Key Takeaways
- Union Pacific is one-half of a rail duopoly controlling the Western US. The other duopoly partner is Buffett’s Burlington Northern Santa Fe.
- We believe that railroads are an instrument of US economic, social, and political policy. Government regulators changed gear in the 1980s and 1990s, moving from strict anti-monopolists to tacit supporters. We believe this support is crucial for UNP and other rail operators to generate their present high level of profits.
- UNP’s revenue growth has generally mirrored nominal GDP growth. However, this relationship is masked by the inclusion of fuel surcharges.
- We believe that several of UNP’s important cargo lines – Coal and “Intermodal” – face secular weakness. Together, these cargoes make up over a third of revenues.
- Profitability on an OCP basis is higher than many Tech firms. Government rules create an environment in which our high profitability estimates are likely understated by roughly 20%.
- The firm spends roughly 45% of its profits on expansionary projects. These projects have been successful in allowing UNP’s profits to expand at a very rapid rate since the end of the Great Recession.
- This report is not a valuation, but rather an analysis of valuation drivers. We will publish a valuation report and Tear Sheet soon.
Introduction
Railroads were built in the 1800s as what we would term today as “public-private partnerships.” The passage of the Sherman Anti-Trust Act in the early XX century was directed at Standard Oil and the railroads, and for a good part of that century, the government kept a close rein on these firms.
However, the environment began to change in the mid-1970s, and railroading was one industry that was materially changed by the deregulation movement of the mid-1990s.
UNP – the largest publically traded US railroad by market capitalization and the railroad with the most miles of track in the US – and its owners have profited handsomely from this change in regulatory environment.
While this report does not place a fair value on UNP, it is an excellent learning example of IOI-style valuations. We spend a lot of time understanding the dynamics of the demand environment and look at profitability from the standpoint of an owner of the firm.
Please continue reading the entire report in the Research section 
and contact us with any questions.