The Business Of

Transportation | Union Pacific | What Do They Do?

Morning All!

Hope you had a great week. Last time, in the first part of our The Business Of Transportation series, we explored the business model of Maersk. And we saw that whilst the Danish shipping giant is crucial for the global economy...

… the company has really struggled to make consistent profits! This week we’re going to look at another transportation company – but one that’s had no problems making consistent profits. It’s the biggest public railroad company in the world. It’s Union Pacific Corporation!

Now, I’m uncertain how many readers will have actually heard of Union Pacific. I know I definitely hadn’t heard of them when I was at uni! But the company is absolutely huge - it’s worth $147 billion! And the world would look a pretty different place without them.

Anyway, if you haven’t heard of Union Pacific (and even if you have), this week will be an absolute cracker for your commercial awareness. The business model really is pretty special (you’ll see why on Wednesday when we look at margins). So, without further ado, let’s jump into what this railroad giant does!

Ships Get You From China To LA… But What About LA To New York?

Okay, so to understand how railroads really fit into the whole transportation industry, let’s use the Nike example we looked at last week. Nike get a lot of their shoes manufactured in China. And to bring those shoes over to the US, companies like Maersk will ship the shoes from the Port of Shanghai to the Port of Los Angeles – which we can see in the image below.

But question – how do Nike get those shoes from the Port of Los Angeles to their customers all over the US?

Well, the answer is… via rail (train) and trucks! In the image below, we can see both transportation methods in action. And it’s clear to see that whilst trucks can usually only transport one container at a time, trains can carry >100 containers on a single journey!

Now, some of us may be thinking… which is better - train or truck? Well, it’s actually a great question - and one we’ll be diving into in some detail on Friday. It’s also a very relevant and topical question at the moment with the rise of autonomous trucks. But anyway, we’ll save that for Friday! For now, let’s crack on and dive into the industry that we’ll be focusing on for the rest of this week - the railroad industry!

Locomotives + Freight Cars + Track = Railroad Company!

Okay, so first thing’s first. What actually makes up a railroad company? Like, what do railroad companies need to operate? Well, the answer is really 3 things. They need (i) locomotives, (ii) freight cars, and (iii) lines of track. Don’t worry if you have no idea what that means - we’ll break them down now!

So, let’s start with locomotives. Locomotives are basically the big parts at the front of trains, that power trains. They make the trains move! Now, it’s probably not surprising that railroad companies like Union Pacific have a few of these locomotives lying around. But I was astonished that Union Pacific actually have a whopping 7,338 locomotives!

Okay, so that’s locomotives. What are freight cars? Well, freight cars are basically the things that help transport goods. For example, a flat car or well car (like seen in the image above) is good for transporting containers. But an autorack freight car is much better for transporting things like actual cars - your Tesla’s and Ford’s! As we’ll find out tomorrow, companies like Union Pacific are transporting far more than just containers - they’re transporting cars, coal, grain, food, and lots more! And because of this, Union Pacific have a huge number of freight cars - an extraordinary ~56,379 freight cars were used in 2022!

Alrighty, the final thing all railroads need is tracks. And obviously, tracks are needed for the trains to move smoothly. Now, in North America, there is actually a whopping ~140k miles of track. And Union Pacific have ~34k miles of this - about a quarter! To put that in perspective, the UK from top to toe is ~600 miles long. So, yes ~34k miles is an incredible amount of track!

Okay, so to sum up: ~7k locomotives, ~56k freight cars, and ~34k miles of track. Let’s move on!

The Land Of Duopolies!

Okay, so in this next section, we’re just going to quickly look at who the other railroad companies are in North America. Because whilst we saw that Union Pacific has ~34k miles of track… which companies have the other >100k miles? Well, this is super interesting. Because despite there being thousands of miles of track in N America, there’s only really 6 companies who actually own all these tracks! In fact, the N American railroad market basically consists of 3 regional duopolies!

What do I mean? Well, in the West of America, there’s 2 major railroad companies – Union Pacific Corporation and BNSF. You can see rail tracks - that connect >20 states - in the image below.

In the East of America, there’s another 2 railroad companies – CSX and Norfolk Southern. You can see their respective lines added in below.

And then there’s 2 companies that operate mainly in Canada – Canadian Pacific and Canadian National. The other company in the image below, Kansas City Southern, was actually acquired by Canadian Pacific, back in 2021!

What’s so interesting about this is that - although there’s 6 main companies in this N American railroad market. Union Pacific Corporation over in the West of America, don’t have 5 other competitors. THEY ONLY HAVE ONE - BNSF! Because think about it - if Nike want to transport their goods from the Port of LA to the other side of America via train - there’s only 2 companies that have the tracks to do that: Union Pacific and BNSF. And hence Nike only have 2 choices: Union Pacific or BNSF!

And as we’ll see over the course of this week, this gives Union Pacific and the other railroad companies a fair amount of pricing power! So much pricing power in fact, that none other than Warren Buffett actually bought 100% of BNSF in 2009!

However, just a reminder that this competition we’re talking about is within the rail industry. As we touched on earlier, Union Pacific faces strong competition from outside the rail industry – from the trucking industry! But we’ll get into this more on Friday!

Railroads… The Semiconductors Of The 1880s!

Okay, final thing to wrap up. I know railroads aren’t the most exciting industry in the world right now. But I just wanted to mention how incredibly vital the industry was back in the day. During the 1860-1900 period, Americans started to realise how important the transport of goods, and hence railroads, would be to grow the US economy. As a result, the construction of railroads took off and railroad companies became the hottest companies of their time!

In fact, in 1884, when Charles Dow (the creator of the Dow Jones Industrial Average) came up with his first index, he only had 11 companies in the index. And 9 of them were railroad companies! Railroads really were the semiconductors of that time!

The first Dow Index was pretty much all railroads!

However, things didn’t stay that way for long. By the 1920s, people weren’t as excited by trains… they were excited by cars! The US government started investing in roads and highways. Which led to more competition for trains vs trucks. The railroad industry became less dominant. And many commentators over the last 100 years have thought the railroad industry would become extinct.

But, for the train-lovers out there - fear not! Because as we can see in the chart below, despite all the change and threats of extinction, US railroad stocks have performed incredibly well over the last two decades. $100 invested into Union Pacific Corporation in 2001 would be worth $2,689 now. Versus only $350 if you’d invested in Maersk. And $460 if you’d invested in the S&P 500.

But how could this be? How can such an ancient industry still be producing great results for investors? Results that are better than the wider stock market? Well, over the course of this week, we’re going to break down Union Pacific’s business model and find out!

18th Dec 2023

Nigel Jacob CFA