Monday, June 8, 2015

Union Pacific Corporation (UNP) Dividend Stock Analysis

Hello,

This is Div4Son. This is a dividend stock analysis of Union Pacific Corporation (UNP).





Normally, I use a simple screen for stocks:

  • Yield over Avg Yield > 1.10
  • Yield > 2.5% (but less than 7%)
  • Payout Ratio < 0.8
  • Chowder > 10
However, I am missing good quality numbers with lower yields. Sometimes, a low yielding stock, with good dividend growth can provide excellent total return.


Luckily, I read a lot of blogs. I got this idea from Dividend Mantra.

After readjusting my screen, UNP easily passes my key criteria (with the exception of yield).

Union Pacific (UNP) Dividend Stock Analysis


Union Pacific Corporation owns the Union Pacific Railroad Company, one of America's leading transportation companies and operator of one of the largest railroads in North America. UNP provides transportation for:agricultural, automotive,chemicals, energy, industrial products, and intermodal shipping.


UNP 6/2015AreaCriteriaCheckListComment

Quality Company
Dividend Growth>5 yearsYes7 years
ROE/EPS/Op MarginStableYesSee Chart
Long term Avg GrowthStableYesSee Chart
FCF over DividendsYesYesSee Chart
M* MoatWide MoatYesM* Wide
M* & S&P
Credit Rating
> BBB+YesS&P A-
Cash to Debt & Interest Coverage, Debt to EquityCash Debt >1 or Interest Coverage > 5YesCash to Debt 0.13
Interest Coverage 58.41
Debt to Equity 14.16
M* & S&P Stars> 3 Stars for bothYesM* 4 Stars
S&P CapIQ 4 Stars A+ Quality
Payout Ratio<60%Yes34.00%

Dividend Growth
& Yield
Dividend Yield>3%No2.20%
Dividend Growth>5%Yes27.20%
Chowder>12%Yes29.40%

Valuation
Yield/Avg Yield>1.1Yes1.16
Dividend Yield Theory Mid PointBelow Mid PointYesMid Point 110.78
Low Point 74
DRRM~10%YesAssuming 7% growth; projected return=11.17%
M* Estimate<M* estYesM*115
S&P Estimate< S&P cap IQ estYesS&P Cap IQ 137



Quality analysis

Years of Dividend raises

UNP has 7 years of dividend raises. The industry is very cyclical. Frozen dividends and cuts are not uncommon. However, looking back to 2000, UNP dividend has been pretty stable.


Stability of key metrics

These ratios provide an indication of how wide the moat is. I am looking for overall stability (or even better - growth). If the ratios decline year over year, then this is an indication of moat reduction. I also compare these ratios with other companies within the same sectors.

 
UNP ROE and Operating Margins are actually growing. This is a very strong indication of increasing of moat.

 Free cash flow over dividends 




I use the free cash flow per share and compare this with dividends per share. FCF should cover the dividends. As you can see UNP FCF YoY are easily covering the dividends (with the exception of 2007 and 2008 when they froze the dividend.)




Average growth 


Here, I look for the stability of growth indicators over ten years using the EPS and Revenue. 




From a 10 year perspective, EPS and Revenue are growing 7-8%. We will use the 7% in the later DDRM calculation.


The 10 year and 3 year averages show strong growth after the recession.


 



M* Moat


I simply use the moat indicator from M* to validate my findings.  M* indicates that UNP has a wide moat. From looking at the UNP deployment map, they have good geographical coverage from western US region all the way to Texas. Also, the wide moat also reflects the growth in the key indicators above.


Credit rating


Here, I look for companies with credit rating of BBB+. Just like banks wanting good credit from you when you apply for a loan, you want companies which are stable from a credit perspective.

UNP's credit rating from S&P is A-.

Debt

I look at the debt to equity ratio (<50) and cash to debt (<1) and interest coverage (>5). Sometimes, a little good debt is good for a business. But too much debt can be a burden. 


UNP's Cash to Debt 0.13 with Interest Coverage at around 58 which means the debt can be easily covered. The Debt to Equity is 14.16 which is way below the 50% threshold.
Over the years, the debt to equity ratio is well controlled (under 60% for the last 10 years)




M* and S&P capital IQ rating



I am looking for 3 stars and above from either. A four/five star is a bonus.  

M* gives UNP 4 Stars and S&P CapIQ gives 4 Stars with A+ quality company

I am seeing that if the combined M* & S&P Capital IQ stars is 8 or more, then this usually is a good indication to buy (if the company has good fundamentals). 

UNP combined stars is 8 - which means it is a good indication to buy.
 

Dividend Yield and growth 

Dividend Yield>3%No2.20%
Dividend Growth>5%Yes27.20%
Chowder>12%Yes29.40%
  • Dividend yield is 2.2% which is below my threshold of 3%. 
  • 5Y CAGR dividend growth is 27.20% which is much higher my threshold of 5%. The high growth is difficult to maintain though.
  • Chowder is around 30 which is above my 12% threshold.


 
 The dividend growth since 2008 is generally over 15%.


Payout Ratio


The payout ratio for UNP is around 35% which is below the threshold of 60%.  YoY it is generally lower than 30%.
 
Value analysis


Average yield



The current yield per average yield for 5 years ratio is 1.16. I use this as a quick indicator for valuation.This basically means that UNP's current yield is 16% over the average yield.


Dividend yield theory mid point



Using the dividend yield theory spreadsheet (based on the Dividends Don't Lie book), I calculate the mid and high points for the yield, from which I derive the price. 
Note: You can get the spreadsheet at: http://div4son.blogspot.com/2015/03/dividend-yield-theory-spreadsheet.html


 

I estimate the high and low yields to be:


High3.00%
Low1.50%

This gives the following high, mid and low price ranges.

High Price:147.71
Mid Price:110.78
Low Price:73.85

At around 100, UNP is between the mid point and low point. Based on the low point, there is a possibility of further reduction in the current price. This would be a good opportunity to average down.


Dividend Drill Return Model


Also, using the DDRM model per the Dividend Playbook, I try to estimate the total return. Using the growth information from above, I estimate a conservative  growth rate of 7% based on the growth information above.


DDRM
Dividend Rate ($)2.22
Divided by: share price100.71
Current yield (%)2.20
Core Growth Estimate (%)7.00
Divided by: ROE (%)24.61
Multiplied by: EPS ($)5.87
Cost of Growth (%)1.67
Earnings per Share ($)5.87
Minus: Dividend2.22
Minus: Cost of Growth1.67
Funding Gap ($)1.98
Divided by: Share Price ($)100.71
Share Change (%)1.97
Core Growth (%)7.00
Plus: Share Change (%)1.97
Total Dividend Growth (%)8.97
Plus: Dividend Yield (%)2.20
Projected Total Return (%)11.17

My threshold for total return is 10%. UNP's projected total return is 11%.

Rearranging the numbers based on the growth, I get a price of 73.85.


Dividend Rate ($)2.22
Required Return (%)10.00
Growth (%)7.00
Price73.85

Again, I think it is possible for price reduction, which makes it good to average down (assuming the fundamentals - especially the growth aspects are still there).

M* and S&P valuations

Morningstar gives UNP a target of $115. S&P capIQ gives a target of $137. Therefore, with a current price around $100, UNP is reasonably priced.



Risks
  • Regulation & safety bills can adversely affect railroads companies
  • Railroads industry have high maintenance requirements
  • UNP's automotive franchise contributes a significant amount of revenue - which makes it overexposed in case of auto volume reduction

--

The railroad industry is very cyclical. The dividends can be frozen (or even cut in the case of NSC) when times are bad. 

Therefore, I think a degree of caution is warranted. Moreover, I need to prepare my mindset that the dividend can frozen or cut in the decades I will be holding this stock. 

I am impressed with UNP metrics for ROE and Operating Margin which are growing YoY. Moreover, their total return is 11% assuming a conservative 7% growth.

At the beginning of June, I bought 17 shares of UNP at around $101. This adds around $35 to my forward dividends.

That's it for now. Please let me know what you think of UNP

Div4Son


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