Stock of Union Pacific edged down to $92.94 this week after an encouraging, month-long climb back to $97, peaking last week. Curiously, this rebound, beginning on September 28th, does not seem to be tied to a specific piece of news. More likely, it is a correction to its valuation, which was thought by many analysts to be far below its intrinsic value. We entered this position over a year ago, and at a price of $92. To recount since then, UNP equity is down 22% YTD, so despite a slight positive return ITD, we missed perhaps the best time to exit the position. Union Pacific is scheduled to release earnings before the trading day of 10/22.
We are challenged by current macroeconomic data. Protracted low oil prices has ushered, as some economists earlier predicted, a structural shift to petroleum and out of coal. In dollar terms, coal encompasses nearly one fifth of Union Pacific’s revenue. The U.S. Coal Index, once at 120 nearly a year ago, now rests at 27, having decreased every month in between. Agricultural price indices have edged slightly lower. Weakening Chinese demand, evident in revisions to its GDP forecast, has driven commodity prices into the ground. Commodities represent another key freight item—both directly and indirectly—to Union Pacific. To make things worse, China in specific is a key endpoint for UNP’s cross-country freight. This, however, represents a global trend; economists at the UN have already revised estimated global growth down 0.2%. Though Union Pacific has cut capital spending goals to $4.2 billion from $5 billion, cash flows will be impacted by hits to top-line, trickling down to bottom-line.
The price target of the revised model, dependent on favorable long-term and perpetual growth rates, can no longer be justified. As such, cash flow valuations now hover in the low $100s. This is in line with the average analyst prediction of $104. The only mixed piece of news is that this analyst consensus has barely flinched over the last three months (during which, much news has taken place.) Only two of the twenty-two analysts assigning a ‘buy’ rating three months ago, have downgraded. The aggregate rating, though slightly lower, is still in strong overweight territory. Nevertheless, it is unlikely UNP will reach the consensus $1.43 earnings per share this quarter; surges in the later part of the year rest on seasonal coal and foodstuffs—both of which are doomed by weak global demand. We must decide if it would be in our interest to exit the position before this announcement.