Union Pacific

Class I railroad Union Pacific's second-quarter revenue grew 12% year over year on strong intermodal growth, higher carloads, and high-single-digit all-in yield gains (surging fuel surcharges, positive core pricing). Adjusted margin fell, due mostly to fuel noise.

Why it matters: Carloads (excluding coal and intermodal) grew 4% on strong grain shipments and new business wins for various industrial carload categories. Improving US industrial production probably lifted a few end markets as well. Coal fell on tough comparisons due to higher natural gas prices last year. Intermodal volume trends flipped positive (up 4%) on good service levels over the past few years, save for slight recent deterioration, along with tightening capacity and rising rates (including fuel) across the competing truckload industry. Rising truckload rates boost intermodal's value proposition. UP's adjusted operating ratio (expenses/revenue; lower is better) deteriorated 120 basis points to 59.2%—slightly worse than our forecast—due to the mathematical impact of rapidly rising fuel costs and surcharges (despite lower net fuel outlays), coupled with wage inflation, partly offset by productivity gains. Management still expects OR improvement in 2026.

The bottom line: We raise our $239 fair value estimate for wide-moat Union Pacific to $250 after lifting our medium-term revenue forecasts on faster-than-anticipated intermodal demand recovery and surging fuel surcharges. After a substantial rally this past year on a potential Norfolk Southern merger, rebounding intermodal demand (including recovering truckload rates), and hints of an industrial sector recovery, the shares look slightly rich relative to our long-term free cash flow forecasts. Valuation aside, UP's new business pipeline appears healthy, intermodal truck-to-rail conversions are strong, and we expect demand improvement among several industrial end markets this year, barring a tariff- or oil shock-driven economic pullback.

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Following second-quarter results, we are raising our fair value estimate to $250 per share from $239 after lifting our medium-term revenue forecasts on faster-than-anticipated intermodal demand recovery and surging fuel surcharges. Following Union Pacific's July 2025 announcement that it intends to acquire Norfolk Southern (pending regulatory approval), our fair value estimate includes modest value dilution (including synergies) associated with the premium paid over our discounted cash flow-derived equity value for Norfolk Southern.

Several cross-currents were at play in 2024, driving only modest revenue growth of less than 1%, which came from intermodal volume recovery. Total yield (revenue per carload, including fuel) fell 2% due to mix headwinds (outsize international intermodal growth) and stubborn intermodal pricing pressure from depressed truckload sector rates. Total traffic grew 3% on the intermodal rebound and healthy new business development. International container activity benefited from a spike in US West Coast imports driven by a pull-forward ahead of a potential ports strike and tariffs. On the other hand, industrial end markets remained weak, and coal plummeted on low natural gas prices.

Excellent profitability improvement was the highlight of 2024, despite soft intermodal rates, anemic coal activity, and wage/benefit inflation. UP's OR (expenses/revenue; lower is better) improved an impressive 240 basis points to 59.9%, driven by intermodal volume growth and strong network efficiency gains, including workforce productivity, longer train lengths, and headcount management. We attribute a large portion of the firm's solid margin execution to the 2023 appointment of PSR specialist Vena as CEO.

Lackluster top-line growth continued into 2025, as UP's revenue grew 1%. Carload volume was up 2%, driven by new project development and higher coal (swing to favorable natural gas prices) and grain carloads, partly offset by lingering sluggishness across many industrial and construction end markets. Intermodal volume came in flat as first-half strength—driven by the import pull-forward—was largely offset by tough comps in the second half. Total yield came in flat as unfavorable mix and intermodal rate pressure (low truckload rates) offset positive core pricing on carload business. UP's OR improved to 59.3% in 2025, driven by healthy core pricing and another year of good productivity gains.

For 2026, assuming tariffs or an oil shock don't spark an economic pullback, we expect the US industrial sector to see modest improvement in carloads (along with new business development tailwinds) and truck-to-rail conversions to remain strong for intermodal. We also expect improvement in intermodal contract pricing as rates recover in the competing truckload sector. Overall, we model 7%-8% revenue growth in 2026, driven by spiking fuel surcharges, higher volume (especially intermodal and grain), and incremental core pricing gains. We look for more modest revenue growth of around 4% in 2027, but that's mostly due to tough comps for grain and domestic intermodal containers. Otherwise, we assume industrial end-market demand and new business wins remain healthy.

We model additional OR improvement to 59.2% in 2026, with progress to 57.6% in 2027 and 57.0% in 2028.

In our view, each of the North American Class I railroads we cover, including Union Pacific, enjoys a wide economic moat rooted in cost advantages and efficient scale. Core pricing and margin resilience in past freight recessions and in the face of substantial coal volume losses over the past decade-plus are a testament to their robust competitive positioning. With near certainty, we expect the rails to continue to turn their two core moat sources into economic profit for the next 10 years, and more likely than not, 20 years from now.

Cost advantage is a key factor in Union Pacific's wide economic moat. While barges, ocean liners, aircraft, and trucks also haul freight, railroads are by far the low-cost option where no waterway connects the origin and destination, especially for freight with low value-per-unit weight (bulk commodities). Along those lines, railroads enjoy roughly quadruple the fuel efficiency of trucking (per ton-mile of freight), and through greater railcar capacity and train length, rails make more effective use of locomotive assets and manpower despite the need for train yard personnel. Rails can also carry significantly more freight at once. Even for freight that can be shipped by truck, we estimate railroads enjoy a 10%-30% discount on a similar lane (on average). Marine shipping by barge is less costly than rail for certain bulk commodity shippers that are located near the inland waterways, offering access to the desired destination. However, customers in a position to ship via barge already do so, thus removing any threats barging could pose to current railroad volume. Even for intermodal container freight, which consists largely of consumer-related products, rail has historically been cheaper (on average) than key competitor truckload shipping on average over the cycle, thanks to the rails’ aforementioned fuel efficiency and more economical use of labor.

Furthermore, route density plays a role in rails' cost advantage relative to a would-be new railroad entrant in a given corridor. We don’t expect any new mainlines to be built, but the incumbent Class I providers would enjoy vastly lower unit and marginal costs than an upstart, given immense network/lane density—the existing six North American Class I railroads have thousands of customers across numerous end markets and geographies that drive significant freight volume across their networks.

In addition to cost advantage, the Class I railroads benefit from efficient scale. Would-be rational competitors have little incentive to enter because massive upfront infrastructure costs and the potential for creating excess capacity amid limited demand would preclude economic profit and destroy value. The network of tracks and assets that US Class I railroads have in place is essentially impossible to replicate. Union Pacific's network spans the Western US, from the Pacific to the Mississippi, capturing roughly half of the rail volume in the region. Would-be entrants are fended off by the steep barrier to entry formed by the need to obtain contiguous rights of way on which to lay continuously welded steel rail spanning a significant portion of North America. Railroads occasionally build new spurs, but we anticipate no new mainlines will be built, given the massive barriers to entry.

Efficient scale followed industry consolidation, escalated by the 1980 Staggers Act, which permitted extensive rail line sales, abandonment, and combination while allowing for private contracts and rate setting based on market demand. In 1980, more than 40 Class I rails operated across North America; today, there are only six (by definition, a Class I rail generates at least $475 million of revenue). Consequently, on all but the busiest lanes, a single railroad often serves an end-of-the-line shipper, only two railroads operate in most regions, and the railroads have been able to reinvest while becoming quite profitable. In fact, we suspect that, barring government intervention, the rational number of competitors on the continent would be four, via additional consolidation. This is because in most regions, customers already have only two capable providers that service the market efficiently.

PSR efforts yielded impressive progress for UP's operating ratio between 2019 and 2021. Despite setbacks in 2022 and 2023, the firm rekindled margin improvement over the past several years under PSR veteran Jim Vena's leadership.

Intermodal shipping should enjoy favorable long-term trends, including secular constraints on truckload capacity expansion and shippers' efforts to minimize transportation costs through truck-to-rail conversions.

Network service has improved materially from lackluster performance in 2021 and 2022, thanks in part to efficiency gains.

Union contract wage and benefit inflation will remain a partial margin headwind over the near term.

The STB oversees railroad pricing, so there will always be an underlying risk of reregulation in a policy shift to a more heavy-handed approach.

Coal volume will probably see near-term headwinds from lower relative natural gas prices and elevated utility inventories.