Union Pacific Downgraded to Neutral - Analyst Blog

We downgrade our recommendation for Union Pacific Corp. (UNP) to Neutral based on its current valuation, which has moved up by 52% in the last one year and is currently trading at higher multiples with respect to several valuation metrics compared to the S&P 500 average.

Union Pacific is currently trading at the high-end of its 52-week price range. At this high valuation level, we believe there exists very limited scope for any near-term above-market gain.  

The company's third quarter 2010 results were far ahead of the Zacks Consensus Estimates. This excellent performance was achieved through best-ever operating ratio, massive growth in business volume, cost control and pricing gains. An improving U.S. economy, massive surge in automotive and intermodal shipments, together with a sharp rebound in many of the company's end markets, are expected to fuel future growth of Union Pacific.

Recently, the board of directors of Union Pacific decided to raise the quarterly dividend by 15% to 38 cents per share from 33 cents. Remarkably, this is the second time in 2010 that the company has decided to increase its dividend rate. In early 2010, Union Pacific raised it dividend to 33 cents from 27 cents. The company has raised its dividend by a whopping 40.8% in 2010 alone.

During the first nine months of 2010, Union Pacific generated $1,034 million of free cash flow compared to just $391 million in the year-ago period. This healthy liquidity position together with solid future business visibility encouraged the company to the raise its dividend rate.

Recently, Standard & Poor's Ratings Services has lifted the rating of the company to “BBB+” from “BBB.” Both these are lower medium grade ratings from S&P. However, the overall financial outlook of Union Pacific is now upgraded to “Stable” from “Positive.” We believe the major reason for the S&P rating upgrade is the stellar performance of the company during the last couple of quarters.

According to our view, Union Pacific is better insulated against economic uncertainty as approximately 37% of its revenues are tied to less cyclical consignments like agriculture and coal. Union Pacific competes with other freight railroad operators in the U.S. like KansasCity Southern (KSU), CSX Corp. (CSX) and Norfolk Southern Corp. (NSC).

 
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