Cramer's Investing Club: Strong Q4 at Union Pacific sets up for a solid 2022

Published Thu, Jan 20 20221:36 PM ESTUpdated Thu, Jan 20 20222:50 PM EST

Union Pacific (UNP) reported better-than-expected fourth-quarter results before the bell Thursday. Revenues of $5.733 billion (+12% YoY) outpaced the $5.607 billion consensus. Earnings per share of $2.66 (+30% YoY) exceeded expectations of $2.61 per share. CEO Lance Fritz commented in the release: "The Union Pacific team concluded its most profitable year ever in 2021. We produced double digit fourth quarter revenue growth by leveraging our great rail franchise to generate positive business mix and core pricing gains, despite ongoing global supply chain challenges that impacted volumes. For the third consecutive year we improved our fuel consumption rate, taking steps to reduce our carbon footprint and meet the goals of our 2021 Climate Action Plan. While our safety and operational performance in 2021 did not meet expectations, we look to convert recent progress into sustained improvement in 2022. Although uncertainty remains around COVID variants and supply chain disruptions, we see a positive demand environment in 2022 and continued traction from business development efforts driving growth as we deliver value to all our stakeholders." Firmwide Metrics Taking a look at companywide metrics, Union Pacific's operating ratio of 57.4% (+180 bps YoY, -230 bps vs FY4Q19) missed the 56.0% consensus with management attributing the deterioration to higher fuel prices. Operating income was in line with expectations at $2.44 billion (+22%). As for a few other operating performance metrics in the quarter, enhancements were seen in workforce productivity, which improved 1.4% YoY to 1,046 car miles per employee and in regard to average maximum train length, which increased 1.8% YoY to 9,319 feet. Fuel consumption was flat versus the year ago period, however, on a full-year basis improved 1% versus FY2020. On the other hand, there was some deterioration in freight car velocity, which declined 12% YoY to 197 daily miles per car; locomotive productivity, which declined 9% YoY to 129 gross tone-miles (GTMs) per horsepower day; and the full year personal injury rate, which increased to 0.98 per 200,000 employee hours from 0.9 for the full FY2020. On the capital return front, the company repurchased 5.8 million shares for a total return to shareholders of $1.4 billion. For the full FY2021, management has now returned a total of $10.1 billion to shareholders via buy backs (33.3 million shares) and dividend payments, and reduced the average shares balance by 3% this year. Segment Results Taking a look at the various operating segments, Bulk sales of $1.809 billion (+16% YoY) edged out the $1.758 billion consensus as volume increased 5% YoY and average revenue per car (ARC) increased 10% YoY. On the call, management attributed strength to "higher fuel surcharges, positive mix, and strong core pricing gains." Versus the year ago period, coal and renewables shipments were up 13%; grain and grain products were down 1%; fertilizer was up 9%; and food and refrigerated were flat. Looking ahead to FY2022, management commented on the conference call, "We are optimistic about the growth in most of our markets due to favorable market conditions and Business Development wins." In fertilizer, incremental growth was thanks to strong market demand. For grain, the team did warn about tough comps versus 2021, but noted that in grain products the company is "leading the market in biofuels development by securing opportunities on both sides of the house. The inbound feedstocks and the outbound finished biofuels." On coal, the team said they "originally anticipated coal to be a half-point headwind over the next three-years. But with current natural gas prices and recent business wins, that business should actually provide a tailwind in 2022." On the Industrial front, sales of $1.897 billion (+14% YoY) came up short versus the $1.904 billion consensus. However, they benefited from volume increasing 8% YoY and ARC increasing 6% YoY. Management attributed the positive ARC performance to "higher fuel surcharges and core pricing gains." Versus the year ago period, forest products increased 7%; industrial chemical and plastics increased 6%; metals and minerals jumped 18%; and energy and specialized shipments were flat. Regarding FY2022 expectations, management commented, "We continue to be encouraged by the strength of the forecast for Industrial production. This will positively impact many of our markets like metal. Customer expansions and Business Development wins will drive growth in our Industrial Chemicals & Plastics commodity groups; however, as we move through the year, we expect lumber shipments to be adversely impacted by the current forecast for housing starts." Finally, in the Premium segment, sales of $1.591 billion (+1% YoY) outpaced the $1.517 billion estimate despite volume falling 14% YoY as ARC increased 17% YoY, benefiting from "higher fuel surcharge, core pricing gains, and a positive mix of traffic." Within the segment, automotive shipments were down 10% versus the year ago period. However, management noted on the call that shipments were up 10% sequentially as semiconductor availability improved. As for intermodal, shipments were down 15% versus the year ago period and 10% sequentially with management citing continued supply chain disruptions. As for FY2022 expectations, management expects a "strong uplift" in both the automotive and intermodal businesses. Specifically, the team called out that "automotive sales are forecasted to increase from 15 million units in 2021 to 15.4 million in 2022 due to the vehicle inventory re-stocking effort." Moreover, the team called out "wins to convert finished vehicles and auto parts shipments from over-the-road," i.e., automotive shipments moving to the rails and away from Union Pacific's primary competition, trucks. On the intermodal front, management commented "domestic intermodal will benefit from retail inventory re-stocking, continued strength in retail sales, and tight truck supply. We're seeing slow improvement on our international volumes but we also remain cognizant of the continued labor shortages that are impacting the global supply chain." Guidance Taking a quick look at higher level guidance, management expects continued improvement to the company's operating ratio and reiterated their long-term target 55% ratio, with expectations to close out 2022 with a 55.5% ratio for the full year. They expect to achieve this via a combination of volume growth, pricing above inflation and strong incremental margins. Speaking of margins, while the company continues to target incremental margin in the mid-to-high 60% range (a 2022 to 2024 target provided at the last investor day), the team expects to be on the lower-end of that range in 2022. As for the volume cadence of the year, management expects the first half of the year to be led by bulk and industrial with the back half being more premium-driven "as supply chains and chip shortages improve." Some key macroeconomic assumptions that shape management's thinking include expectations for a 4.8% increase in industrial production, a 7% decline in housing starts, a 3.1% advance in light vehicle sales, and flat consumer spending (excluding services). Bottom line — stage is set for a breakout All in, despite the operating ratio coming in above expectations (a negative as this is a ratio in which lower is better), there was a lot to like in this quarter. Coal flipping from a headwind to tailwind in 2022 due to natural gas prices was certainly a nice surprise and we are encouraged by the sequential improvement seen in automobiles. We are especially pleased with the demonstration of pricing power which management expects to carry into 2022. As members know, inflation remains the key concern weighing on investors' minds, and pricing power is the primary weapon companies have to combat rising input costs and protect margins. Lastly, while the team will certainly continue to invest in the business, with expectations to spend $3.3 billion (in line with guidance of < 15% of revenue) in 2022, management called out that "strong top-line growth, increasing profitability and ongoing capital discipline should result in a cash conversion rate near 100%." As a reminder, cash conversion is defined as cash provided by operating activities, less cash used in capital investments, divided by net income. That's a crucial metric for investors as that strong cash generation means that management can maintain Union Pacific's industry-leading dividend payout and continue to repurchase shares, which it expects to do so at around the same levels as we saw in 2021. Bottom line, the positive end market trends we are seeing and continued operational improvements, combined with the team's efforts to take market share from the trucking industry, which is suffering from high fuel costs and a driver shortage, sets Union Pacific up for a strong 2022. (Jim Cramer's Charitable Trust is long UNP. See here for for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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Lance Fritz, CEO, Union Pacific

Scott Mlyn | CNBC