Will Union Pacific Stock Recover To Its Pre-Inflation Shock Level?

Union Pacific stock (NYSE: UNP) currently trades at $192 per share, around 30% below its level of $277 on March 30, 2022 (pre-inflation shock high), and seems like a good investment opportunity. Union Pacific saw its stock trading at around $213 at the end of June 2022, just before the Fed started increasing rates, and is still 10% below that level. In comparison, the S&P 500 gained about 10% during this period. The stock price has suffered over recent months due to a decline in the volume of carloads, and with economic growth deteriorating, volumes may remain tepid in the near term. Furthermore, the company’s operating ratio of 62.1% in Q1 2023 reflected a 270 bps rise from the prior-year quarter due to higher costs and inflation. 

Returning to the pre-inflation shock level means that Union Pacific stock will have to gain more than 40% from here. However, we do not believe that will materialize any time soon, and we estimate Union Pacific’s valuation to be around $216 per share, about 13% above the market price. This is because the recent uncertainty in the financial sector has made investors concerned about a potential recession. Union Pacific’s business will see an adverse impact on its volume if the U.S. economy were to go into recession.  

Our detailed analysis of Union Pacific’s upside post-inflation shock captures trends in the company’s stock during the turbulent market conditions seen over 2022 and compares these trends to the stock’s performance during the 2008 recession.

2022 Inflation Shock

Timeline of Inflation Shock So Far:

• 2020 – early 2021: Increase in money supply to cushion the impact of lockdowns led to high demand for goods; producers unable to match up.
• Early 2021: Shipping snarls and worker shortages from the coronavirus pandemic continue to hurt the supply
• April 2021: Inflation rates cross 4% and increase rapidly
• Early 2022: Energy and food prices spike due to the Russian invasion of Ukraine. Fed begins its rate hike process
• June 2022: Inflation levels peak at 9% – the highest level in 40 years. S&P 500 index declines more than 20% from peak levels.
• July – September 2022: Fed hikes interest rates aggressively – resulting in an initial recovery in the S&P 500 followed by another sharp decline
• Since October 2022: Fed continues rate hike process; improving market sentiments help S&P500 recoup some of its losses.

In contrast, here’s how Union Pacific stock and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of S&P 500 index
• 12/31/2009: Initial recovery to levels before accelerated decline (around 9/1/2008)

Union Pacific and S&P 500 Performance During 2007-08 Crisis

UNP stock rose from nearly $29 in September 2007 to $41 in August 2008 (pre-crisis peak) and fell sharply to $19 in March 2009 (as the markets bottomed out), implying UNP stock lost over 50% of its pre-crisis value. It recovered post the 2008 crisis to levels of around $32 in early 2010, rising roughly 70% between March 2009 and January 2010. The S&P 500 Index saw a decline of 51%, falling from levels of 1,540 in September 2007 to 757 in March 2009. It then rallied 48% between March 2009 and January 2010 to reach levels of 1,124.

Union Pacific Fundamentals Over Recent Years

Union Pacific’s revenues rose from $21.7 billion in 2019 to $25.1 billion in the last twelve months period. This can be attributed to a strong recovery in demand post the pandemic-induced lockdowns. Furthermore, the company realized strong pricing gains, passing on the higher costs and higher fuel prices to the customers. For perspective, the company’s average revenue per carload grew 17% between 2019 and 2022, while its total carload volume was down 2%. Union Pacific’s EPS also increased from $8.41 to $11.33 per share over this period. The earnings growth was driven by higher revenues and an 11% decline in total shares outstanding as the company spent $23.7 billion on share repurchases between 2019 and now.

Does Union Pacific Have A Sufficient Cash Cushion To Meet Its Obligations Through The Ongoing Inflation Shock?

Union Pacific’s total debt increased from $25.2 billion in 2019 to $33.8 billion now, while its total cash increased from around $0.8 billion to $1.1 billion over the same period. The company also has long-term investments, which rose from $2.0 billion in 2019 to $2.4 billion now. It also garners about $9 billion in cash flows from operations. Still, the high debt burden is a near-term risk that the company faces.

Conclusion

With the Fed’s efforts to tame runaway inflation rates helping market sentiment, we believe Union Pacific (UNP) stock has the potential for strong gains once fears of a potential recession are allayed. That said, the pressure on the company’s balance sheet remains a risk factor to realizing these gains. This, clubbed with fears of a potential recession and its impact on the railroad business means it may take a while for UNP stock to reach its pre-inflation shock highs of over $275.

What if you’re looking for a high-performance portfolio with a low downside instead? Here’s a reinforced value portfolio that has beaten the market consistently while limiting losses during periods of sharp market declines.

[1] Month-to-date and year-to-date as of 5/25/2023
[2] Cumulative total returns since the end of 2016

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