The Business Of

Transportation | Union Pacific | How Do They Make Money?

Morning All!

So yesterday, we started Part 2 of The Business Of Transportation. And our focus this week is on Union Pacific Corporation. We saw that whilst shipping companies like Maersk are great for transporting things TO AND FROM America. Companies like Nike still need trains (and trucks) to help them transport things WITHIN America.

Today we’ve got a super interesting newsletter in store. Because we’re going to dig into what sorts of ‘things’ Union Pacific actually transport. In the chart below, we can see that the railroad giant made a whopping ~$25bn in revenue in 2022! And this mammoth figure was split fairly evenly into the 3 main segments we see below…

Now, you may be wondering, ‘who are Union Pacific transporting cars for? Or coal? Or metals? And how is this even done? What does it look like?’ Well, we’re about to find out!

And by the way, just a heads up – there’s a million things we could discuss about each of these segments. But to keep things simple, I’m going to try and make things short and sweet! Alrighty, let’s dive into containers and cars!

Car Manufacturers Have Rail Tracks Basically Inside Their Assembly Plants!

Alrighty, to kick us off, let’s first start with containers and use our Nike example again! To remind us how this all fits in, I’ve put in the image below which we saw yesterday.

So, a company like Maersk ships over containers from the Port of Shanghai to the Port of LA. And inside the containers are a load of Nike’s trainers. We said yesterday that Nike will use railroad companies like Union Pacific to get those trainers to their customers all over America. But this isn’t that easy to understand – like how does it actually work?

Well, I think a good way to think about this is like the London tube map! Union Pacific basically has loads of ‘stations’ – called intermodal ramps - dotted all over America. And these stations are all connected together by Union Pacific’s tracks. The screenshot below shows us that one of these stations is in LA. And no surprise, this station is right next to the Port of LA!

So, to keep it short and simple - what happens is the following. Maersk transport Nike’s containers from the Port of Shanghai to the Port of LA. Trucks (maybe Maersk’s) take the containers from the Port of LA to Union Pacific’s station – which is right next to the port.

Now, at Union Pacific’s station, the containers will get placed onto freight cars (the things that carry the containers). And the containers will then be on their way to wherever Nike wants them on Union Pacific’s train line map!

Okay, so that’s a little bit about containers. Now, let’s talk about cars. I found this pretty extraordinary but ~75% of the new cars bought in America in 2022 were transported by rail. What do I mean? Well, let’s use Toyota as an example. The Japanese car manufacturer has assembly plants around the US (assembly plants are where the cars are put together). But they have one specific plant in San Antonio. And the reason I single out this plant is because it has railroads basically inside it!

And guess who these railroads belong to? Yup, you guessed it – Union Pacific Corporation! Union Pacific basically transports Toyota’s cars directly from their assembly plant in San Antonio to the Union Pacific stations around the US – which are close to Toyota’s dealerships (their final destination point)! The image below shows us some Toyota cars being loaded into freight cars, which will then be transported via rail…

Pretty cool, right! But here’s a question – we’ve seen how Union Pacific help companies like Nike and Toyota transport containers and cars – but how does the company actually make money from all this? Well, the answer is that Union Pacific charge their customers (Nike and Toyota) for every freight car they transport!

In 2022, Union Pacific transported a whopping 3.9 million ‘container and cars’ freight cars. At an average revenue of $1,905 per freight car. And what’s 3.9 million x $1,905? A huge $7.4 billion in revenue! Alrighty, that’s enough container and car fun. Let’s move on!

What Do Coal and Grain Companies Need Union Pacific For?!

Alrighty, the next section we’re going to look at is the coal, grain and other segment. And no prizes here – the main things Union Pacific transport in this segment are… coal and grain! Okay so, let’s start with coal - and one of the main customers for Union Pacific in this segment is Peabody Energy. I doubt many people will have heard of Peabody, but they’re actually one of the largest coal miners in the world!

So, what do Union Pacific do for Peabody? Well, Peabody Energy have ~20 coal mines around the US. From these coal mines, they basically extract coal. And then they want to transport this coal to their power plants – where the coal is used to generate electricity. And this by the way, is pretty massive. As we can see from the chart below, in 2022, coal was still the largest source of electricity generation globally!

So, how does Union Pacific help Peabody? Well, Union Pacific transports Peabody’s coal from their coal mines to their power plants. The images below show us coal being mined (on the left) and then transported via train out of the mines. And this is a little bit like the Toyota assembly plant by the way. Union Pacific will have rail tracks running through these coal mines, which helps speed the whole process up!

One thing to quickly mention about coal. Despite being the largest source of electricity generation in 2022 – coal’s dominance is decreasing. The amount of coal Union Pacific has transported has fallen considerably over the last couple of decades as the push towards a greener economy has seen coal replaced by some of the cleaner fuels we saw in the chart above.

Alrighty, so that’s coal. Now, let’s briefly chat about grain! Now, I know what you’re thinking – why on Earth are we talking about grain?! Well, the reason is because grain is super important. You know that flour you need to bake your cupcakes? Or the vegetable oil you use to cook? Or the animal feed needed for raising animals? Well, they all come from grains like wheat and sunflower seeds!

Companies like Archer Daniels Midland basically buy wheat, sunflower seeds, and other grains from farmers around the US. They then need to transport these grains to their processing plants, where the grains become the flour, vegetable oil and animal feed! And again, who do they call? Yup, UnionPacific! The images below show farmers getting their grain (left) and Union Pacific transporting this grain to processing plants (right).

Okay, so we’ve seen how Union Pacific do what they do for coal mining companies and grain companies. But how much money did they make from this segment? Well, again, it’s a function of the number of freight cars transported x the average revenue per freight car!

In 2022, Union Pacific transported 2.1 million freight cars. At an average revenue of $3,658 per car. Giving the company a revenue of $7.5bn from this segment! Now, some of the eagle-eyed readers will have noted that the average revenue per freight car in this segment ($3,658) is way higher than it was in the previous ‘containers and cars’ segment ($1,905). Good spot if you did notice that! And on Friday, we’ll get into why this is!

Steel Is One Of Union Pacific’s Largest Markets!

Okay, last segment for the day – metals and other. And we’re not going to spend much time at all on this because this newsletter’s getting fairly long! But basically, on top of all the containers, cars, coal and grain, Union Pacific also transport a fair few metals across America! And the main one they transport is steel.

Now, steel is one of the most popular metals in the world. It’s used for so much around us - cars, construction, washing machines + much more. And in order for companies like Nucor Corporation (the largest steel producer in America) to transport their steel from their steel mills to their customers, they need railroads. Enter, Union Pacific! The image below shows us the various steel mills around America. And the green dots show all the mills where Union Pacific helps out!

And this is like what we’ve seen earlier. Union Pacific basically have their ‘stations’ all over America which help transport containers, cars, coal, grain, steel, etc for all their massive customers! Now, on top of metals, Union Pacific also transport plastics, paper and a few other industrial goods - but we don’t need to get into those now. We’ve looked at enough today!

So, what’s the revenue from this ‘metals and other’ segment? Well, in 2022, Union Pacific transported 2.2 million freight cars of metals and other industrial goods. At an average revenue of $3,704 per freight car. Giving the company a revenue of $8.2bn from this segment!

Wait Hold On… Union Pacific Transports Less In 2022 Vs 2001?!

Alrighty, let’s wrap up! We’ve gone through a fair amount today. And the final thing to do is to bring all the previous 3 segments together. So, as we can see from the equation below, in 2022, Union Pacific Corporation transported a total amount of 8.2 million freight cars. The average revenue they made from each freight car was $2,835. And multiplying the two numbers together gives us a whopping ~$23 billion in revenue!

Now, that is obviously a massive number. But how has this revenue figure evolved for Union Pacific over time? Well, the chart below shows us. And it’s a fairly sedate picture! In 2001, Union Pacific had revenue of ~$11 billion. And over the last 2 decades, the company’s revenue has risen at a very modest rate of ~4% per year.

And if we break Union Pacific’s revenues down into their two main drivers - (i) number of freight cars transported, and (ii) the average revenue/freight car – we can kind of see why revenue growth has been so low.

The number of freight cars (yellow bars) that Union Pacific transported in 2022 was actually lower than it was in 2001! 8.2 million (2022) vs 8.9 million (2001) - mind-blown! Let me say that again. Union Pacific transported less freight cars in 2022 than they did in 2001.

Now, whilst the number of freight cars transported has declined over the last 20 years – the average revenue the company has made per freight car has nearly tripled over that period! In 2001, Union Pacific made $1,165 per freight car. But in 2022, this had increased to a whopping $2,835.

And the reason I found this so amazing, is because it’s the complete OPPOSITE to what we saw last week. In the chart below, we can see Maersk’s 2 revenue drivers – (i) the number of 40-foot containers transported, and (ii) the average freight rate per container. As we can see, Maersk increased their containers transported from 7 million (2007) to 12 million (2022). But the company’s pricing (their freight rate) was declining consistently before the explosion due to COVID In 2020.

Now, why is this? Why have Union Pacific been able to increase their prices consistently over the last 2 decades, despite actually transporting less volumes? Well, have a think – we’ll crack this mystery tomorrow!

19th Dec 2023

Nigel Jacob CFA