Stock Purchase: Union Pacific Corp (UNP)

 

I recently sold off another sizable chunk of mutual funds from my 401k account as part of my conversion of 401k mutual funds to dividend growth stocks.  The goal of this Dividend Retirement portfolio is to invest in high quality dividend paying stocks that have solid, stable businesses and perpetually increase their dividends.

My recent mutual fund sales raised about $16k which allows me to initiate 5 new positions (~$3k each).  Last month I went on a tear and spent $30k on 10 different companies that represented 9 different sectors – not a bad start.  With this new cash I’m going to slow down a bit, mostly due to fear of a market pull-back.  Even though I’m investing long-term now (as opposed to my option trading days), I still want to purchase stocks on sale if possible.

I recently identified a stock that I believe to be on sale, Union Pacific Corporation (UNP).  Steadily growing earnings and a recent dip in the stock price provide a great opportunity to buy UNP.

 

Company Overview

From Union Pacific Corp’s investor relations site:

Union Pacific Railroad, a principal operating company of Union Pacific Corporation, is one of America’s most recognized companies. We provide a critical link in the global supply chain by linking 23 states in the western two-thirds of the country by rail. We serve many of the fastest-growing U.S. population centers, operate from all major West Coast and Gulf Coast ports to eastern gateways. We connect with Canada’s rail systems and are the only railroad serving all six major Mexico gateways. We provide value to roughly 10,000 customers by delivering products in a safe, reliable, fuel-efficient and environmentally responsible manner.

One of the things investors look for when evaluating a stock for a dividend growth portfolio is barriers to entry, or the company’s moat.  Well best of luck to any company trying to enter the railroad space when Union Pacific already covers two-thirds of the country with 32,000 miles of rails!

Union Pacific System Map
 

Union Pacific Performance

UNP’s earnings growth has been phenomenal over the past 10 years, increasing every year except for 2010.

UNP data by GuruFocus.com

In fact, just about all financial metrics have a positive trend over the past 10 years including margins, revenue, return on capital, and free cash flow just to name a few.

The expected 2015 earnings growth for UNP is 10.4% compared to 11.9% for the industry.  This isn’t ideal, but UNP has a 2015 PE of 16.96 vs 18.70 for the industry.  And with a PEG ratio of 1.32, Union Pacific looks very attractive.

There are currently 18 analysts following Union Pacific who are mostly positive on the stock.  Thirteen rate UNP a strong buy, 1 rates UNP a buy and 4 say hold, with a consensus price target of $125.  Using a discounted cash flow analysis (EPS=5.87, 10yr growth rate=13% (based on previous years), terminal growth rate=4%, discount rate=10%) I come up with a fair value estimate of $125.43, in line with the analyst consensus.

Finally, Union Pacific’s stock chart shows the current price resting on fairly strong support which could potentially limit downside risk.  This isn’t a key factor in my analysis but it does help me sleep at night.

Union Pacific One Year Stock Chart
Chart from TradeKing
 

Union Pacific Dividend Performance

2009 2010 2011 2012 2013 2014
Dividend $0.54 $0.66 $0.97 $1.25 $1.48 $1.91
% Increase 21.30% 47.48% 28.88% 18.88% 29.05%

The table above says it all, but I’ll go into a bit more detail.  The Union Pacific dividend has been paid for 116 consecutive years and has increased each of the last nine years.  The dividend growth has been insane over the past 5 years, increasing an average of 29% each year.  At that rate, an investment today at a 2.05% yield would have a yield on cost of 6.53% in 5 years!

Even with this phenomenal dividend growth, UNP has managed to keep their payout ratio quite low, between 25 and 30% over the past 5 years.  Given this data, the Union Pacific dividend is extremely attractive even at a relatively low current yield.
 

Union Pacific Stock Purchase

Based on the UNP stock analysis above, I decided to initiate a position in my Dividend Retirement portfolio.  Here are the details:

5/5/2015 – Union Pacific Corporation (UNP)

  • Shares purchased: 28
  • Cost per share: $106.7899
  • Commissions: $14.95
  • Cost basis: $3005.07
  • Yield: 2.05%
  • Expected annual income: $61.60

I know that yield is low, but as I mentioned above I expect the dividend growth rate to more than make up for it.
 

Portfolio Impact

This purchase provides some exposure to the railroad industry, something that I did not have in either portfolio.  Unfortunately my portfolio yield on cost decreased from 3.18% to 3.08% but again, dividend growth should bring it right back up very soon.  Most importantly, this purchase pushes my forward annual income over the $1k mark.  I am now expecting to receive $1019.40 per year.

Any thoughts on UNP?

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2 Responses

  1. Nice purchase! I used to own UNP a few years ago, but I sold it impulsively. What can I say, I was young and stupid. Since then, I’ve really warmed up to owning railroads, and at one point I had all seven of the major North American ones on my to-buy list (UNP, CSX, NSC, CNI, CP, KSU, and BNSF through BRK.B) and even GWR for some shortline exposure. I’ve since narrowed my must-own list down to NSC (which I already own) and – you guessed it – UNP. I personally consider it on the very high end of fairly valued, but don’t see much of a problem in buying now and averaging down as the opportunity presents itself. UNP should treat you very well over time, and I hope to join you as a shareholder in the next few months!

    • Ken Ken says:

      Thanks for the comment, DD. It was a tough choice between UNP and NSC. The incredible dividend growth that UNP has had recently swayed me to buy. I will continue looking for a good time to add NSC to my portfolio. Hopefully (for my sake) UNP will hold at the current support level.

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