In the process of researching Union Pacific’s investment spending (detailed in these articles: one, two, three, four), I also looked into the revenues generated by the firm this year versus our model’s expectations. There are a few adjustments that I will not be able to do until the firm publishes its annual report (February 2018), but this initial research has turned up an interesting trend that will cause us to change some of the details of our revenue model for UNP.

Union Pacific reports revenues generated from charging clients a fuel surcharge as part of its freight revenues. The dollar amount of the total fuel surcharge is included in a footnote to the annual report, but is not included in any of the quarterly reports. We believe that viewing the fuel surcharge separately from the other part of freight revenues give us a better picture of price and volume changes per freight type, so this is how we’ve set our model up. The disadvantage to this is that we can only true our model once a year.

Despite this, we eyeballed the first nine months of freight revenues versus our projections and found several freight categories that we’ll need to adjust.

Figure 1. Source: Company Statements, Framework Investing Analysis

The left- and right-most columns are our worst- and best-case projections for 2017 revenues, respectively. You can see the bright green layer that represents our forecasts for the fuel surcharge.

The middle column represents a simple extrapolation of the first nine months of Union Pacific’s revenues into a full-year figure. Note that there is no bright green layer in this middle column because the fuel surcharge revenue is added into each freight category.

The first thing worth noting is that the Extrapolated Actual column is tracking pretty close to our worst-case revenue projections; we have mentioned this trend in each of our quarterly earnings reviews (1Q, 2Q, 3Q).

The next thing to note is the variance between our projections for each freight type and the extrapolated actual values. Most of the categories are well within our projected range — especially considering that each of the actual columns will shrink slightly when fuel surcharges are backed out. The two categories that are most different are:

  1. Industrial
  2. Coal

Coal actually may wind up to be within our range once fuel surcharges are backed out of the revenues, so I’ll set that aside for a moment. This leaves the Industrial segment as our largest outlier. Here is how the company management characterized the reason for the Industrials increase in the third quarter of 2017:

Source: SeekingAlpha Transcripts

Of the reasons mentioned here, we believe the one driving the revenue increase is the increased shipments of sand for fracking shale wells. Frac sand (known technically as “proppant”) is forced into cracks blown into shale formations during the fracking process to keep the cracks open. Oil and gas flows more freely the wider those cracks are left open. Over the past few years, “proppant intensity” — meaning the amount of sand used in fracking — has increased, especially in certain regions.

Figure 2. Source as noted

The Permian Delaware, Permian Midland, and Eagle Ford formations — three of the top four fields shown above — are located in West Texas / southeast New Mexico. Niobara is in Colorado. All are serviced by Union Pacific rail lines, which have seen the brisk increase in sand shipments mentioned in the earnings call transcript.*

The article from which the figure above was taken notes that recently, drillers have started to reduce proppant intensity (note the downward sloping line for Permian Midland, especially) as more cost-efficient fracking techniques and chemicals are developed.

The take-away from all of this with relation to our valuation model is that our forecasts for the Industrials freight category are probably too low, but the other categories appear mostly appropriate. Once we are able to analyze the annual data and split out fuel surcharge revenue, we will incorporate our refined view into our revenue model. At present, our overly generous assumptions for fuel surcharge are serving as a useful “fudge factor” so despite the outperformance of the Industrials business, our revenue model has served as an accurate forecast of Union Pacific’s actual revenue.

One last thing to note is that the firm has announced it will change the categorizations used to report its freight traffic starting in 2018. The company will report historical results for a few years using the new classifications, but it is a headache when companies change categories like this, as it necessitates a larger refresh of models.


* Sand mines are located in the Upper Midwest — Wisconsin, Illinois, and Iowa, mainly. Union Pacific services sand minds, as does its competitor, BNSF.