(The following column by Mark Bruno appeared on the Financial Week website on November 2.)
WASHINGTON, D.C. — Amid intense market volatility, frozen credit markets and the possibility of a deep and prolonged recession, most CFOs are gloomy about their companies’ prospects for the near future.
Then there’s Robert Knight.
Mr. Knight, the chief financial officer of Union Pacific Corp., actually likes the railroad company’s chances in this tough environment. So much so that during Union Pacific’s third-quarter earnings call last month, he offered some upbeat guidance for the company’s fourth quarter (a rarity among recent earnings announcements) and raised the company’s earnings expectations for the full year.
Union Pacific execs didn’t stop there: With no coaching from analysts, they extended their outlook into 2009, boldly asserting that the company should generate “low double-digit earnings” increases next year.
“We’re one of the few companies offering a sneak peek at next year,” Mr. Knight said in an interview with Financial Week days after the company announced its third-quarter earnings were up 38%, or $1.38 a share, and operating income surged 21%, to $1.2 billion. “That tells you something about how confident we are in the business.”
Mr. Knight said that for the fourth quarter, the company is likely to report similar earnings growth—between 34% and 45%—which would mean a full-year earnings growth of 30% for 2008. That’s no small feat considering that Union Pacific has seen a notable drop in carload volume on its railroads this year while battling fuel costs that have surged some 60% in the past 12 months.
“We’re certainly not immune to an economic slowdown,” Mr. Knight said. “Which is why diversity and operational efficiency are an absolute necessity.”
The economic slowdown translated into about a 5% drop in Union Pacific’s carload volume during the past several months, as a significant chunk of its hauls come from companies in the automotive and housing industries. With fewer consumers purchasing cars, and fewer people buying and building new homes, there’s less of a need to transport autos or materials associated with housing.
The company is expecting another 5% decline in volume for the fourth quarter, which will be another headwind, yet it expects conditions to improve slightly next year. Mr. Knight said volume should be either unchanged, at best, or drop off by roughly 2%.
Of course, if the economy worsens, Union Pacific could be staring at larger drop-offs than it expects, which could eat away at its earnings expectations for 2009, noted Goldman Sachs analyst Chris Hussey. With the way economic conditions have so quickly deteriorated, of course anything is possible, and Mr. Hussey estimates volume is likely to drop 2.5% next year, although declines could be steeper if the recession is severe.
But the company has found ways to offset these volume declines. During the most recent quarter, there was a major spike in Union Pacific’s energy and agricultural freight businesses. Revenue in its energy business was up 28%, to almost $1.1 billion, accounting for about 22% of Union Pacific’s $4.6 billion in total sales for the third quarter. Similarly, its agricultural freight revenue was up 27%, to $848 million.
“We have been developing these businesses for several years now as a way to consciously capitalize on the opportunities that we’re seeing right now,” said Mr. Knight, noting that over the last three years, Union Pacific has been shipping considerably more coal and ethanol, as well as parts for windmills and natural gas exploration projects.
Yet beyond simple increases in revenue in these lines, Mr. Knight pointed out that he’s been trying to drive more efficiencies from every one of the companies’ businesses—demand and volume may ebb and flow, he noted, but increasing productivity, improving customer satisfaction and cutting back on waste will benefit the company in any economic environment.
That should enable the railroad to charge more for rides, Mr. Knight said, and also retain more of its price increases. With rising fuel costs, trucking companies have become more expensive providers of transportation, and Mr. Knight notes that railroads are now three to four times more efficient than trucks.
So while volume may be down, the company is now making more off of every ride than it was a year ago—even in its automotive business. Each of its six business units boasted increases in the average amount of revenue generated per car during the third quarter, with energy jumping 24%, to $1.7 million for each car, while average auto revenue climbed 22%, to $2.1 million a car.
These are exactly the types of results Mr. Knight’s been aiming for in the last several years, since he first kicked off Project 75—an initiative designed to get Union Pacific’s operating ratio to 75%. The company has managed to trim more than 11 percentage points off its operating ratio in the last three years, and it ended the third quarter at 74.8%.
“It couldn’t have come at a better time,” said Mr. Knight.
No kidding. And it’s part of the reason that Union Pacific has been able to increase its dividend 80% over the last 18 months, while repurchasing $2.8 billion worth of its stock. Roughly 500 companies cut their dividends in the same period, according to Standard & Poor’s data.