Rail Company Union Pacific Likely to Build Steam Even as Its Industry Struggles

The railroad industry has been a bellwether of U.S. economic health, since the Golden Spike joined the rails of the First Transcontinental Railroad in 1869, at Promontory Summit, Utah Territory.

Railroads enjoyed a mini-boom that coincided with the economy's rebounding from the 2008 Great Recession through 2014. But the fall of commodity and energy prices sent the industry tumbling. Union Pacific (UNP) is the likely survivor of a ruthless shakeout about to hit the industry. The stock also is among a class of safe, high-dividend payers that belong in your income portfolio.

U.S. freight railroads collectively have invested about $550 billion in their rail networks since 1980, including $115 billion over the past five years, according to the Association of American Railroads. The work has included new tracks and facilities, and upgrades to bridges and tunnels. This massive amount doesn't include the money spent to modernize locomotives to make them safer and more fuel-efficient.

UNP Chart UNP data by YCharts

Foremost among potential rail mergers, Canadian Pacific Railway is courting a resistant Norfolk Southern. This month, Canadian Pacific announced that it would force a shareholder resolution urging Norfolk's board to negotiate a merger. The proposed deal has the aggressive support of activist investor Bill Ackman.

Union Pacific has demonstrated its ability to survive long-term. It was one of the original railroads ceremoniously connected in 1869.

Union Pacific's rail network comprises nearly 32,000 miles linking Pacific Coast and Gulf Coast ports, with major rail hubs in the the Midwest and eastern U.S. Founded in 1862 and headquartered in Omaha, Neb., it is a barometer for overall economic growth. But lately, times have been trying for the company.

For full fiscal year 2015, Union Pacific earnings were $4.8 billion or diluted earnings per share (EPS) of $5.49, compared to $5.2 billion or diluted EPS of $5.75 in 2014, representing declines of 8% and 5%, respectively. These ostensibly disappointing results are weighing on the stock, but it's important to put them into perspective.

Union Pacific is engaged in a multiyear program of operational streamlining that will make it one of the nation's most efficiently run railroads. Despite declining revenue and earnings, Union Pacific's capital program in 2015 totaled $4.3 billion, an increase of $200 million compared to 2014.

From 2006-2015, Union Pacific invested approximately $33 billion in its network and operations, preparing the company for renewed growth when commodity and energy prices rebound. Union Pacific operates in 23 states in the central and western half of the U.S., coveted territory that gives it huge flexibility to raise prices when market conditions warrant.

The company also returned value to shareholders in 2015, by repurchasing 35.3 million shares at a cost of about $3.5 billion. With a dividend yield of 2.85%, this stock is a long-term ride for growth and income.

The transportation sector has struggled recently, on concerns about sputtering demand, particularly from oil, gas and coal producers. The SPDR S&P Transportation ETF is down 2.41% year to date (YTD), but Union Pacific has racked up a YTD gain of 2.07%.

With a trailing 12-month price-to-earnings (P/E) ratio of 14.55, Union Pacific's stock is a bargain compared to the trailing P/E of 18.27 for its industry. The stock now trades at about $79, with the median one-year analyst consensus projecting a price target of $85, for a gain of about 8%. On the high end, the one-year target is $101, for a gain of nearly 28%. In a broader market that many analysts are saying will be lucky to break even in 2016, those gains (combined with a robust yield) look enticing.

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John Persinos is editorial manager and investment analyst at Investing Daily. At the time of publication, the author held no positions in the stocks mentioned.

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