” Of course, it plans to grow the dividend and to repurchase $4 billion to $4.5 billion of stock (roughly equal to 2.5% – 3% of its current market cap of $151 billion).
Its balance sheet remains healthy with net debt of $31 billion (which is down over $2 billion from last year), a net debt-to-EBITDA of 2.6x (down from 2.9x last year), and an EBIT/interest expense of 7.7x (up from less than 7x in 2023). In the last five years, Union Pacific has generated average annual FCF of about $5.5 billion so its net debt-to-FCF is not nearly 6x, which is higher than I’m normally comfortable with. But I think it is healthy-enough for a stable yet capital intensive business. It has an A rating from all three credit rating agencies.
I really like Jim Vena as CEO who has worked in the industry for more than 40 years and worked under (and was mentored by) legendary railroader Hunter Harrison at Canadian National. Vena is a railroader through-and-through. He’s worked in the rail yards and on the trains in nearly every position. He started off in maintenance and became a brakeman, conductor, locomotive engineer, trainmaster and superintendent. From there he started taking on more managerial roles. He came out of retirement in August 2023 to take on the role as CEO of UNP. He inherited a company with a bloated labor structure, and he’s taken actions to right-size the company. Under Vena, Union Pacific has cut costs and dramatically improved operations and now has the best operating ratio in the industry. Vena is laser focused on accelerating revenue growth, leaning into the company’s pricing power, and driving even further improvements in customer service/value proposition, further improvements in the operating ratio, and driving at least 7% – 10% EPS growth over time.
I tell my clients that to understand Union Pacific’s competitive advantages all you have to do is look at a map of its rail lines. It operates in a duopoly in the Western U.S. with nearly 33,000 route miles connecting 23 states. It has access to all of the largest west coast and gulf coast ports and it is the only railroad that has access to all six gateways into Mexico is also perfectly positioned to transport grains (from famers out west) and petrochemicals from the Gulf South (where I live). Union Pacific and the few other Class 1 railroads are moving/driving (pun intended) critical parts of the U.S. economy (moving imports into the U.S. across states lines and moving domestic manufactured goods to port for export). These railroads are an asset to the U.S. economy.
Union Pacific is a wide-moat business with – in my opinion – almost insurmountable barriers to entry that is crucial to the U.S. economy and positioned to benefit from the reindustrialization of America (on-shoring, re-shoring, etc.) that is trading at about 21x forward earnings and 19x based on two-year out consensus estimates. As I tried to explain above, I think its EPS could actually surprise to the upside once the industrial economy improves, volumes finally pick up for the industry, and the operating leverage really starts to kick in (look at how they’ve still been able to drive down the OR in a difficult operating environment). And if I’m wrong about my operating leverage thesis, this is a management team led by Jim Vena that I am confident will be able to hit its medium-term targets to grow EPS by 7%-10% (and assuming the P/E multiple holds, remember that 7% growth is a 10-year double in the stock price with even additional returns from the 2%+ dividend yield).
Railroading may not offer sexy/fast EPS growth, but Class 1 railroads operate in regional duopolies in the U.S. and are about as wide-moat as businesses come. Some bulk goods like grain, coal, and steel can really only move long distances on rail. And often times, there is only one rail that passes right by a grain facility or coal plant. When you think about the lack of substitutes, the pricing power on some of the cargo really starts to become clear. I think rail should take market share from trucks over time because, according to Goldman Sachs, intermodal rail is often 25% cheaper than trucks (but I’ve read other places that its 10%-15% cheaper) and 4x less carbon intensive, and in recent years rail service levels are improving to be more competitive with trucking. Rail is also un-disruptable from AI. AI can’t build over 30,000 route miles strategically located next to industrial and agricultural offloading facilities with capital that it doesn’t have on land that it doesn’t own. If anything, AI would enable railroads to improve service (through better routing and scheduling) and margins (through further workforce rationalization and even more automation and robotics). It may be a slower grower, but it has exactly what we want: durable per share growth. I think that its runway of 7%-10% annualized EPS growth could run into the decades, and it’s the duration of profitable growth that really drives the magic of compounded returns.
(On February 14, 2025, after I shared the original version of this note with my clients, Union Pacific initiated a $1.5 billion accelerated share repurchase program. I interpret this as an indication that Union Pacific’s management team thinks the stock is undervalued and that it wants to buy in the shares before the eventual upturn in the U.S. industrial and freight economy).
Key Quotes from the Q4:2024 Earnings Call…
“Fourth quarter revenue, excluding the impact of fuel surcharge grew 4%. Our ability to generate strong volume growth and core pricing gains more than offset an unfavorable business mix. Reported expenses year-over-year improved 4%, while lower fuel prices led the way, the team demonstrated strong productivity utilizing 3% fewer employees to move 5% more volume.”
“Quarterly workforce levels decreased 3%. Our train service employee workforce was flat against the 5% volume growth as we effectively handled the additional volume. All other workforce areas decreased to 4%. These efforts resulted in record workforce productivity, demonstrating our strategic focus on delivering operational excellence. For 2025, we expect our all in cost per employee to be around 4% as we continue to find ways to be more productive with our workforce through process improvements, technology and investment.”
“Our fourth quarter operating ratio of 58.7% improved 220 basis points year-over-year. And as Jim noted, when you adjust for the Brakeperson Agreement, our quarterly OR came in at 58%, a great outcome, reflecting very strong quarterly performance by the UP team as we work to safely and efficiently serve our customers.”
“Let me quickly recap full year 2024. Operating revenue of $24.3 billion grew 1% on a 3% volume increase, core pricing gains, partially offset by lower fuel surcharge revenue and business mix. Excluding fuel surcharge, our freight revenue grew 4% versus 2023. Operating income totaled $9.7 billion, a 7% increase and our full year operating ratio of 59.9% improved 240 basis points, both great indicators of how good railroading produces solid operating leverage and cost control. Earnings per share of $11.09 increased 6% versus 2023, while our return on invested capital improved 30 basis points to 15.8%.”
“Full year 2024 cash from operations totaled $9.3 billion, up almost $1 billion from 2023. Our cash flow conversion rate improved to 87% and free cash-flow increased from $1.5 billion to $2.8 billion. These year-over-year improvements reflect the change in year-over-year labor agreement payments as well as the growth in our operating income. We rewarded our shareholders returning $4.7 billion in 2024 through dividends and share repurchases.”
“In 2024, we invested approximately $3.4 billion across the railroad as we continue to reduce capital intensity while still delivering value to our shareholders. In 2025, we are targeting capital spending of roughly $3.4 billion, flat versus last year.”
“Our adjusted debt-to-EBITDA ratio finished the year at 2.7 times as we maintain a strong balance sheet and continue to be A-rated by our three credit agencies.”
“And as we talk about the year, all of our guidance is within the context of the three-year targets we provided at our Investor Day in September. Our team understands those commitments, we are focused on achieving them and our 2025 performance is the first step.”
“Key for me is that we’re on target to achieve the long-term guidance that we laid out at the Investor Day in September.”
“But our goal is, just as we showed in 2024 with the 7% increase that we think that — that’s where we’re going to be. We are going to be high single-digit, low double-digit. Now if there’s things outside of our control, then we’re going to have to work harder. But this is not a change from what we said before and I would expect that every year we deliver high single-digit to low double-digits [EPS growth].”
“We also acknowledge there are some tough spots, namely from reduced coal demand and the year-over-year international intermodal comparison we’ll face in the second half of 2025 as today’s mix impact turns into a volume challenge. So while there are puts and takes on the volume side, we are confident that we will continue to drive operational and financial improvement in 2025.”
“I think it’s unfair to really kind of focus in on one commodity line like international intermodal. You’re right the comps are going to be extremely tough in the back-half, but there’s a lot of other businesses that we move and that’s really what’s going to ultimately play into what our financial results will be. So maybe domestic intermodal offsets some of that, but we’ve got a lot of other business lines that we’re going to move and we’re going to try to maximize those.”
“We talked at our Analyst Day about how our international intermodal has our lowest revenue per unit of any commodity that we haul. And so when that’s growing strong within that group, you see that impact.”
“The only thing I could add, Tom, is just on the productivity side of the way we’ve been able to change the way we operate our lowest revenue movements. And no if, ands or buts, there’s a big difference between some products that we move because we don’t price the same for every commodity. But at the end of the day we’ve done a lot of work on terminal dwell, car speed, car velocity, how many boxes we can put on a train to be able to make it more efficient for us so that we handle that difference in the revenue that we make.”
“We will achieve that goal by continuing to control the controllables by generating pricing dollars that are accretive to our operating ratio, gaining further technology, productivity through technology and by empowering every UP employee to drive asset efficiency. We expect the combination of our activities to drive volume, price and productivity will deliver earnings per share growth for the full year that is consistent with attaining our three year Investor Day CAGR of high single to low double-digit growth. Finally, with the capital allocation, as you heard from Eric, this year, we plan to invest $3.4 billion back into the railroad. We remain committed to our industry leading dividend payout ratio of around 45% of earnings and we plan to return excess cash to shareholders through share repurchases of $4 billion to $4.5 billion during the year.”
“We were price accretive in 2024 and we expect to be price accretive in 2025. Eric and the team have really done a great job of providing a strong service product. Our commercial team sells it and we’re providing the service that we sold to our customers. I want to hit that hard. We’re sharing the investments that we’re laying out to support the growth. Our commercial team is crystal clear on what’s acceptable going in from a pricing standpoint based on the service that we sold. With that, we’re going to take some risk, but it’s all about aligning the service we’ve sold with maximizing price.”
“Coal continued to experience the same challenges seen throughout the year as demand remained soft due to the high inventory levels and the competition from low natural gas prices. Grain volumes increased for the quarter as there was strength in export grain to Mexico, coupled with UP service during — strong UP service during the harvest. Lastly, grain products grew in the fourth quarter as our work to locate renewable diesel plants on our railroad is paying dividends in the form of increased demand for feedstocks and we expect that growth to continue with the startup of two new facilities, one in Nebraska and one in Kansas that came online in the fourth quarter, bringing the current count of UP accessible plants to 15 with more expected this year. Turning to industrial, revenue was up 1% for the quarter as volume remained flat.”
“The forecast for industrial production shows a slight increase, while GDP growth slows from 2024.”
“Moving on to industrial, while the forecast for industrial production in 2025 remains muted, our diverse business mix, strong service and robust franchise will help us grow in some markets.”
“Overall, we anticipate a soft economic environment and face difficult comps in 2025, but I’m excited about onboarding LCRA, the new coal customer mentioned earlier, and I’m encouraged by the incremental volume we will gain from new and expanding facilities across multiple business segments. In fact, we currently have over 200 track construction projects in progress with a potential revenue of $1.5 billion, and our business development pipeline is just as strong as it was this time last year.”
“Our full year locomotive productivity metric improved 5% versus 2023, while the deployment of buffer resources to handle higher volume levels drove a 3% decline in our fourth quarter results. Workforce productivity, which includes all employees improved 6% in both the fourth quarter and full year versus 2023. Further, 2024 marked a fourth quarter and full year record for workforce productivity. We continue to remove unneeded work and automate operations, while improving the safety of how we work. Train length improved 1% versus 2023, marking our sixth consecutive quarter year-over-year improvement. All in, 2024 set an all-time record for train length.”
“And let me be clear, there is more opportunity and we’re working to capitalize on that. Let’s go back to our Investor Day and kind of level set from that perspective. First thing I said at Investor Day was that we focus on productivity because it puts Kenny and the team in the best position to grow in the markets and that’s still and will always be true. The second thing that we focused on was our culture, our mindset here at Union Pacific, which is to be perpetually dissatisfied with ourselves when it comes to productivity, to keep pushing to find additional opportunities. So specifically to your question about what are those opportunities, it’s going to be some of the same things you’ve heard in the past and a lot of new things that I’m excited about. The fundamentals, they always stay true. Those are the things in the past that we continue to focus on. The improvements we made in the fourth quarter regarding our recruit rate. Even moving that just a single point has a significant productivity driver for us. The work that we did to reduce our people starts in our yards and locals approximately 2% and 4% respectively in the fourth quarter. That’s about the technology we’re putting in the yards and being able to be even more productive with it. On the technology front, the work that we do and have continued to do and will continue to do on the automation of our terminals and pushing to reduce dwell. Then when you get outside of the terminals and the transportation side, you mentioned a couple of them and the engineering team as they work to continue to automate inspections, maintenance tasks, distribution of materials. And then of course, you have the whole bucket of purchase services and I see great opportunities in that. And we capitalized on those in 2024, but there’s more. When you start to think about the technology we have to automate some of our vans across the system and when you’re using hundreds of thousands of van starts per year, a 10% improvement in that is really meaningful for us. So here’s the bottom line. There’s more than 75 initiatives up against how we think about driving productivity across this company. And I really do mean across the company. It’s not just operating. I’m very confident about our plan in ’25, and I’m encouraged that we’ll be telling you about those results as we go through ’25.”
“Well, I think the largest thing [from a potentially more favorable regulatory environment] is that we’ve applied for a lot of waivers that would help with the technology that we’ve implemented to make the railroad more efficient, provide better service to our customers. Those are the things that are out there that we hope with the turning of the page and how regulations are being talked about at the federal level that we get those improvements will allow us to be able to provide better service and of course, be more productive. So those are just to name a few and there’s a lot of waivers that we’ve applied for that are being outstanding for years now that we’re looking forward to it. So I could go on here for about 45 minutes on things that the regulation wise, I think would help the industry, make us safer, provide better service and be more productive, but that’s a good way to look at it as those waivers that we’ve applied for over the last number of years.”
“We have the capability at Union Pacific to react to anything that’s thrown at us. Good strong balance sheet, real good focused marketing team operations that’s looking to be more efficient. And I look at the entire package, if we get tariffs but we also get the regulatory changes and we get the tax changes that we’re talking about by the President with how depreciation is going to work on capital and how our corporate tax rate works that could be a lot of positive. Now I don’t expect any of that. That’s not what we plan. We plan for the worst if something really bad happens, make sure that we are in a good position to handle that. So I think that with the puts and takes of where our business is, we’ll deal with it, and we’re waiting to see what actually happens.”
“it’s a complicated network that we have. It truly is. It’s not linear, it’s complicated. But I think we’ve fundamentally figured out a way to operate it and be as efficient as possible. We want to be the leaders when it comes to operating ratio and that’s what we’re delivering. And I’m not sure what the other railroads are going to because we’re first up. I’m assuming that we will have the best operating ratio. That’s an outcome of everything we do. That’s the important piece is Ari. what do we do with — do we provide good service, so we can maximize price so our customers could win and grow in the marketplace. That’s real important for us, that triangle. Is that operationally — do we look at our assets, how we operate, the number of people and do we use technology? We’re excited about net control and how we were going to be able to quickly change our operating plan faster than we’ve ever been able to do before to operate the railroad more efficiently. So with all those things, I personally, and I’ve said this publicly and I’ll say it again, all the railroads should be very close when it comes to operating ratio. There’s no reason for the Class 1s not to be. And I know some — I’ll probably get some notes from some of the other CEOs and I’d appreciate the call or the text. But at the end of the day, we want to be in the best position and you can see what happens when we have a little bit of volume, we price smart, we operate the railroad efficiently, we end up with a 58.0%. Are we always going to be at a 58.0%? No, we might go up a little bit depending on what the market conditions are. But we’re going to drive that to be the best and stay tuned, okay. I don’t think anybody thought we were going to be able to deliver a 58% and hang on and watch us go.”
“We move every day, products that America needs for finished products, consumer goods and inputs to the economy.”
“And then we got to look at some of these other macro indicators, what’s going to happen with housing starts that has a really, I’ll call-it a step function impact on us from a lot of different commodities.”
FOR EDUCATIONAL AND INFORMATIONAL PURPOSES ONLY. The information provided here is for educational and information purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice.