Recent Buy: May 28th, 2015
I struggled in May to find an investment worthy of my hard earned dollars. Finally, on one of the last days of the month, I locked in and purchased a brand new business for my portfolio. Let me put on my conductor hat, now that I own a piece of the railroad Union Pacific Corporation (UNP). After cutting their dividend in 1998 to conserve cash and deal with integration troubles following their merger with Southern Pacific, this freight railroad has more than made up for it with 9 years of rising dividends and super fast fundamental growth.
This is a new position for me, and I now own a part of 25 wonderful businesses that raise their dividends each and every year. On May 28th, I purchased 14 shares for $101.35 each and a $6.95 commission for a new total transaction of $1,425.85 in my taxable Sharebuilder account. The 2.17% yield on my purchase will provide $30.80 in annual income for a new 12 month total of $1,886.77. I’m aiming to achieve quick dividend growth in this investment with a fair amount of capital appreciation and this post will cover UNP’s operations, fundamentals and valuation.
Union Pacific has been in operation for more than 150 years and serves over 7,300 communities and 10,000 customers throughout the western two-thirds of the United States while also connecting to railways in Canada and Mexico. Currently their rail network includes 32,000 route miles that travel through 23 states. This industry is very monopolistic in nature and has a huge barrier to entry thanks to the gigantic cost of securing land, building railroad tracks and maintaining train cars. Railroads are the most cost and energy efficient way to ship materials and goods long distances, trumping trucking and air freight. Here was the track layout as of 2014:
UNP’s shipped goods are very diverse with six commodities making up revenue in 2014:
2014 carload composition saw 61% domestic activity compared to 39% international.
With a growing population and increasing need for shipment, this industry is set to continue growing strong well into the future.
UNP’s total 10 year return through June 1st with dividends reinvested was a staggering 617.60%; that’s a full quarter more than you would have received from competitor CSX and almost double the return of competitor NSC over the same time frame. Revenue has grown from $13.578 billion in 2005 to $23.988 billion at the end of 2014 for a compound annual growth rate (CAGR) of 6.53%. Earnings per share increased from $0.96 to $5.75 for a CAGR of 22%. This shows UNP is still growing strong over a century and a half later.
The business supports a solid and responsible use of cash flow over the last decade, investing more than $31 billion in its network and operations to support America’s transportation infrastructure. They’ve maintained healthy leverage as well, with only 35% Debt/Capital.
Dividends have been wonderful in their past nine years of growth, increasing from $0.30 to $2.01 a share for a CAGR of 22.8% and an average annual increase of 23.4%; that means the dividend has almost doubled every four years in that time frame which really excites me as a dividend growth investor. This information backs up my investment thesis of future fast growing dividends. While that future may not hold these same results, my yield on cost from the current small dividend yield of 2.17% should grow swiftly in the coming years.
Since railroads are almost like a toll road collecting tons of cash, the company has been buying back its shares at a strong pace to increase earnings per share. Here is what that’s looked since 2007:
We feel very good about our long-term outlook going forward. The fundamentals are strong, supported by a diverse franchise that allows us to pursue new, attractive market opportunities.
We’ll continue to focus on improving returns to support capital investments that will strengthen and enhance our network, create value for our customers, and drive increased returns for our shareholders. ~Rob Knight, EVP – Finance & CFO
- Ever changing government regulation on rates and business practices
- Downturns in the economy will affect the amount of goods shipped
- Competition from truckers, air freight, drones, and other shipment methods
- Railroads are heavily unionized with large percentages of workers retiring in the coming decade with increasing pension and healthcare obligations
- Personal injury and overall safety
- The overall capital intensity of operating a railroad
A current fast graph shows that UNP is currently attractively valued compared to its earnings (for those unfamiliar with Fast Graphs, when the black current price line moves into the dark green earnings area it indicates the business is undervalued. Here is a basic demo on how to read fast graphs).
My investment objective is primarily faster than usual income growth with some solid capital appreciation to boot. Aside from fully understanding a business, I try to invest with some sort of total return expectation which helps me understand whether or not the current stock price is trading at a fair value. Using Chuck Carnevale’s precise return strategy, I’ve estimated the following scenarios:
- Analyst Estimates: This calculation uses S&P Capital IQ data to help us predict a reasonable return:
With growth capitalized at a reasonable P/E ratio of 15, we will have witnessed a solid 9.47% total annual rate of return through 2018. That’s a $29.58 gain in price per share and $9.34 gain in potential prorated dividend income. Here’s how often UNP has met analyst expectations:
- Historical Compounded Annual Growth Rate (No Analysts): Here I use the lowest annual growth rate from the last decade which is a 6 year annual return of 17.1%:
Wow, we see a big jump with a total annualized return of 20.06% through 2018.
- Most Pessimistic Case: This calculation is based on the lowest normal P/E multiple of 16.6 over the last 10 years:
If a 12.40% annualized annual return through 2018 is pessimistic, I’m completely sold.
- Most optimistic Case: This calculation is based on its highest premium normal 10 year PE ratio of 19.3:
Here we witness a solid total annualized return of 16.94 through 2018.
All aboard! Union Pacific Corporation appears to be fairly valued and definitely worthy of my investment dollars. Future growth may not be as fast as in the recent past, but things are really looking up for this railroad. I’m mainly impressed with the dividend growth over these last nine years, and I trust management knows how to keep that going. UNP is currently heading toward 52-week lows in price and if my position decreases by 5% or more, I’m likely to add more shares. I’ve wanted to own a railroad since I began investing and now I finally do, so dearest UNP, I choo choo choose you.
What do you think about UNP? What stocks are on your radar?