Union Pacific: Railroad Strikes Back With Biden’s Support (NYSE:UNP)

UNP: Recovery Gains Posted Before Labor Dispute Legislation

Union Pacific Corporation (NYSE:UNP) stock has recovered remarkably from its October lows, in line with its industrial peers. In addition, the recent settlement of the nationwide railroad strike through legislation by the Biden Administration helped avert a crisis in the country’s critical supply chain.

The recent legislation was also the “first time in 30 years that Congress has intervened in a railroad labor dispute.” We believe it demonstrated the criticality of America’s leading railroad, supporting the competitive moat of UNP.

Therefore, it has removed a significant near-term headwind in UNP’s operating performance. Notwithstanding, most of its recent gains were reflected pre-legislation, as astute investors correctly anticipated the positive outcome. Hence, we parsed that investors’ focus has likely turned to how Union Pacific could navigate the intensifying macro headwinds in 2023, with a recession increasingly likely.

The company remains committed to achieving growth in 2023 as it adjusts its mix and pricing while also focusing on efficiency. Notably, it telegraphed that the fuel costs have come in less than anticipated for FQ4, constructive for recovering its 55% operating ratio (or OR) target moving forward. However, investors need to be prepared for a higher projected OR of 60% in the near term, given the headwinds from elevated inflation, fuel costs, and service challenges.

Union Pacific’s Regulatory Challenges Remain A Hindrance

Also, the company’s operational challenges have not been resolved and, therefore, could likely impinge on investors’ confidence moving ahead.

Notably, some of its customers have not been pleased with its service embargos, which are intended to alleviate congestion and operational challenges. Management also highlighted in recent hearings that labor shortages were the main culprit, even though its customers highlighted that railroads are “notoriously difficult to do business with.”

As such, we believe regulatory challenges could still hamper the company’s operational performance moving forward. CFO Jennifer Hamann accentuated at a recent conference that “an embargo can be done with 100% permit. So [it] allows permits for the customer to continue to ship against that embargo.”

Notwithstanding, Hamann also indicated that regulatory issues remain a concern, in which “it’s probably early days” to enunciate the long-term impact for investors to parse.

As such, we urge investors to continue monitoring the company’s dealings with the Surface Transportation Board or STB moving ahead.

UNP: Has Its Valuations Reflected A Recessionary Scenario?

With the recent strike incidents resolved, investors need to assess whether Union Pacific is well-positioned to ride through the recession. Accordingly, we parsed that Wall Street analysts have likely anticipated marked growth headwinds, as they penciled in EBIT growth of just 2.4% in 2023, down from 2022’s projected 8.6% uptick.

Hence, it’s arguable that analysts have already factored in a growth slowdown, but not a severe recession, in line with management’s commentary.

Furthermore, we gleaned that analysts have also downgraded the earnings projections for the industry, likely anticipating significant macro headwinds. Hence, we believe it sets up UNP well to outperform if the economic headwinds are less damaging than expected.

However, with the remarkable recovery from its October lows, UNP last traded at an NTM EBITDA of 13.3x, well above its 10Y average of 11.1x. Hence, we gleaned that its valuation doesn’t seem attractive at the current levels and may be too aggressive if the recession turns out worse than expected.

Takeaway

We observed that UNP’s October lows look highly robust and should be a valuable yardstick for investors to assess the strength of buying support at the recent pullback.

Several critical resistance zones have held back UNP’s upward recovery, as its medium-term bias has turned bearish. However, if UNP can continue to consolidate constructively above its October lows, buyers who have high conviction over its execution can consider adding.

Investors who remain concerned over its valuation and a potentially deeper recession can consider waiting for a deeper pullback before adding more positions.

Rating: Hold (Reiterated)