The Business Of

Transportation | Union Pacific | What Are Their Margins?

Morning All!

So, yesterday we dug into how Union Pacific Corporation makes money. And we saw that Union Pacific transports goods for some of the biggest companies in the world including Toyota (cars), Nike (shoes), Peabody Energy (coal) and Nucor Corporation (steel)! We saw that the company transported 8.2 million freight cars in total in 2022. And the average revenue they made per freight car was $2,835. Which gave the company a massive 2022 revenue of ~$24 billion!

But anyway, that’s enough about revenues. Today, let’s switch our focus to margins and start by looking at how Union Pacific’s cost structure is split…

Now, from looking at the chart, we can see there’s 2 main costs that make up over half of Union Pacific’s costs – (i) compensation, and (ii) fuel. So, let’s dive into those two and get exploring! The compensation section here is absolutely crazy by the way!

Errr… How Do I Apply For A Railroad Job?!

Okay, so before we get into looking at how much Union Pacific’s workers get paid, we first need to talk about something pretty important in the railroad industry. And that thing is precision scheduled railroading (PSR). So, what on Earth is that?

Well, to keep it simple, back before the 1990s, railroad companies weren’t the most efficient businesses. Too many freight cars would be unused and idle at stations for too long - meaning missed revenue. There would be far too many workers… not doing much work! And a host of other inefficiencies.

But then, in 1993, a chap called Ewing Hunter Harrison introduced an operational strategy called precision scheduled railroading. His strategy - which you can read more about here and here - basically made railroad companies far more efficient by reducing unnecessary operational costs. Quite amazingly, this strategy has become so popular in the railroad industry that it’s come to be employed by pretty much ALL of the 6 major railroad companies in North America… way to go Ewing!

Now, why are we talking about Ewing? And how does this relate to employees? Well, one of the main components of PSR is to save costs by reducing the number of employees. And this is crystal clear to see at Union Pacific! Since adopting PSR in around 2015/16, Union Pacific Corporation have cut their workforce by a whopping ~35%! From 48k (2015) to 31k (2022) – as we can see below.

Now, whilst adopting PSR and reducing costs sounds like a good strategy for Union Pacific... it’s obviously not the best thing for employees! One, they’re scared of losing their jobs. But also, the increased efficiency and precision required by their railroad bosses meant that railroad employees didn’t get any paid sick leave! Like even if they had an emergency doctor’s appointment and had to take the day off work - they would have to use up their annual leave! Which is pretty unheard of in most industries.

Fortunately for railroad employees though, this was changed just a few months ago in May 2023!

Okay, so we’ve seen employee numbers have been cut quite dramatically. The employees that remained have had to fight super hard just to get paid sick leave! I’m sure most of us are thinking - these poor guys and girls are probably not getting paid a lot either right? Welllllll, here’s the twist! Because whilst that is a fair assumption - we couldn’t be more wrong if we tried!

The chart below shows us that the average Union Pacific worker makes an absolutely incredible $151k per year! That’s about ~$110k in salary + ~$40k in pension, bonuses, etc. $151k!!!

And this whopping compensation apparently puts US railroad workers in the top 7% of highest paid workers in the whole of America! Remember, the average annual compensation and benefits for an employee at Charles Schwab - the US banking/brokerage giant - was only slightly more at ~$168k. So, yes railroad workers get paid incredibly well… even without paid sick leave!

So, final thing on compensation costs. We’ve seen Union Pacific cut their employee numbers by ~35%. But their remaining employees are getting paid lots more. So, what has this meant for their overall employee costs over the years? Well, the chart below show us that compensation and benefits has actually reduced from being 33% of revenue in 2001 to 19% in 2022! Union Pacific has benefitted massively from employee cost savings over the last two decades!

Crude Oil Prices Are A Lot Harder To Control Than Employees!

Okay, that’s employee costs. Let’s move onto fuel. And this is very similar to what we saw last week in The Business Of Maersk. The Danish shipping company needs bunker fuel to power their ships. And Union Pacific needs diesel fuel to power their trains.

In the chart below we can see how Union Pacific’s average diesel fuel price has trended since 2001 (blue line). The brown line shows you how Maersk’s bunker fuel price has fluctuated since 2013 (unfortunately Maersk don’t break the figures out further back than that!). But what’s clear to see is the correlation between both fuel prices over the last decade.

So, question - why is there this correlation between bunker fuel prices (for ships) and diesel fuel prices (for trains)? Well, it’s pretty straightforward. Both Maersk’s bunker fuel, and Union Pacific’s diesel fuel are derived from crude oil! And so when the price of crude oil fluctuates, the price of bunker fuel fluctuates (affecting Maersk). And so does the price of diesel fuel (affecting Union Pacific).

Now, this impact on Union Pacific can be seen pretty clearly in the chart below. COVID’s entry in 2020 saw crude oil prices drop initially - and then spike afterwards. Union Pacific’s diesel fuel price jumped more than 2x from $1.50/gallon in 2020 to $3.65 in 2022! And as we can see, fuel costs as a % of revenue jumped from 7% in 2020 to 14% last year.

So, whilst Union Pacific have been able to adopt precision scheduled railroading, and control their employee count to achieve a huge reduction in their employee costs as a % of revenue. The uncertainty and lack of control they have over crude oil prices means fuel costs as a % of revenue have been a lot more up and down!

Where Maersk Is Weak, Union Pacific Is Strong!

Alrighty, let’s wrap up and bring it all together. We’ve seen over the last couple of days that Union Pacific is a vital cog in the US and global supply chain. But what does this mean for how profitable they are? Because last week we saw another transportation company - Maersk - who also are incredibly important for the global supply chain. But they didn’t have the highest or more stable margins.

So, should we expect something similar from Union Pacific? Well… not quite! The chart below shows us that Union Pacific’s EBIT margin has increased incredibly consistently over the last 2 decades from ~19% in 2001 to ~40% in 2022!

But what on Earth is going on here? How has one massive transportation company - Maersk - got such inconsistent margins? But the massive transportation company - Union Pacific - has super high and consistent margins?!

Well, the answer is to do with pricing power! In the shipping industry, the price at which containers are transported for customers (the freight rate), isn’t really set by an individual company like Maersk. The price is set by the marketplace! Because shipping is basically a commodity industry - the services Maersk provides customers is pretty much identical to what their competitors are providing - no one player has market power to really dictate pricing. Add on top of that, the fluctuations in supply of containers - and Maersk really has very weak pricing power!

But now, let’s consider Union Pacific. Yesterday, we saw that Toyota’s assembly plant in San Antonio has Union Pacific’s rail tracks right next to it. If Union Pacific say to Toyota - ‘Hey Toyota, this year we’re going to increase the price, you’re going to have to pay us 4% more for every car we transport’ - do you think Toyota are going to say no? Of course not - the track is right there! If Toyota want to transport their cars by rail, they won’t have a quicker or cheaper option than Union! Which means strong pricing power for Union Pacific.

Or let’s look at Nike. If Nike wants to transport a container of their goods from the Port of LA to somewhere else in the West of America by train - they literally only have 2 options - Union Pacific or BNSF! These companies are the only major railroad companies that have the tracks in the West of America to help Nike! So again, Union Pacific and BNSF are able to exert loads of pricing power. If both companies say - ‘Hey Nike, we’d be happy to help you - but we’ll be increasing our prices by 4% this year’ - Nike don’t really have much of a choice! This article on pricing power is a nice, simply read - and hopefully clears up any questions!

20th Dec 2023

Nigel Jacob CFA