All aboard: Recovery should boost rail

Union Pacific expects good things in the second half of 2010 and could be a good way to capture momentum.

By Jim J. Jubak Mar 19, 2010 1:57PM

Jim JubakAs Warren Buffett said when Berkshire Hathaway (BRK.A) bought Burlington Northern Santa Fe (BNI), this buy is a bet on the strength of the U.S. economy.

Union Pacific (UNP) historically hasn't been an especially well-run railroad, but it is run well enough so that the transcontinental road will get a big boost from the recovering U.S. economy in the first half of 2010 -- and expectations for further improvement in the second half.

I'm not convinced that expectations for second-half growth will prove out, which is why I'm keeping this buy on a very short-term leash. 

But I think momentum -- both in stock price and in the economy -- will make this a profitable short-term way to take advantage of the relative outperformance of the U.S. stock market in the first half of the year. (For more on why I believe that out performance is likely to continue for a few months, see this post).

When Union Pacific reported fourth-quarter 2009 earnings back in January, the company not only beat Wall Street expectations for the period (with $1.08 a share when estimates called for $1.04), but signaled its belief that traffic would pick up in spring. Data from February suggest that management was right on the mark.

Total U.S. and Canadian rail traffic for the last week in February was up 6.4% from the same week in 2009. Traffic for the entire month increased by 2.1% from February 2009 despite a snow-related drop in traffic in mid-February. 

The growth was driven by what railroad analysts call economically sensitive carloads (traffic in commodities and products that fluctuates with the state of the economy). That part of total railroad traffic climbed 8% from February 2009. Big gains came in chemical, metals, and auto volumes.

Growth in traffic volumes at Union Pacific actually exceeded overall railroad volume growth. For February, volume was up 14% from February 2009.

The one worry for all the transcontinental roads is the softness in coal traffic caused by big stockpiles at utilities that burn coal to generate electricity. Because of the mix and location of the utilities Union Pacific serves, that doesn't seem to be as big a problem for the company as it does for competitors such as CSX (CSX)

In February, Union Pacific's coal volumes were up 5% from February 2009, and management has predicted that coal volumes will return to normal by summer.

April brings the real test for Union Pacific and my projections for growth in traffic. That's when large customers sign contacts for fall shipping. Signs so far suggest prices will trend upward.

As of March 19, I'm adding Union Pacific to Jubak's Picks with a target price of $81 a share by June 2010. (It traded around $73 Friday.)

At the time of this writing, Jim Jubak didn't own shares of any company mentioned in this post.

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