After publishing several research pieces* about Union Pacific (UNP) in April 2016, we have watched its stock price climb over the last year. When its most-recent annual report came out, we checked through to see if there might be an opportunity.
In our newest valuation, we did something that we usually do not – namely, we tried to “stress test” our valuation by providing very bullish revenue growth numbers rather than trying to find “realistic” best-and worst-case scenarios.
In our new valuation, our worst-case revenue assumption generates growth that averages about the same as our old best-case scenario. Our new best-case revenue growth assumption reflects the conditions that led to the highest historical growth the company has had. Our 2017 worst-case revenue assumptions show sales at $22.6 billion. In contrast, the highest revenue forecast from Wall Street analysts is $21.5 billion.
This is not to say that the investment is “safe” – the markets can remain irrational longer than anyone can remain solvent, after all – but it helps ameliorate our concerns that our view of the demand environment is overly negative.
In 2016, we believed that, as an instrument of US industrial policy, Union Pacific had been given a license to print money. We considered the benign regulatory environment a big positive “Balance Sheet Effect.” Now, however, with the specter of international trade frictions, we believe there is an offsetting negative Balance Sheet Effect – namely, UNP’s reliance on trade deals like NAFTA and a steady stream of imported consumer goods from China.
The Tear Sheet summary is below – we’ll have a ChartBook out shortly.