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Union Pacific Corporation  (UNP - Analyst Report), one of the leading rail transportation companies, is slated to release its third quarter 2012 results on Thursday, October 18. The current Zacks Consensus Estimate for the third quarter earnings per share is pegged at $2.19, representing a year-over-year increase of 18.11%.

Second-Quarter Flashback

Union Pacific Corp.’s second quarter earnings of $2.10 per share surpassed the Zacks Consensus Estimate of $1.96 by 7.1% as well as the year-ago earnings of $1.59 by 32%, driven by increased cargo hauling despite weaker coal volumes.

Revenues increased 7% year over year to $5,221 million but fell below our expectation. Volume growth from Automotive, Chemicals, Industrial Products and Intermodal continued to aid revenue growth, compensating for the lackluster performance by Coal and Agricultural product lines.

Agreement of Estimate Revisions

Estimate revision for the third quarter and fiscal 2012 and 2013 remains downward skewed, projecting a negative market sentiment towards the stock.

For the third quarter, out of 24 estimates, four moved downward in the last 7 days while no upward revision was witnessed. Over the last 30 days, there were one upward and sixteen downward estimate revisions.

For 2012, out of 26 estimates, one moved positive direction and five moved the opposite in the last 7 days. In the last 30 days, two estimates were positively revised, whereas seventeen were revised negatively.

The trend remains the same for fiscal 2013. In the last 7 days, out of 26 estimates, one was a positive revision, while two were negative. For the last 30 days five estimates made upward movement against seven downward.

We believe this negative bias is primarily due to the declining coal volumes of the company, which remains a key revenue contributor. The company has already stated that coal volumes would decline in the range of low to mid teens in the third quarter, tempered by lower Southern Powder River Basin (SPRB) coal. The company expects the loss of two legacy contracts last year and soft demand in some utilities due to higher stockpiles to restrict growth at SPRB.

In addition, agriculture volumes are also likely to weigh on top-line growth. The U.S. agricultural market remains impacted by drought conditions across the globe. Global food grain production remained restricted by dry weather conditions in Eastern Europe, lower grain production from major grain-exporting countries such as Russia and Kazakhstan, and poor monsoon in India.

Further, International intermodal volume will also remain under pressure due to weak container imports and contract losses. Wage increases that came into effect on July 1, will likely take rail inflation 2.5% higher in the second half of the year that would weigh over the near-term operating margin.

Magnitude of Estimate Revisions

Over the last 7 and 30 days, the estimate for the third quarter fell by a penny and 3 cents, respectively.

For 2012, the current estimate is $8.29, down 2 cents over the last 7 days and 6 cents over the last 30 days.

However, for 2013, the estimate revision remained unchanged at $9.52 over the last 7 and 30 days. 

Earnings Surprises

The company has delivered positive earnings surprises over the trailing four quarters with an average beat of 7.11%.

Our Recommendation

Despite hovering coal headwinds, we are hopeful about the company’s continued strong performance based on encouraging market trends for non-coal franchises. We believe that the company has an attractive product franchise through its exposure to a unique mix of commodity end markets alongside the strength in intermodal services.

We expect cyclical recovery in these markets coupled with improved cost structure to support earnings growth in the future. However, stringent regulations, rising expenditures and competitive threats from its peers like CSX Corp. (CSX - Analyst Report) may limit the upside potential of the stock.

Union Pacific retains a Zacks #3 Rank (short-term Hold rating). We also reiterate our long-term Neutral recommendation on the stock.

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