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On Nov 27, we maintained our Neutral recommendation on rail transport service provider Union Pacific Corporation (UNP - Analyst Report). We are encouraged by the company’s growth in chemicals and industrial segments. However, sluggish economic growth, fierce competition and a weak coal business remain causes for concern. This Omaha-based company holds a Zacks Rank #4 (Sell).

Why Maintained?

The company is progressing well on its operating and productivity improvements. We believe that the company has opportunities to improve yields backed by a higher rate of contract re-pricing compared to its Class I peers, continuous productivity gains and increased volume. Union Pacific is favorably positioned for 2014, having successfully renewed 50% of the $100 million legacy contract for the year. These actions are expected to contribute to operating profit growth.

Moreover, the company’s optimism surrounding growth across the majority of its product lines is complemented by strong crude-by-rail market conditions, increased grain shipments and recovery in housing starts. These are likely to be its near-term growth drivers.

Additionally, strength in intermodal volume is expected to continue based on the ongoing truckload conversion and domestic expansion. We also anticipate near-term revenue growth in the automotive division as the demand to replace old vehicles is high.

Despite making huge investments, Union Pacific possesses one of the industry's strongest balance sheets with solid free cash flow. This allows the company to provide high returns to shareholders via dividends and share buybacks.

However, Union Pacific’s performance is likely to be hurt by sluggish domestic economic growth. Challenges in the coal business are anticipated to weigh on the company’s coal shipments in the fourth quarter, offsetting the positive impacts of other products lines. Further, the company expects that the loss of a customer contract early this year to continue hurting coal volumes.

It also foresees an increase of about 5% to 7% in depreciation expenses in 2014. Further, Union Pacific plans to make long-term investments of about 17–18% of total revenue over the next several years, supporting operating efficiencies. These investments are likely to be accretive over the long term, but might weigh upon its margins in the near term.

Other Stocks

Other stocks worth considering within this sector are Canadian Pacific Railway Ltd (CP - Analyst Report), Arkansas Best Corp. and Covenant Transportation Group Inc. (CVTI - Snapshot Report). All these stocks currently hold a Zacks Rank #2 (Buy).

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