STATE OF THE RAILROAD Union Pacific and CSX Company Analysis

JUAN MANUEL SEGURA ACCOUNTANCY 20100 8/3/2011 EDWARD F. HUMS

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TABLE OF CONTENTS

1.) HISTORY OF THE RAILROADS a. GENERAL HISTORY3 b. UNION PACIFIC4 c. CSX..8 2.) UNION PACIFIC FINANCIALS a. INTRODUCTION11 b. INCOME STATEMENT..12 c. BALANCE SHEET..16 d. STATEMENT OF CASH FLOWS..22 3.) CSX FINANCIALS a. INTRODUCTION....24 b. INCOME STATEMENT...25 c. BALANCE SHEET...28 d. STATEMENT OF CASH FLOWS....33 4.) CONCLUSION a. SEGURA EQUITY SOLUTIONS REVIEW.....35

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HISTORY OF THE RAILROADS

GENERAL HISTORY

The rail road industry in the United States has its roots in the early 19 th century when John Stevens made an experimental track around his property work. After this successful demonstration case, his work would be replicated though out the east coast, developing a rail road fever. In 1829, Horatio Allen implemented a steam locomotive made for a 16 mile track for Delaware & Hudson Canal Company. Their first locomotive, the Stourbridge lion, was used primarily to haul coal from mines in Carbondale to Honesdale.1 The famous Tom Thumb locomotive, hailed for its historical appearance and influence in the railroad industry, was implemented by the South Carolina Canal & Road company and it was designed by Peter Coopery. This company was also the first to build a locomotive to carry passengers on Christmas day in 1830. Through a series of charters and acquisitions, railroading soon struck the hearts and imaginations of Americans as an efficient way of transporting goods and services.2 By the early 1840s, talk of a transcontinental railroad came into being. Asa Whitney, a famous and well known speculator, proposed that congress give a charter of 60 miles of track through its public domain in order to finance the operation. Whiteny proposed that wages be paid in land, facilitating the movement west and acquiring cheap labor from recent immigrants such as the Irish and the Germans. Because of bitter disputes consisting of exactly where the railroad would run through, Congress never took action on the proposal. Despite Whitneys failure, his ideas started fierce national discourse over the idea of there being a transcontinental railroad. Through a series of explorations and surveys done by merchants and prospective investors in the railroad industry, Abraham Lincoln in 1862 was convinced of the need for a transcontinental railroad and enacted the Railroad Act of 1862.3 In 1869, completion of the transcontinental railroad signaled new opportunities for the nation as a whole. In 1870, a person could travel through the country in a week instead of months, demonstrating how social mobility both through the country and opportunity began to benefit all people involved in the operation of the railroads in the United States. New trains
1

"Railroad History, An Overview Of The Past." The American Railroads. Americanrails.com. Web. 23 July 2011. <http://www.american-rails.com/railroad-history.html>. 2 ibid 3 "History of Railroads and Maps." Memory.loc.gov. Library of Congress. Web. 23 July 2011. <http://memory.loc.gov/ammem/gmdhtml/rrhtml/rrintro.html>.

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harnessing the power of steam such as the Neptune and Jupiter became the engines that propelled railroading companies such as the Santa Cruz Railroad company to expand. The industry expanded so much that by the 1890s, 163,000 miles of track have been laid and in use. Such developments that emerged from this period was the introduction of the standard track of 4 feet, 8 inches and the air brake. Below is a graph demonstration the progression of track mileage in the United States since its inception in the early 19th century4: 1840 2,808 1860 1870 1890 1900 1916 1945 1963 1995 Today 30,000 52,922 163,597 193,346 254,027 226,696 214,387 170,000 160,000

Up through the 1920s railroads reached their zenith in profitability in terms of both passenger and freight transport. From this period onwards, however, locomotive track has been in decline due to the rise of the automotive industry. World War 2 is considered one of the last great runs of the railroad industry before the national highways were created and really made a blow to the rail road companies market share. Up till then, rail road companies have been investing heavily in passenger luxury trains in an attempt to sway passengers back 5. By the end of the 1950s, smaller rail companies have been disappearing, being consolidated by larger rail companies. It was at this point in the period of the 1960s and 70s that the government entered into the rail industry in order to revitalize the rail road industry. Conrail made its debut in 1976, and even before that in 1971, Amtrak became the biggest provider of passenger rail6. The industry witnessed massive deregulation in the early 1980s by virtue of the Staggers Rail Act. Before this point in time, many, if not most of the rail companies were subject to government mandated rates and other similar provisions denying the rail companies in being flexible to adapt to any market changes. Thanks to the Staggers Rail Act, most of these decisions returned to the rail companies and major consolidations occurred bringing about major rail companies such as the Burlington Northern Santa Fe, CSX, and several acquisitions done by Union Pacific and Northern Sulfux.

Union Pacific History Union Pacific was formed with the idea of connecting both the east and west coasts of the United States. 7 With the ratification of the Pacific Railroad Act of 1862, President Abraham
4 5 6 7

Rail Road History ibid ibid "Union Pacific Corporation -- Company History." Find Funding with Banks, Investors, and Other Funding Sources | FundingUniverse. Web. 23 July 2011. <http://www.fundinguniverse.com/company-histories/Union-PacificCorporation-Company-History.html>.

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Lincoln authorized, through both economic and military necessity, the public corporation of Union Pacific Railroad Company to build track to the Nevada California border where it would join tracks with Central Pacific Railroad Company. The countrys ambitious effort to connect both coasts of the Americas would only be possible with government intervention in the form of the issuance of bonds. The U.S government agreed on bonds to be paid back in 30 years. In addition, the railroad company would acquire land grants worth 6,400 acres. In retrospect, despite Union Pacific being created as a public corporation, it would primarily be driven by the private sector.8 Leadership within the company consisted of individuals such as Thomas C. Durant and the Ames Brothers. Because the company had a responsibility to its shareholders, Durant and others were able to form a construction company by the name of Credit Mobiler of America (CMA). In retrospect, it appears as though this was the most effective way for the leaders of the company to funnel off exorbitant profits under the nose of the government and Union Pacifics shareholders. Despite this rampant corruption within the company, the project was completed when in 1869, the golden spike was nailed into the finished railroad on 1,000 miles of track between Nebraska and Utah territory to commemorate the historical significance of the event9. The importance of this event can be seen in the rapid migration west by farmers, ranchers, manufacturers and others seeking fame and fortune out west. For 15 years United Pacific dominated the scene and handsome profits were made by investors. Their dominance would range from 1873 to around 1885 by Jay Gould. Gould oversaw the rapid expansion of Union Pacific through the territories which amounted to an outstanding exapansion.10 . Unfortunately for the company, Gould paid out huge dividends in 1878, the majority of which he owned, and sold his share for large profit. Because of his actions, the company struggled to raise enough money for the government debt they owed that had its maturity in 1895. In 1884, Charles Francis Adams took charge of the company; however, because of the companys past activities, Adams did not have the full confidence of the public and most importantly of congress11. Not only did the company have this debt to handle, they had to weather the panic of 1893. By this time, three rival railroading companies have been cutting away at the operating income of the company, making UNP lose its market power it once had full reign over. In 1893 the company went into government receivership due to its inability to pay off its government debt, but the New York investment banking house of Kuhn, Loeb, and Company was able to raise the necessary capital to pay off the government debt in 1897. They sold the company to another rail company which could carry the same name as its predecessor. Edward Harriman was
8 9 10 11

ibid ibid ibid ibid

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chosen to lead Union Pacific that would become part of the remarkable leadership that would lead Union Pacific successfully into the 20th century12. Harriman, until his death in 1909, expanded the companys lines from 2000 to 6000 miles of track. He also bought out Southern Pacific, which in turn made Union Pacific and Southern Pacific one entity and monopolistic enterprise. Harriman was able to temporarily merge with Northern Pacific and Great Northern Railroad, controlling vital lines coming in and out of Chicago. This realization was short lived when the Supreme Court ordered that the company dissolve in 1904. Despite the split, Union Pacific left the deal with 20% of both Northern Pacific and Great Northern13. With his new holdings in cash, Harriman reinvested the majority of new found net income into renovations of the company. In 1913, the Supreme Court dissolved the companys holding of Southern Pacific on the premise that it was inhibiting competition. Though Harriman died before he saw these events take place, he oversaw the expansion of Union Pacific in an unprecedented period of growth which would become a model for other railroading companys in the future to look on14. From the beginning of the 20th century till the era of WWII, Union Pacific experienced tremendous growth. From revenue in 1916 of $100 million, the company increased revenue by more than double that amount to $211 million in 1923. Over the next couple of decades, Union Pacific became witness to steady increases in overall growth thanks to its oil and gas holdings, excellent performance in freight and passenger transport, and having key investments in prime real-estate. The rapid expansion of the automotive industry in the 1930s made a dent in the companys earnings, resulting in earnings amounting to $125 million. Despite this slowdown, the company invested in key diesel locomotives and with the advent of World War 2, Union Pacific experienced rapid expansion and growth, employing more than 60,000 personnel, leaving an impact of continual expansion and growth well after the war of more than $500 million in revenue15. In the mid 1950s, the company lost freight revenue to the trucking industry made Union Pacific lose most of its revenue that it had earned in the last four decades. Through a process of restructuring, the company was able to focus its energies in three key markets; mineral, oil and gas exploration. Through the purchase of Champlin Petroleum Company and Pontiac Refineries, Union Pacific was able to fully realize its oil and gas initiative. Frank Barnett
12 13 14 15

ibid Ibid Ibid Ibid

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oversaw this process of Diversification of Union Pacific in 1967. In 1969, Barnett turn the company into a holding company, where Union Pacific Railroad would become one of the subsidiaries of the newly founded Union Pacific Corporation. The companys revenue reached $4 billion in the early 1970s due to the oil crisis alongside its coal reserves too16. In 1962, Union Pacific participated in a merger with Chicago, Rock Island & Pacific Railroad, which was taken apart by the ICC in 1980 where most of the lines that the company owned were sold to other railroading companies. These included Missouri Pacific and MissouriKansas-Texas Railroad17. With the advent of deregulation reform in the 1980s, Union Pacific acquired Missouri Pacific and Western Pacific railroads. This acquisition resulted in an additional 11.500 miles of track in several states consisting of Texas, Missouri, and Oklahoma. The main drive Union Pacific had in this consolidation was gain in access to the coveted Chicago rail lines, which it has been denied for most of its existence. Despite profits being up by 30%, the newly obtained companies presented Union Pacific with too many workers in the sense that all of the operations were crowded. Through a series of massive layoffs and restricting maneuvers by the company, Union Pacific was able to cut 12,000 employees, increasing productivity tenfold18. As noted previously, Union Pacific has been in constant competition not only with rival rail road companies, but with the trucking industry in particular. The consolidated the disparity between the two industries, Union Pacific bought Union Pacific Corporation in 1987. Another company Union Pacific bought shortly after entering the trucking industry was Missouri-KansasTexas in 198819. In 1995, Union Pacific acquired C&NW for $1.1 billion. This subsequent merger caused chronic shipping delays and decrease in productivity in Union Pacifics services. Another company UNP attempted to consolidate was the Santa Fe in 1994, which it subsequently lost to Burlington Northern. As a concession to Union Pacifics loss in the bid, Burlington Northern Santa Fe gave Union Pacific significant tracking rights. Despite losing Santa Fe, Union Pacific merged with Southern Pacific in 1996. Despite fierce opposition by major government departments and organizations, the merger went through with the permission of the newly formed Surface Transportation Board, which replace the ICC. As a result, Union Pacific was able to increase its track and by the end of the decade had more than 30,000 miles of track and an additional $10 billion in revenue20.

16 17 18 19 20

Ibid Ibid Ibid Ibid Ibid

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Just as the Chicago& North Western merger was inefficient, so too did the Union and Southern Pacific merger run into similar problems. Some historians and rail experts contend that it was indeed even worse than past aquicisitions by the company. The main issue at hand was gridlock beginning to manifest itself in 1997. Rail customers suffered an estimated $1 billion due to shipment delays. With the guidance of the STB, Union Pacific opened its freight business in the Houston Hub all the way to Kansas City Southern. Union Pacific lost approximately $600 million in 1998 due to both its trucking business and issues arising in its freight business21.

CSX Company History CSX did not come into existence until Chesapeake and Ohio Railway and Seaboard Cost Line merged in 1980. One of the first companies that preceded CSX was the Baltimore and Ohio Railway. The company was chartered in 1827 and posed a considerable threat to business in the canals and also for making transportation of passengers and freight more cheaply. 22 Up until the Civil War, 1/3 of the companys revenue consisted of coal, a ratio which would persist for the majority of its lifespan into the 20th century23. After the war, B&O continued to grow, earning a good reputation in part to the excellence of its management. Despite the companys success, dividend policies reminiscent of Gould from Union Pacific also plagued the company, becoming weaker by both its internal policy and the debt it owed. Just before the turn of the century, B&O was placed into receivership and experienced stable growth up till the end of the Second World War24. Throughout the 1950s, revenue declined and the companys labor costs skyrocketed due to the ever increasing demands of the unions for higher wages. Due to its crippling financial position, the C&O bought a 61% share in the company and was approved by the ICC in 1961 to take over the company. The consolidation of these two railway companies produced an 11,000 mile rail system25. C&O also began in the early 19th century, being chartered in 1836. In the beginning of its operations it was known as the Louisa Railroad providing freight traffic for farmers and merchants in Virginia. It changed its name to the Virginia Central Railroad and by 1867 was officially known from then on as the Chesapeake and Ohio Rail Company. Collis P. Huttington was its president after the reorganization of the company in 1867 but was later replaced by J.P. Morgan in 1888 after years of financial trouble. Morgan was so successful with the company that

21

Ibid "CSX Corporation -- Company History." Find Funding with Banks, Investors, and Other Funding Sources | FundingUniverse. Web. 23 July 2011. <http://www.fundinguniverse.com/company-histories/CSX-Corporation-CompanyHistory.html>. 23 Ibid 24 Ibid
22 25

Ibid

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it became extremely profitable by the end of the century, being a well run 1,445 mile long rail line connecting several locals such as Virginia and Kentucky26. The financial history of C&O in the first half of the 20th century was dominated by fiscal responsibility. After a series of acquisitions such as a 2,000 mile track from Pere Marquette Railroad, the company grew soundly, avoiding most of the difficulties that plagued railroads previously mentioned. By 1954, C&O was a flourishing company, earning annual revenue upwards of $350 million and 5,000 miles of track. This success led to the purchase of B&O in 1963. Through the leadership of Hays T. Watkins in 1971 became diversifying the companys assets and would later merge with Seaboard Rail in 198027. CSX was consolidated after the merger of Chesapeake and Ohio Railway and Seaboard Coast Line in 1980. In response to difficulties that manifested from the Penn Central merger, both Seaboard and C&O did not finish their complete merger until the end of the decade. To lead CSX in the current decade was Hays T. Watkins. While the merger was taking place, CSX decided to diversify its assets. In 1983, the company made a deal with the Southern New England Telephone Company to place fiber optic cables alongside the tracks owned by CSX. Another example of CSXs diversification is found in its decision to purchase Texas Gas Resources Company for $1 billion also in 1983. The company was one of the largest gas and oil reserves company in the country, adding $2.9 billion in revenue to the companys coffers28. The ICC is known throughout the history of the railway companies to block mergers of considerable size in accordance with antitrust. For CSX, however, most of its acquisitions were approved in the decade of the 80s; deregulation became the norm. One noted acquisition is the $800 million purchase of Sea-Land Corporation whose main operations involved sea barge transportation through the use of container ships. At this point, not only was CSX involved in the intermodal business nationally, but also international with the help of its previous purchase. Through the leadership of Watkins, CSX was able to expand rapidly into a variety of markets. Despite his ambition, the companys board of directors were beginning to feel disenchanted with the low profits the company was gaining due to labor cost and more problems arising from the companys new set of purchases. In 1989, John W. Snow replaced Watkins29. In stark contrast to Watkins leadership of the company in past years, Snow sold the companys oil and gas business and other recently purchased acquisitions. In addition to getting rid of the companys recent acquisitions, Snow shook up management with the sole purpose of making its rail industry become more profitable. Snow also bought back stock and deployed

26 27 28 29

Ibid Ibid Ibid Ibid

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more effective management after agreeing with labor unions to downsize the companys workforce30. Through Snows work with the company, CSX increased its revenues from $8.21 billion in 1990 to $10.4 billion in 1996. Snow became extremely meticulous in the activities of the company whch resulted in the acquisition of 42% of Conrail Inc. In a bitter dispute with Norfolk Southern, the two companies decided to split Conrail after each attempted to outbid the other in the Conrail purchase. Through its purchase, CSX gained approximately 4,500 miles of track31.

30 31

Ibid Ibid

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UNP COMPANY OVERVIEW Union Pacific Corporation is one of the nations largest transportation companies. The companys main subsidiary is Union Pacific Railroad, one of the leading railroad companies in the railway industry. Union Pacific owns 32,000 miles of track and employs 43,500 workers.32 Union Pacifics capital spending since 2006 has been $11.3 billion, owning a total of 8,200 locomotives. The railway company covers 23 states and link major West and Gulf Coast ports, providing service through cities such as Chicago, St. Louis, Memphis, and New Orleans. The company aids in the transport of major commodities such as coal, agriculture, chemicals, and minerals. Union Pacific Corporations customers range from steamship lines, vehicle manufacturers, agriculture, utilities, and chemical companies.33 The current President of Union Pacific Corporation is James R. Young. He was named senior vice president in 1999. He came to the company as president in 2005 and was later elected chairman in 2007 but has been involved in the company through a variety of management positions from 1978. 34

32

Union Pacific Corporation. "UP: Company Overview." Redirecting to Up.com. Web. 01 Aug. 2011. <http://www.uprr.com/aboutup/corporate_info/uprrover.shtml>.

33 34

Ibid Union Pacific Corporation. "UP: Executive Profiles." Redirecting to Up.com. Web. 01 Aug. 2011. <http://www.uprr.com/aboutup/exec/index.shtml#young>.

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INCOME STATEMENT

OPERATING REVENUE

35

Union Pacifics Operating Revenue was increasing steadily up until the start of the recession in 2008 and has been in the process of recovering from the economic downturn. The increase in freight revenue from 2009 to 2010 should be attributed to increased efficiency, rising fuel prices, and, most importantly, growing demand for the companys services. Since 2009, there has been a 20% increase in freight revenue. According to Union Pacific, revenue is generated through the transportation of its six commodity groups.36 Most agreements between the company and its customers are based on set contracts. As shown below, Union Pacific is involved in the transportation of agriculture, industrial products, energy, chemicals, automotive parts, and intermodal transport. Segura Equities looks for consistency in revenue growth as a large component of our buy recommendation. Union Pacific has gone through a large inconsistency in its sales performance. Even though much of the fluctuations have the sour economy to blame, decreases and increases as big as 20% in the last couple of years may raise red flags for investors. Due to the lack of consistency in UNPs sales revenues, the company is encouraged to demonstrate to investors that it can stabilize its revenues in the near future in order to restore confidence in both the company and management. In addition, indicators of long term
35

Union Pacific. (2010, December 31st). Form 10-K: 51 Ibid 30

36

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sustainability usually relate as to how well a company can operate with both shocks in supply and demand. Decreases in sales in the double digits create a certain amount of uncertainty in the ability of management to navigate through tough economic times. OPERATING EXPENSES

37

Union Pacifics expenses that have remained relatively stable through the last three years have been depreciation, equipment (mainly leasing costs), and compensation and benefits. An increase in depreciation costs from 2008 to 2009 suggests that the company has been making considerable capital investments expecting long term growth in the future. UNPs expenses for equipment have decreased in the last couple of years. UNP attributes these decreases to its restructuring of locomotive leases and further decreases in leases for freight cars. 38 The decrease in the companys short term lease expenses in 2009 are described by the company as a decrease in shipments of industrial products.39 In its presentation to investors, Union Pacific described how they controlled their fuel costs by applying a fuel surcharge. The company notes how fuel prices have increased in 2010. Union Pacific has had a 31% increase in their fuel consumption but at the same time was able to control costs through investments such as more fuel efficient locomotives. In addition, the aforementioned fuel surcharges also played an instrumental role in raising revenue to $2.3 billion in 2010, a 92% increase in freight revenue when considering the effects from the companys fuel surcharges.40

37 38 39 40

Ibid Ibid Ibid Ibid

51 31 30 30

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NET INCOME

41

Union Pacifics 2010 net income has exceeded the previous years results even before the financial crisis took root. Union Pacific reported net income as high as 2,335 in 2008 and bested this record high after its downturn in 2009 to 2,780 in 2010. At first glance, these numbers suggest that Union Pacific did indeed have a speedy recovery with savvy management decisions and that the overall health of the overall rail is recovering comparatively. INCOME SHEET RELATED RATIOS Net Profit Margin

UNP 16.4
42

INDUSTRY 17.1

S&P 500 12.9

Union Pacifics Net Profit Margin is calculated when dividing net income from net sales. The ratio illustrates whether a company is generating a larger profit from every dollar made in sales or services after all of its costs. In the case of UNP, the company is doing slightly worse than the industry and fairing fairly well when compared to the economic average. In 2010, UNP reported a margin of 16.4, an increase of 22% from 2009s 13.4. These statistics show how UNP is effectively managing all of its sales and expenses in 2010.43

41 42 43

Ibid 51 http://moneycentral.msn.com/investor/invsub/results/compare.asp?symbol=UNP http://www.advfn.com/p.php?pid=financials&btn=annual_reports&mode=&symbol=NYSE%3AUNP

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Gross Profit Margin

UNP 71.2
44

INDUSTRY 55.3

S&P 500 37.7

UNPs gross profit margin demonstrates that in comparison with both the industry and the economy as a whole, it has been effectively selling goods and services for more than the direct costs it takes to produce those goods or services. Over the past three years, UNP has fluctuated primarily due to the financial crisis of 2008. At face value, UNP is currently managing its sales to their corresponding cost extremely well, beating the industrys and economys average by 29% and 89% respectively.45

44 45

MSN UNP ADVFN UNP

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BALANCE SHEET ASSETS

46

According to UNP, the company has additional cash reserves in order to make sure there is sufficient liquidity for when there are future financial downturns. 47 This is a smart move by UNP because the transportation business relies heavily on the market price of commodities in its every day trading. Despite the companys implementation of a surcharge on fuel, UNP has to assure its investors that it is fully capable of confronting downturns or higher expenses and this additional liquidity proves just that. UNPs assets demonstrate considerable liquidity with more than one billion dollars in cash or cash equivalents. UNPs largest set of assets are found in its Net Properties which creates some level of caution on the part of Segura Equities future buy/sell recommendation. If there ever was an immediate funding need beyond the cash reserve, there would be a considerable amount of difficulty in liquidating rail road tracks and locomotives to help bridge some kind of cash shortfall. Even with the difficulty in liquidating rail long term assets, Union Pacifics asset allocation paints a good picture of a company ready to invest in capital intensive operations but at the same time able to maintain a steady flow of liquidity in order to back up their operations in case of any financial burden that may come across the company in an unexpected fashion.

46 47

Union Pacific Form 10-K: 52 Ibid 52

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LIABILITIES

48

When comparing UNPs assets to liabilities, the company records working capital amounting to $480 million. This number demonstrates UNPs bandwidth to continue their operations since their assets are considerably greater than their liabilities. The amount of long term debt that UNP is subject to clearly illustrates the workings of the railroad industry and the reality of high yearly interest payments as highlighted in the income statement. UNP relies heavily on credit in tangent with their assets in order to continue financing their capital-intensive operations. The amount of debt that UNP has, however, should be carefully analyzed over the next couple of years. Later, we will analyze how UNPs liabilities are affecting its debt to equity ratio and cash flow expectations. UNPs debt should be closely considered since too much debt can cripple an institutions ability to pursue other initiatives and investments by consuming most of its available cash on hand. Segura Equities will continue to monitor UNPs debt load and debt servicing costs going forward as it is a crucial indicator of the companys long term health.

48

Ibid 52

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STOCK HOLDERS EQUITY

49

One of the first aspects that shine when looking at Union Pacifics owners equity is its retained earnings, which shows a 14% increase from 2009 to 2010. This statistics demonstrates how UNP is trying to accumulate more earnings, showing they have a conservative stance with its funds so as to be prepared for any future financial disturbances in the industry or growth projects. In addition, UNPs treasury stock illustrates how the company has been purchasing more of its own stock. Segura Equities belief is that the company believes that through these purchases, it will generate a larger return after future earnings will appreciate the stock it owns and create a considerable gain. In addition, taking billions of dollars of stock out of the market will decrease supply therefore increasing the price of each individual share, benefitting existing shareholders and UNP. PROFITABILITY RATIOS Return on Equity

UNP 16.7
50

INDUSTRY 16.3

S&P 500 24.2

Union Pacifics ROE has fluctuated since the arrival of the financial crisis of 2008. In 2009, there was a noticeable drop in ROE from 15.1 in 2008 to 11.2 in the following year: a 35% decrease. In 2010, however, the ratio improved by 49%. This jump means that each shareholder
49 50

Ibid 52 MSN UNP

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is rightly benefitting from the increase in earnings. Compared with its industry, UNP is doing slightly better, demonstrating that it is efficiently utilizing its equity compared to competitors. In contrast, the ROE of the economy as a whole is 48% better than the rail industrys average. 51 ROE is made up of three key ratios; net profit margin, asset turnover, and financial leverage.. Union Pacifics asset turnover shows how the company was able to generate sales revenue for each dollar of assets employed. UNPs asset turnover ratio is as follows:

Asset Turnover UNP .4

52

INDUSTRY .4

S&P 500 .8

Union Pacifics asset turnover ratio demonstrates that the company is slowly recovering from the financial crisis which resulted in an abysmal ratio of .3. However, the company was not able to generate as many sales dollars per dollar of assets used as it did in 2008 with a ratio of .5 before the effects of the crisis settled in. Though the numbers show that UNP has not fully recovered in utilizing its assets, they do show that they are recovering by either generating more sales or restructuring their assets employed. As mentioned earlier, the more likely of the two would be the generation of more sales. UNP reported an increase in freight revenue, giving some credit to rising fuel prices in 2010 that gave them an advantage with their fuel surcharge policy. In comparison with the industry, UNP is on par while the industry as a whole trails behind the average of the economy which is slated at .8 after the crisis. The last ratio that makes up return on equity is financial leverage. Financial leverage measures how many dollars of assets are employed for every dollar of stock holders equity. Union Pacifics financial ratios for the last three years are as follows: Financial Leverage UNP 2.4
53

INDUSTRY 2.5

S&P 500 3.6

UNPs financial leverage ratios from 2008 demonstrate how the company has been progressively decreasing its reliance on debt in order to finance its operations, which was at a 2.6 before the crisis materialized. The decreasing ratios can mean that the company is losing its credit worthiness or is interested in leveling off some of the debt it currently holds. As we will examine in the debt to equity ratio, UNP has a considerable amount of debt which is actually fairly common in the railroad industry since debt is one of the major tools in financing most of the operational activities. In this case, debt is decreasing meaning the company might want to

51 52 53

ADFN UNP MSN UNP Ibid.

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head in a direction where they minimize their reliance on debt and strive for efficiency in their deployment of assets. Overall, the companys Return on Equity shows how UNP is striving for more efficiency in cleverly deploying its assets and assembling alternative revenue mechanisms. Besides efficiency and lessening its reliance on debt, UNP is also managing its sales in relation to its expenses and is improving its profits. Union Pacifics debt to equity ratio demonstrates the companys balance between debt and equity. Debt is looked upon as being riskier than equity because the company is bound by contract to pay back its creditors, pressuring the company in ensuring that it has sufficient assets to guarantee its obligations. UNPs debt to equity ratios, for the last three years, are as follows: Debt to Equity UNP .49
54

INDUSTRY .63

S&P 500 1.04

Union Pacifics debt is the main contributing factor to how the company finances its activities. Compared with the industry, UNP is in good shape, scoring a ratio 29% lower than the industry average. UNP has had debt as high as .58 during 2008 and 2009. The drop in the ratio illustrates how UNP is taking measures that reflect how it does not want to be straddled in debt. UNPs ratio of .49 may be considered too high for some, but when compared to both the industry and the economy, UNP scores high marks.55

Current Ratio UNP 1.2

56

INDUSTRY 1.1

S&P 500 1.2

The current ratio describes how well a company can pay off its short term debt with current assets. A ratio below 1 demonstrates that the company will have considerable difficulty in paying back its short term obligations. In the case Union Pacific, its current ratio has been above 1 for the last two years. However, they were on the border of not being able to comply with their short term obligations in 2008. Despite the danger they faced in 2008, Union Pacific has improved on their ability to pay their short term obligations.57 In comparison with the industry, UNP is faring slightly better than its competitors and is on par with the economy as a whole when analyzing their ability to pay off their current liabilities. Most of the financial data provided thus far by Union Pacific has shown that the
54 55 56 57

MSN UNP ADVFN UNP MSN UNP ADVFN UNP

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company is improving its financial position when taking into account the effects of the financial crisis and increasing prices.

Receivables Turnover UNP 12.9

58

INDUSTRY 11.3

S&P 500 14.5

Receivables turnover indicates how fast the company is able to convert credit into cash. A higher ratio indicates that it takes less time for this process to occur. For Union Pacific, the company is struggling in comparison with the industry. In contrast, UNP is faring better than the economy as a whole by 12%. These ratios clearly demonstrate that Union Pacific is attempting to prop up its sales, extending more time for their customers to actually pay what is due.

58

MSN UNP

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STATEMENT OF CASH FLOWS

59

59

Union Pacific Form 10-K: 53

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Union Pacifics operating activities shows a positive increase in cash flow. In addition, the companys cash provided by operating activities is larger than its net income. This illustrates that the company is generating enough cash for both future investments and paying its debt when due. In Union Pacifics investing section, the company has increased capital expenditures by 5%, demonstrating that the company is investing in PPE for the future. In the companys financing section, Union Pacific has been increasing its debts to be repaid by 62%, signaling that the company is willing and, more importantly, able to repay its obligations. In addition, the company has repurchased common shares showing how the company is interested in expanding its treasury stock and increasing the price of their shares outstanding, providing a larger return for their shareholders.

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CSX COMPANY OVERVIEW CSX Corporation is considered as one of the leading transportation companies in the industry. The company owns about 21,000 miles of track in 23 states and also D.C and several provinces in Canada. More than 2/3 of the nations inhabitants live within the service territory of CSX, highlighting its overall influence in the country. Apart from rail, the company also contributes to major markets within the nations major waterways such as the Mississippi River and the St. Lawrence Waterway. With the help of rival rail companies, CSX has access to pacific ports as well.60 The current President and CEO of CSX Corporation is Michael J. Ward. Ward has worked for the company for 33 years, serving as chairman, president, and CEO since 2003. Wards experience in the rail industry consists of his experience with the companys sales and marketing and operations and financing divisions.61

60

CSX Corporation. "Company Overview - CSX." Welcome to CSX.com - CSX. Web. 01 Aug. 2011. <http://csx.com/index.cfm/about-csx/company-overview/>.
61

CSX Corporation. "Management Team - CSX." Welcome to CSX.com - CSX. Web. 01 Aug. 2011. <http://www.csx.com/index.cfm/about-csx/csx-leadership/management-team/>.

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CSX FINANCIAL INFORMATION

Revenues and Expenses

62

CSX attributes the majority of their growth in the last year after the financial crisis to an increase in volume of sales. The companys revenue increased by 18% and can be attributed to an increase in the volume in merchandise transported; consisting of agriculture, industrial, and housing construction. These are all signals of increased demand and an indicator that the overall economy is improving. CSX also attributes their increase in revenue to rising fuel prices. Like Union Pacific, CSX also employs fuel surcharge mechanisms when performing their services. 63 Even though revenue increased over the last year, so did CSXs expenses. CSXs expenses have increased since 2009 by 12%, almost matching their revenue increase of 18%. The company attributes this increase primarily to an increase in labor costs and fuel prices. CSXs expenses consist of labor, materials and supplies, increasing volume of sales, safety, operating expenses, fuel, depreciation, and equipment.64 When considering both revenue and expenses, CSX has improved and is recovering from the financial meltdown in 2008. CSXs operating income has increased by 35% and exceeds the operating income before the recession. These statistics demonstrate that CSX is improving in
62

CSX. (2010, December 31st). Form 10-K: 61

63 64

Ibid 28 Ibid 37

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their efficiency and that management is adapting to the market after experiencing a brief, but significant downturn.

Net Income

65

CSXs net earnings in 2010 exceeded its net earning recorded in 2009 and 2008, demonstrating that the company has indeed increased return after a yearlong lag in sales. A 37% increase from 2009 to 2010 illustrates the companys recovery and expansion in the market.

65

Ibid 61

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CSXs financial numbers thus show promise for future operations but they must control their labor cost in order to not only increase revenue but, more importantly, increase net earnings. If CSX is not able to manage their costs with sufficient care, labor costs may continue to increase and further weaken the companys bottom line and future prospects.

Net Profit Margin CSX 15.4

66

INDUSTRY 17.1

S&P 500 12.9

CSXs net profit margin shows how the company is effectively managing its sales and expenses. In comparison with the industry, CSX is lagging behind the industry by 11%, illustrating how the company must better manage its sales and expenses. In comparison with the economy, the company is doing 19% better. In 2010 there was a 16% increase from 2009 and a 21% increase from 2008. Despite the economic downturn in 2008, the company is increasing the amount of profit it makes from its sales. This is a strong indicator of the companys growth and future outlook in the coming years. The companys net profit margin should assuage any investors worries that CSX will not be able to make a healthy profit after the recession

Gross Profit Margin CSX 65.3

67

INDUSTRY 55.3

S&P 500 37.7

CSXs gross profit margin demonstrates how well the company is doing when selling its services for more than the cost it takes to carry them out. In comparison with the industry, CSX is ahead of the curve by 18%. In comparison with the overall economy, CSX is doing better by 73%. Despite its position in the current year, CSXs gross profit margin has fluctuated over the past couple of years. Despite the growth in the ratio from 2008 to 2009 from 59.0 to 73.0, the economic recession most likely caused a downturn in the ratio between 2009 and 2010 and into
66 67

http://moneycentral.msn.com/investor/invsub/results/compare.asp?symbol=CSX Ibid

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the present year. These numbers indicate how CSX has been faltering in its approach of selling its services for more than the cost its takes to make them available to its customers. Investors should be wary of CSXs fluctuating gross profit margin. Future emphasis on consistency in selling its services for more than their corresponding cost would benefit investors in making them confident in the companys future. Despite the inconsistencies, the company is currently doing better than the industry promising efficiency to remain in CSXs current activities.

BALANCE SHEET ASSETS

68

The assets of CSX are typical of the assets found in any related company involved in the transportation industry, more specifically railroading, which include liquidity on hand and a majority of assets based on its property plant and equipment. CSXs largest expenditure consists of replacing track. The second largest capital expenditure the company engages in is in its locomotives and freight cars. CSX appears to be operating as a railroad company should be with a majority of assets based in properties and enough liquidity to ensure there is a safeguard against any collateral damages the company may incur either through accidents, lawsuits, or any additional regulations.
68

CSX Form 10-K: 62

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LIABILITIES

69

CSXs liabilities demonstrate any short and long terms obligations the company must fulfill. The majority of the companys liabilities can be found in its long term debt. One of the main preoccupations the company has is the fact that the companys short term liabilities almost match all of the companys current assets. The main issue lies in the possibility that if the growth in the companys short term liabilities outpace its current assets, then it will lack the means to fulfill all of its short term obligations. This inability to fulfill its current year obligations might cause CSX to lose any valuable credit rating it currently holds or by forcing the company to liquidate long term assets.

69

Ibid 62

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STOCK HOLDERS EQUITY

70

CSXs owner equity has not experienced any significant changes in the last couple of years. Their retained earnings is on par with last years and their common stock has virtually stayed consistent. The lack by management at CSX in issuing more stock could be a problem for the company considering the amount they already borrow. PROFITIBILITY RATIOS Return on Equity CSX 19.9
71

INDUSTRY 16.3

S&P 500 24.2

CSXs return on equity ratio demonstrates how the company is faring in comparison with the industry. Currently the company is ahead of the industrial average by 22% illustrating that CSX has been managing their equity efficiently. CSX made a positively changed from last years ROE, improving from a ratio of 13, a 53% gain.72 2009s ratio was a drop from a ratio of 17 in
70 71

Ibid 62
MSN CSX

72

http://www.advfn.com/p.php?pid=financials&btn=s_ok&mode=annual_reports&symbol=NYSE%3ACSX&s_ok=OK&start_d ate=13

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2008, however, despite the financial crisis of 2008, CSX is outperforming the average industrial ROE. When comparing CSXs ROE with the economy, the company still has some work to do in improving how it utilizes its equity. With the current trend, CSX should meet expectations and inch closer to the S&P 500 average.

Asset Turnover CSX .4

73

INDUSTRY .4

S&P500 .8

The asset turnover ratio for CSX has been disrupted by the financial crisis in 2009 with a drop from .4 to .3, however, the ratio returned to its previous position of .4 in 2010. This ratio describes how CSX was effective in generating sales dollars per dollar of assets used. Returning to its previous position and demonstrating that the management was able to more effectively use its resources, increasing efficiency and accountability in its deployment of assets.74 In comparison with the industry average, CSX is on par signaling that in relation to the rest of the industry, CSX is stable with its asset turnover ratio. When comparing CSX with the overall economy, the company is lagging by 100%. The disparity between the ratios shows how the transport industry generates less sales dollar per dollar of assets employed, illustrating the types of returns that are expected when working in heavy industry.

Financial Leverage CSX 3.2

75

INDUSTRY 2.5

S&P 500 3.6

The financial leverage of a company demonstrates how much it relies on its debt in order to finance its assets. In the case of CSX, the companys leverage is 28% higher than the industrial average, demonstrating how much more the company relies on debt in order to finance their activities. When comparing CSX with the economy, the railroad industry relies less heavily than the economy taken as a whole.

73

74
75

MSN CSX

ADVFN CSX
MSN CSX

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Though some may consider CSXs leverage to be too high, it can be an indicator of CSXs hope to grow. Borrowing is both important and expensive. Results from future years will further highlight whether CSX is benefiting from these investments in debt or whether the company is indeed in financial troubles.

Debt to Equity CSX .97

76

INDUSTRY .63

S&P 500 1.04

Debt to equity illustrates how much debt there is to equity. CSX relies more heavily on debt than the industry of transportation does as a whole. When compared to the S&P 500, the economy relies more heavily on its debt financing than those in the railroad industry. The following ratios do not paint a promising picture of the companys financial future. When reviewing the CSXs financial leverage for the past three years, the company has been consistently flirting with a high debt to equity ratio. Current Ratio CSX 1.2
77

INDUSTRY 1.1

S&P 500 1.2

The current ratio demonstrates how well a company is able to pay off its short term debt. As shown in the table above, CSX is in a better financial position than its competitors in relation to its ability to finance its current debt. Because of CSXs heavy reliance on long term debt, unless the company reorganizes its finances, its current ratio should be expected to decrease.

Receivables Turnover CSX 11.0

78

INDUSTRY 11.3

S&P 500 14.3

76 77

Ibid Ibid

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Receivables turnover indicates how fast a company is able to convert extended credit to cash. In the case of CSX, the company had a decrease in their receivables turnover in 2009, however they were able to make a rebound in 2010 by means of a 24% increase. This increase indicates that the company has become more efficient in managing its credit when converting it to cash. In comparison with the industry, CSXs competitors are slightly better than CSX in converting credit into cash. In comparison with the economy, both CSX and the industry lag behind by 30% and 27% respectively.79

STATEMENT OF CASH FLOWS

78

79

Ibid

ADVFN CSX

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80

CSXs operating section shows a positive increase in cash flow. In addition, the companys cash provided by operating activities is larger than its net income. This illustrates how the company is generating enough cash for both future investments and current financing. The companys investing section shows an increase in capital expenditures by 28%, signaling to investors it intends to improve its operations for future business. CSXs financing section shows a decrease in debt to be repaid by 186%, signaling to investors it will continue to rely on debt in order to make further investments. The company paid dividends by an increased 8% from last year and has repurchased stock in order increase existing shareholder return.
80

CSX Form 10-K: 63

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SEGURA EQUITIES SOLUTIONS RECOMMENDATION

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Taking all of the information presented by Segura Equity Solutions above, we recommend that our clients invest in Union Pacific Corporation for the following reasons: The company benefits from a well developed logistics network based on 32,000 miles of track across 23 states. The companys revenues for the year ended 2010 were balanced and cash flows from operating activities showed positive growth, strongly suggesting the soundness of UPNs current activities. UNP is involved in a variety of markets within its intermodal business, decreasing the likelihood that the company will suffer devastating losses due to how diversified its operations are. In comparison to CSX Corp., Union Pacifics Earnings per Share is $5.58, 37% greater than CSXs $4.06, illustrating how the value of Union Pacifics shares are is currently greater than those issued by CSX. Union Pacific reported a $4,105 billion from its operating activities. In contrast, CSX reported $3,246 billion from its operating activities. This comparison highlights how Union Pacific has more cash available to pay greater sums of dividends for its investors and its other investing and financing activities. When coupling this statistics with both companies debt to equity ratio, Union Pacific demonstrates that it does not require the amount of debt CSX maintains in order to be profitable in generating cash. We strongly encourage the investor in participating in the growth of Union Pacific Corporation. The railway industry is growing every year, providing an attractive alternative to other forms of intermodal transport. In addition, the company has faired the economic crisis of 2008 well, further strengthening its reputation as a prudent, but proactive corporation, confident in the future of its business.

Works Cited

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"America on the Move | Railroads Role, 1950-2000." National Museum of American History. Web. 23 July 2011. <http://americanhistory.si.edu/onthemove/themes/story_42_6.html>. "America on the Move | Railroads to Mid-Century / Salisbury, North Carolina, 1927." National Museum of American History. Web. 23 July 2011. <http://americanhistory.si.edu/onthemove/themes/story_42_4.html>. "CSX Corporation -- Company History." Find Funding with Banks, Investors, and Other Funding Sources | FundingUniverse. Web. 23 July 2011. <http://www.fundinguniverse.com/company-histories/CSX-Corporation-CompanyHistory.html>. CSX Corporation. "Company Overview - CSX." Welcome to CSX.com - CSX. Web. 01 Aug. 2011. <http://csx.com/index.cfm/about-csx/company-overview/>. CSX Corporation. "Management Team - CSX." Welcome to CSX.com - CSX. Web. 01 Aug. 2011. <http://www.csx.com/index.cfm/about-csx/csx-leadership/management-team/>. CSX. (2010, December 31st). Form 10-Q Retrieved July 25th, 2011 from http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9ODI0NDZ8Q2hpbGRJRD0tMXxUeXBlPT M=&t=1 "Early American Railroads [ushistory.org]." Ushistory.org. Web. 23 July 2011. <http://www.ushistory.org/us/25b.asp>. "History of Railroads and Maps." Memory.loc.gov. Library of Congress. Web. 23 July 2011. <http://memory.loc.gov/ammem/gmdhtml/rrhtml/rrintro.html>.

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"Railroad History, An Overview Of The Past." The American Railroads. Americanrails.com. Web. 23 July 2011. <http://www.american-rails.com/railroad-history.html>. http://moneycentral.msn.com/investor/invsub/results/compare.asp?symbol=UNP http://moneycentral.msn.com/investor/invsub/results/compare.asp?symbol=CSX

"Union Pacific Corporation -- Company History." Find Funding with Banks, Investors, and Other Funding Sources | FundingUniverse. Web. 23 July 2011. <http://www.fundinguniverse.com/company-histories/Union-Pacific-CorporationCompany-History.html>. Union Pacific Corporation. "UP: Company Overview." Redirecting to Up.com. Web. 01 Aug. 2011. <http://www.uprr.com/aboutup/corporate_info/uprrover.shtml>. Union Pacific Corporation. "UP: Executive Profiles." Redirecting to Up.com. Web. 01 Aug. 2011. <http://www.uprr.com/aboutup/exec/index.shtml#young>. Union Pacific. (2010, December 31st). Form 10-Q Retrieved July 25th, 2011 from http://www.up.com/investors/attachments/secfiling/2011/upc10k_020411.pdf