Let's review the latest results from Union Pacific, the railroad stock in the Charitable Trust that we believe is set to break out.

Union Pacific reported better-than-expected third-quarter earnings results on Thursday as revenues of $5.6 billion (+13% YoY) outpaced the $5.412 billion consensus and earnings per share of $2.57 (+28% YoY) exceeded expectations of $2.48 per share and mark a third-quarter record for the company.

CEO Lance Fritz commented in the release: “The Union Pacific team successfully navigated global supply chain disruptions, a major bridge outage, and additional weather events to produce strong quarterly revenue growth and financial results. In the quarter, the team delivered solid core pricing gains, leveraged business development to produce a positive business mix, and generated productivity to offset flat volume.”

Breaking down the results:

Taking a look at companywide metrics, Union Pacific’s operating ratio was a third-quarter record, roughly matching expectations at 56.3% and representing a 240bps improvement YoY (and a 320bps improvement versus the third quarter of 2019) despite high fuel prices having a 140bps negative impact in the quarter. Operating income also notched a third quarter record, coming in at $2.4 billion (+20%) and outpacing the $2.37 billion the street was looking for. (Note 1 basis point equals 0.01%)
As for a few other operating performance metrics, enhancements were seen in fuel consumption which improved 1% YoY to a quarterly record, workforce productivity improved 5% YoY to a third quarter record of 1,044 car miles per employee, and in regard to average maximum train length, which increased 4% YoY.
On the other hand, there was some deterioration in freight car velocity which was “challenged by wildfires and other weather events” and declined 13% YoY, locomotive productivity which declined 8% YoY, and the year-to-date personal injury rate which fell to 1.0 per 200,000 employee hours from 0.9 for the same period in 2020.
On the capital return front, the company repurchased 8.6 million shares for a total return to shareholders of $1.8 billion. On a year-to-date basis, management has now returned a total of $7.9 billion to shareholders via buy backs (27.5 million shares year-to-date) and dividend payments, and reduced the average shares balance by 3% so far this year.
Speaking to the quality of earnings, Union Pacific has a 95% cash conversion rate year-to-date (defined as cash provided by operating activities, less cash used in capital investments, divided by net income).
Taking a look at the various operating segments, Bulk sales of $1.687 billion (+14% YoY) edged out the $1.632 billion consensus as volume increased 4% YoY and average revenue per car (ARC) increased 9% YoY. On the call, management attributed strength to “strong core pricing gains and higher fuel surcharge revenue.”
- Looking ahead to the fourth quarter, management commented on the conference call, “We're optimistic about grain business due to another strong harvest and grain export demand. Also grain products will continue to benefit from growth of the biofuel market. Food and refrigerated volume should be positive with increased consumer demand post-pandemic restaurant reopening's and truck penetration growth. Lastly we expect coal to remain strong for the remainder of the year based on our current natural gas futures, inventory replenishment as well as export demand.”
On the Industrial front, sales of $1.911 billion (+22% YoY) outpaced the $1.879 billion consensus as volume increased 14% YoY and ARC increased 6% YoY. Management attributed the positive segment performance to “higher fuel surcharge, core pricing gains and positive mix.”
- Regarding fourth quarter expectations, management commented, “we continue to be encouraged by the strength of the forecast for industrial production for the rest of 2021, which will positively impact many of our markets like metals and forests. The year-over-year comps for our energy markets are favorable. However, we expect narrow spreads will negatively impact crude-by-rail shipments. But on a positive note we expect to mitigate the lower crude shipments with strength in other petroleum and the LPG products.”
Finally, in the Premium segment, sales of $1.568 billion (+1% YoY) was slightly short versus the $1.575 billion expected as volume fell 9% YoY and ARC increased 11% YoY. As we have highlighted previously, management called out the ongoing semiconductor shortage and global supply chain disruptions as key contributors of segment weakness, especially in the automotive area.
- As for the fourth quarter, management commented, “We anticipate continued challenges in automotive related to semiconductor shortages for the fourth quarter. In regards to intermodal, limited truck capacity, inventory restocking and strength in retail sales will continue to drive intermodal demand in the fourth quarter. However, we expect international volumes to be constrained as ocean carriers have recently taken additional actions to speed up their container returns as challenges in labor, port capacity, warehouses and drayage persists. And on the domestic side, opportunities will face continued supply chain challenges with limited hallway capacity and slower chassis turn times.”

The bottom line - Stage is set for a breakout:

All in, this was a solid quarter from Union Pacific, with management and the team demonstrating their ability to execute despite disruptive factors out of their control. While they did formally reduce full year productivity and operating ratio improvement guidance to $350 million (from $500 million) and 175bps (from the 200bps), respectively, the possibility for this action was highlighted back in September during a presentation at the Morgan Stanley Industrials conference and we believe the reaction to today’s release demonstrates that the magnitude of the reductions are in line with investor expectations. (The shares were last slightly in the green.)

With those expectations now officially reset and management continuing to target an operating ratio of 55% in 2022, we believe the stage is set for shares – which are trading near and attempting to breakout from all-time highs – to grind higher as the global economy comes back online and supply chain issues get resolved.

Lastly, we reiterate that in addition to the strong execution from management and upside potential from macroeconomic improvement, Union Pacific is a solid name to hold in the face of inflationary fears as the critical nature of the company’s operations in terms of the global supply chain provides it the pricing power to pass costs through to customers and protect profit margins.

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(Jim Cramer's Charitable Trust is long UNP.)