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.

Business Overview

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_TRACK1

UNP’s shipped goods are very diverse with six commodities making up revenue in 2014:

UNP_2014Freight Revenue

2014 carload composition saw 61% domestic activity compared to 39% international.

UNP_2014Carloadcomp

With a growing population and increasing need for shipment, this industry is set to continue growing strong well into the future.

Fundamentals

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.

UNP_10yearreturn

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.

UNP_fastgraphdividends

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:

UNP_sharebuybacks

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

Risks include:

  • 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

Valuation

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).

2015_FG_UNP_

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:

2015_FG_UNP_AnalistEstimate

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:

2015_FG_UNP_analystscorecard

  • 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%:

2015_FG_UNP_CAGR

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:

2015_FG_UNP_pessimist

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:

2015_FG_UNP_optimist

Here we witness a solid total annualized return of 16.94 through 2018.

Conclusion:

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?

My Dividend Growth

http://www.mydividendgrowth.com

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27 thoughts on “Recent Buy: May 28th, 2015
  1. Dividend Diplomats

    Great buy here MDP. the market has been providing some great opportunities in the railroad industry lately, so I’m glad that you bought one of the big companies to take advantage. Big fan of your analysis. Very detailed and explains your thought process well. Seems like a ono brainer by the end of the article haha keep up the great work and congrats on growing your portfolio once again.

    Bert

     
    Reply
    1. My Dividend Growth

      I hear you on the deals in the rail industry, and I’ve seen you diplomats gobbling up NSC which is another fine name. That company is even more undervalued than UNP at the moment, I hope you do really well with it my friend! Those compliments on the analysis mean a lot coming from you, man! Big fan of you both over there. I very much appreciate you stopping by and have a great week ahead Bert!

       
      Reply
  2. Dividend Gremlin

    Ryan,
    They are a monster. They are sitting #1 on my next purchase list in my regular account via Sharebuilder. Behind them I have TROW, BEN, and NSC. Still UNP is taking a beating for no reason. Like you show their fundamentals are excellent and they just keep going – and who in their right mind wants to start a new railroad to compete with the big boys (UNP, BNSF, CSX, NSC, Kansas City Southern, etc)?

    Congrats on the purchase, it should reward you for a long time.
    Gremlin

     
    Reply
    1. My Dividend Growth

      Hope all is well with you my Gremlin friend 😉

      I think you have an awesome list there. Of the names you mentioned I think BEN and NSC are the most undervalued, but UNP and TROW might be growing a little faster to make up for that in a few short years. It’s a real tough call and I think you’ll be happy with any of the four. Who would want to start a railroad you ask? How about the DGI community here once we’re all filthy rich from these dividends, we can all wear conductor hats and shovel coal into the engine, haha. That’s a great point though, the infrastructure is almost impossible to replicate going forward. Who knows what the future will bring though, maybe an Elon Musk type hyperloop for shipping or something, but can you image the cost of something like that? They said a mile long test of the concept will cost billions. I just don’t see much treat to UNP anytime soon. Always great to hear from you my man and take it easy this week!

       
      Reply
  3. Dividend Hustler

    Awesome purchase Ryan. Can’t go wrong with such a Moat. Congrats on the pickup. Definitely a solid company. Thank you for sharing and thanks for taking the time to create a thorough analysis. Take care and keep up the hustle my friend. Feels great!

     
    Reply
    1. My Dividend Growth

      YOU are awesome, Tyler! Thank you for the very kind words and I’m really enjoying your progress over there and motivational writings, please keep at it for all of us who benifit! Your support means the world my friend.

       
      Reply
  4. Dividend Empire

    Great pickup Ryan and congrats on waiting for the big drop. I got in at $107 and I thought THAT was a good price. I might just have to average down on this one…

    Ken

     
    Reply
    1. My Dividend Growth

      Ken, I’m super happy to join you here. I wonder how low it’ll go? I’m hoping a little further so we both get the opportunity to average down. The best part is the price we pay today won’t mean much several years after owning this awesome business. Thanks for the support!

       
      Reply
  5. Dividend Mantra

    Ryan,

    Seeing as how UNP represents my last three stock purchases (including the add today), I’m all aboard with you. 🙂

    Looking forward to collecting rising dividend income for many years to come with UNP. The fundamentals across the board are outstanding, and UNP has made good use of repurchasing as they got a great price on their own shares over the last seven years. Wish I would have been buying alongside management.

    Keep it up!

    Best regards.

     
    Reply
    1. My Dividend Growth

      Nice! You’ve been on fire with UNP lately and it’s easy to see why you’re loading up. I have you to thank for bringing it’s current price drop to my attention. As far as those dividends go, UNP can SHIP em’! I completely agree that this is one of those rare moments where share repurchases actually make sense and I’m a fan, unlike say Nike at these levels where the repurchases keep me scratching my head. I wish I would have been buying any stocks at all over the last seven years, holy crap I’d be ahead of the game right now. Thanks for the support, Jason. It’s always such a pleasure to hear from you!

       
      Reply
  6. JC @ Passive-Income-Pursuit

    Like the purchase of UNP. I’ve been looking for a spot to add them to my portfolio myself. Love the wide moat and the oligopoly structure of the railroads. And since they are the most efficient mode of transportation over long distances that’s a huge plus. I don’t expect growth to be as crazy as it has been the last few years but there should be consistent growth year in and year out.

     
    Reply
    1. My Dividend Growth

      JC, your recent analysis of UNP was super helpful to me in this investment so thank you for that! You’re so right and oligopoly is such a better word than monopoly like I used in the post, this is my main attraction to UNP, one simply can’t replicate what has taken them a century and half to construct. Agreed that growth probably won’t be as good from here because you can only improve margins and do sharebuybacks so much, but this seems like a great long term investment because it’s simply not going anywhere in our lifetimes and we get to sit back and collect the toll. Thank you for stopping by!

       
      Reply
  7. roadmap2retire

    Great purchase, Ryan. Love railroads and doesnt get any better than UNP. I am wondering if I should initiate a position myself or add to my position in CN. Really attractive valuation here – for an industry that doesnt really go on sale.

    Congrats on adding this fantastic company to your portfolio!
    R2R

     
    Reply
    1. My Dividend Growth

      Appreciate that, R2R! I really like CN as well and if I had room in my ROTH I’d be all over it, but I might have to wait till next year. I’m hoping to use my remaining 2K in available contributions for any further downturn in REITs. In hindsight there are several names I wish weren’t in my ROTH and in my Taxable instead. I might have to take a commission hit to sell and instantly re-buy at some point to re balance, but I’m in no rush. I’ve learned a lot of little things like that so far and there’s only so much we can do in hindsight. Keep up that great work yourself, looking forward to how your month tracks with your June outlook post.

      Best,
      Ryan

       
      Reply
  8. Forward Dividends

    Ryan,

    Great purchase and we also have been buying UNP recently. Excellent analysis and thought process in your post. We are happy to be a fellow shareholder with you and look forward to those total return scenarios you outlined. Heck, we will be happy with 70-80% of those total returns. 😉

    Congrats on your 25th holding and keep up the great work!

    All the best.

    FD

     
    Reply
    1. My Dividend Growth

      Hi FD. Great minds think alike, right? It’s one of my favorite things when a bunch of us investors come to the same conclusion, what a solid backing to investment decision making. I’d be happy with a fraction of the return as well, but I do want to make sure the dividends come in as planned or I might get ansy. To me those dividends are way more important than a total return I’d likely never cash out to realize the profits. Glad we’re on the same page there too with this strategy 🙂

      Best wishes!
      ~Ryan

       
      Reply
  9. DivGuy

    Nice analysis! Looks like a pretty good buy indeed. Of course I know this company but never really paid attention to it. Thank you for sharing these fundamentals, looks like something to dig in!

    Cheers,

    Mike

     
    Reply
    1. My Dividend Growth

      It makes my day to hear analysis compliments from you, Mike. You’ve set standards in that department that I highly look up to 🙂 I’d be curious to hear your thoughts if you ever dig in, and thanks for the support my friend!

       
      Reply
  10. DivHut

    Are you a Costco member? If so, you can take advantage of their discounted commish on Sharebuilder. Thanks for sharing this recent buy with us. I see more and more UNP buys among the dividend bloggers. I guess that dividend growth and wide moat business with great valuation makes it very compelling. Like you, I also wondered where I’d be buying in May. But as you know I go to my Canadian banks if nothing else is really compelling. Look forward to your next buy.

     
    Reply
    1. My Dividend Growth

      No Costco for us, my sister and parents are big fans though. Maybe my fiancee and I should check it out and see what all the fuss is about. I’m still liking those bank purchases of yours and I’d be right there with you if it weren’t for limited contribution room in my IRA. I have regrets about a few of the businesses I put in that IRA, almost wishing it were purely for Canadian holdings and REITs, but live and learn I guess. Part of me is still interested in selling PG and buying more OHI or BNS there because my cost basis is very high in PG and it’s growing slower than the S&P 500 ( it was one of my first investments before I implemented my current rules about valuation ). I’m stuck between thinking long term and regret. Thank you for reading, best wishes to you and the family!

       
      Reply
  11. Vivianne

    You are a great creative writer, from the beginning to “cho choo choose … you” . Very great buy, great analysis, you might have convince me to pick up a few share to diversify my porfolio as I don’t have transportation just yet.

     
    Reply
    1. My Dividend Growth

      Vivianne, it’s comments like yours here that make blogging worth it for me. Probably one of the better ones I’ve ever received 🙂 That really brightened my day, thank you so much! I’ll be watching to see where your capital goes next!

       
      Reply
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