Inside Union Pacific’s march to 55% OR

 A Union Pacific train near Painted Rocks, Nevada. ( Photograph: Wikimedia Commons )

A Union Pacific train near Painted Rocks, Nevada. (Photograph: Wikimedia Commons)

New Brazos Yard will help manage growth in Mexican automotive, Gulf Coast petrochemical

At Stifel’s annual Transportation and Logistics Conference earlier this week in Miami Beach, a packed house of investors and transportation industry veterans heard from Union Pacific CFO Rob Knight. Knight went through the typical earnings presentation numbers—earnings per share, capital expenditures, debt load—along with the metrics specific to railroads like train velocity and dwell times. Knight had good news for UP shareholders: for the year of 2017, EPS was up 14% to $5.79 year-over-year, even after excluding the impact of corporate tax reform, and Union Pacific’s operating ratio fell from 63.5 to 63 after excluding the tax cuts. Overall volume was up 2% over 2016, and Union Pacific was able to increase prices at a rate exceeding inflation. 

Regarding specific kinds of freight, Knight said that “Ag is down because of grain… there’s continued uncertainty there—high global supplies and unknown crop production mean we don’t know if we can participate in the export markets,” but he also noted a “huge increase in frac sand,” the volume of which more than doubled from 2016 to 2017. 

But Knight didn’t just talk about 2017—he put Union Pacific’s performance in the broad context of the historic railroad’s 15 year-long turnaround. At the beginning of this century, UP was in bad shape. In 2005, when now-former CEO Robert Young first took the job, Union Pacific was operating at a ratio of 87% on earnings down 29% from the previous year. The railroad Young took over was “a lumbering giant plagued by overcapacity, sloppy service, and an unwieldy acquisition [Southern Pacific]”, as a 2009 Forbes profile put it. 

Young mothballed thousands of locomotives, demanded and got more from Union Pacific’s customers, and revitalized a culture of productivity and efficiency at the 150 year-old railroad. By the time Lance Fritz became CEO in February 2015, Union Pacific’s operating ratio was down to 63.5% (for the year of 2014). 

Now Union Pacific has the cash to reinvest in its business in the form of capital expenditure. Last month construction began at the new Brazos Yard, a new rail yard located in Robertson County, Texas, about halfway between Dallas and Houston. Seven Union Pacific lines intersect at the site, making it the perfect place for a new switching yard. The Brazos Yard will be capable of switching about 1,300 railcars a day and comes with a price tag of $550M, making it the single largest capital expenditure in Union Pacific’s history. In Miami, CFO Rob Knight said that Union Pacific aims to spend about $3.3B on capital in 2018, the majority of it, $1.9B, on infrastructure replacement. 

It makes sense for Union Pacific to invest in facilities that will be able to sort incoming railcars from Mexico—Knight said that Union Pacific expects its Mexico business to be a source of robust growth in 2018. Union Pacific is the only Class 1 railroad serving all six major rail crossings on our southern border, from Calexico to Nogales, El Paso, Eagle Pass, Laredo, and Brownsville. Since 2010, Union Pacific has grown its Mexico volume 33%, from 750K carloads per year to 987K carloads per year. 

66% of that Mexican volume is classified as ‘premium’, which in this case means finished automobiles and automotive parts. Mexican automobile production has grown 143% since 2005, from 1.6M cars built to 3.9M cars in 2017. 2016 alone saw three finished vehicle plants completed: VW in Puebla, Kia in Pesqueria, and Audi in San José Chiapa. This explosive recent growth has allowed Mexico to become the second largest supplier of vehicles to the United States. Union Pacific predicts that Mexican car production will rise to 4.2M cars for 2018, and wants to grow with its customers. 

The Brazos Yard is also well-positioned to sort cars carrying freight from another source of volume growth: the Gulf Coast petrochemical industry. More than 100 petrochemical plants are expected to be built in Texas over the next decade, representing an investment of roughly $50B. Cheap natural gas from newly drilled shale deposits are driving the expansion. Why does this matter for rails? Because ethane, a byproduct of natural gas processing, is the main ingredient in plastic pellets, the raw material from which innumerable plastics products are made. 

“There is a lot of investment occurring which will result in more plastic pellet production,” said Larry Gross, president of Gross Transportation Consulting. “This is a natural commodity for the rails, typically transported in a plastic-pellet-covered hopper, which serves the double function of both transport and mobile storage facility.” One plastic pellet-filled hopper car weighs about 90 tons when full, and the growth in plastic pellet production for Texas alone will amount to millions of tons annually. Chemicals and plastics together made up 34% of Union Pacific’s Industrial volume in 2017.

Last October, European 3PL Katoen Natie and Union Pacific broke ground on a new plastic packaging facility in South Dallas County. Up to 2.5M sq ft of warehouse space with direct access to Union Pacific rail lines will receive railcars full of plastic pellets, which will be packaged and loaded into intermodal containers. The containers will be transported to Union Pacific’s adjacent Dallas Intermodal Terminal, and then the railroad’s premium intermodal service will move the pellets to port. Just as the United States has become a major oil and gas exporter over the past three years, now we’re also producing more plastic than we need. 

ICIS, global energy and petrochemical research firm, said that U.S. producers added 3.5 million tons of polyethylene production capacity last year, with more coming. LyondellBasell, for instance, announced last summer that it is pouring $2.4B into a La Porte, Texas, facility that will become the world’s largest propylene oxide (PO) and tertiary butyl alcohol (TBA) producer. The LyondellBasell CEO, Bob Patel, highlighted the site’s strategic location near Texas oilfields: “Our investment in this plant combines the best of both worlds: our leading PO/TBA process technology with proximity to low-cost feedstocks, which gives LyondellBasell a competitive advantage in the global marketplace for these products.”

Union Pacific’s business plan is, of course, highly complex: it’s the largest railway in the country by revenue, with a territory covering 23 states west of the Mississippi. The new Brazos Yard is just one way that the company is positioning itself to capture growth in key areas like Mexican automotive production and Texas petrochemicals, growth that will help the storied railway on its long march toward 55%.

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