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Sept. 5, 2019, 6:46 a.m. EDT

Union Pacific warns of volume weakness, but can it hold firm on pricing strategy?

Railroad operator to keep prices well above inflation costs; how long can this last given excess truck capacity, lower volumes?

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By Tomi Kilgore, MarketWatch


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Union Pacific Corp. said Wednesday that it remained confident that, despite weaker-than-anticipated volumes, it can hold prices at levels that “well exceed” rail inflation costs.

Really?

‘North American rails seem unwilling to lower rates to drive volumes up, but someone’s going to crack and lower rates to start the cascade downward.’

Eric Ross, chief investment strategist at Cascend Securities

Union Pacific Chief Financial Officer Robert Knight said at the Cowen Global Transportation Conference that third-quarter volumes are currently down 7% from a year ago, weighed down by excess truck capacity and weaker coal demand related to lower natural gas pricing, as well as global trade uncertainty.

“Looking ahead, third-quarter volumes have been softer than anticipated,” Knight said, according to a transcript provided by FactSet. “As a result, our current thinking is that volume for the second-half will now be down mid-single digits versus 2018.”

In July, Knight said in the post-Q2 earnings conference call with analysts that “our best thinking at this point is that volume for the second half will be down around 2% or so versus 2018.” Read more about Union Pacific’s second-quarter results.

One of the economic principles of the law of supply and demand is that when demand falls, so does price, and rail demand appears to be declining. Eric Ross, chief investment strategist at Cascend Securities, said his research suggests rail customers now see it as a “buyer’s market,” as increased trucking capacity gives them more choices, leading to lower rail prices.

Despite the volume weakness, Knight said the company’s pricing strategy remains “unchanged,” which he said ensures pricing will generate an appropriate return.

Basically, the company didn’t want to lower prices to fuel demand, as that would lower returns by eating away at gross margins. And Knight said margins will be “improving” in the second half of the year, so despite lower volumes, previous guidance of sub-61% operating ratio remains intact.

“We remain confident that the dollars we yield from our pricing initiatives will again well exceed our rail inflation costs in 2019,” Knight said.

Cowen analyst Jason Seidl asked during the question-and-answer period following Knight’s prepared remarks, about Knight’s comment that he was confident prices would remain above fail cost inflation: “That means you’re holding your pricing. Obviously, that’s an across-the-board comment, but you’re probably holding your pricing more as a opposed to just slashing and trying to get some of that.”

/zigman2/quotes/209717171/composite UNP 176.25, -0.02, -0.01%
/zigman2/quotes/210598063/realtime DJT 10,879.09, +2.80, +0.03%

Kenyatta Rocker, executive vice president of marketing and sales at Union Pacific, responded by saying:

“I’d tell you the expectation for the team, for the commercial team, is that we’re going to price consistent with the value proposition that we have here. It would not be prudent for us to have some of the best service we’ve had in a few to several years, and then we make adjustments. So, we’re going to stay the course in terms of how we look at the market.”

The company confirmed to MarketWatch that its pricing strategy remained “unchanged.”

“[With] overall volumes slowing, it will be difficult to hold rates up,” Cascend’s Ross wrote in a note to clients. “North American rails seem unwilling to lower rates to drive volumes up, but someone’s going to crack and lower rates, to start the cascade downward.”

The stock /zigman2/quotes/209717171/composite UNP -0.01%  rose 0.5% to close Wednesday at $160.08 after slumping 1.6% on Tuesday, and while the Dow Jones Transportation Average /zigman2/quotes/210598063/realtime DJT +0.03%  rallied 1.2%.

Over the past three months, Union Pacific shares have shed 7.2%, while the Dow transports has edged down 0.6% and the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.11%  has gained 3.2%.

/zigman2/quotes/209717171/composite
US : U.S.: NYSE
$ 176.25
-0.02 -0.01%
Volume: 2.93M
Nov. 18, 2019 6:30p
P/E Ratio
20.77
Dividend Yield
2.10%
Market Cap
$122.37 billion
Rev. per Employee
$544,047
loading...
/zigman2/quotes/210598063/realtime
US : FactSet Prices
10,879.09
+2.80 +0.03%
Volume: 33.77M
Nov. 18, 2019 4:56p
loading...
/zigman2/quotes/210598065/realtime
US : Dow Jones Global
28,036.22
+31.33 +0.11%
Volume: 252.32M
Nov. 18, 2019 4:56p
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Tomi Kilgore is MarketWatch's deputy investing and corporate news editor and is based in New York. You can follow him on Twitter @TomiKilgore.

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