Union Pacific Valuation Model

M. J. NEELEY SCHOOL OF BUSINESS EDUCATION INVESTMENT FUND SESSION: SPRING 2015 ANALYST: VARUN GADIA UNIPN PACIFIC CORPORATION

HOLD

SUMMARY COMPANY NAME

UNION PACIFIC CORPORATION

TICKER

UNP

SECTOR

INDUSTRIALS

INDUSTRY

RAIL TRANSPORTATION

CLASSIFICATION

INCOME AND CAPITAL APPRECIATION

RECENT PRICE

$107.13

52 WEEK PRICE RANGE

$90.36 ‐ $124.52

OVERALL NUMBER OF SHARES

897 MILLION

MARKET CAPITALISATION

$96106 BILLION

CURRENT P/E

18.62x

FY 2017 P/E

17.50x

FY 2014 EPS

$5.77

FY 2017 EPS

$7.74

3 YEARS GROWTH RATE (2014‐2017)

10.14%

CREDIT RATING (STANDARD AND POOR)

A

Z– SCORE

3.4

CURRENT DIVIDEND YEILD

1.78%

FY 2017 DIVIDEND YEILD

2.00%

CURRENT DIVIDEND PAYOUT RATIO

33.08%

FY 2017 DIVIDEND PAYOUT RATIO

35.00%

BETA

.94

CURRENT P/B

4.54

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 1

PROS

CONS

 STRONG US ECONOMY

 LOWER OIL PRODUCTION

 HIGHER US DOLLAR

 WEST COAST PORT SHUTDOWN

 DIVERSIFIED PORTFOLIO

 RAPID BSNF EXPANSION

 PRICING POWER

 SUPPLY CHAIN RISKS

 BENEFICIAL CUSTOMER RELATIONSHIPS

 GOVERNMENT REGULATION

 INCREASING MEXICO BUSINESS

PORTERS FIVE FORCES THREAT OF COMPETITION

MODERATE

THREAT OF NEW ENTRANTS

LOW

THREAT OF SUBSTITUTES

LOW

POWER OF SUPPLIERS

MODERATE

POWER OF BUYERS

MODERATE

COMPANY OVERVIEW Union Paci ic Corporation (or Railroad) is North America’s premier railroad company, covering 23 states across two third of the states of the United States west of the Mississippi. The company was incorporated in 1969 and is incorporated in Omaha, Nebraska.

Union Paci ic (UNP) is classi ied as a class 1 railroad in the United States. The company has operates 32,000 route miles, employees 47000 people, operates 8266 locomotives, operates 67,555 freight cars, and has incurred $4.1 billion in capi‐ tal expenditure in FY 2014. Union Paci ic serves 10000 customers by delivering products in a safe and reliable manner.

The company serves many of United State’s fastest growing population centers, operates from all major West and Gulf Coast ports to eastern gateways, connects Canada’s rail systems and, is the only railroad, serving all 6 Mexican gateways.

The company’s business mix includes agricultural, automotive, chemicals, energy, industrial, and intermodal.

The company’s major competitors include Burlington Northern Santa Fe Corporation (BSNF), Chessie System and Sea‐ board Coast Line Corporation (CSX), and Norfolk Southern Corporation (NSC), and Kansas City Southern Railway Corpo‐ ration (KSU).

ORIGINAL PURCHASE RATIONALE The Education Investment Fund originally purchase Union Paci ic on the 4th of December, 2013. Union Paci ic was pur‐ chased to provide to provide high dividend income, bene it from growth of the economy, bene it from a market leader in the railroad industry, and gain exposure in the Industrials sector. Union Paci ic was initially categorized as a Capital Ap‐ preciation stock, but due to strong dividend growth was changed to a Income and Capital Appreciation stock.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 2

PORTFOLIO CONSIDERATIONS The EiF decided to maintain the allocation of the Industrials sector at 10.4%. Due to recent price decreases Union Paci ic contributes 2.8% of the Industrials portfolio.

Since we have held Union Paci ic, 4th of December 2013, Union Paci ic has returned 39.2% in returns, compared to 2.5% for Boeing and –8.6% for Delta Airlines.

For the Spring of 2015 Union Paci ic has returned –7.4% primarily due to decrease in west port shipments, decrease in oil shipments, and decrease in frack sand shipments. Union Paci ic forms 5.21% of the XLI SPDR. YTD XLI has remained lat with –.7% returns.

Union Paci ic adds a strong diversi ication to portfolio with low correlations with both Delta Airlines and Boeing. Moreo‐ ver, Union Paci ic has a moderate co‐relation with the SPX and XLI which show signs off a potential upside as the US economy continues to recover.

UNP

DAL

BA

SPX

XLI

UNP

1.00

DAL

.425

1.00

BA

.416

.380

1.00

SPX

.715

.524

.567

1.00

XLI

.765

.552

.661

.923

1.00

DATE OF CURRENT PRICE PERIOD RETURN YTD RETURN PURCHASE

COMPANY

CLASSIFICATION

BA

Income and Capital Appreciation

2/13/2015

$153.42

2.5%

18.8%

DAL

Capital Appreciation

1/30/2015

$43.14

(8.6%)

(12.1%)

UNP

Income and Capital Appreciation

12/4/2013

$109.79

39.2%

(7.4%)

SPX

‐

‐

‐

16.93%

0.35%

Overall, due to strong signs of growth for the US economy, recovery of the west ports, increasing imports, and low co‐ relation to its peers I feel we should continue to keep our holding in Union Paci ic. It is a strong addition to our Portfolio and it will continue to add the bene it it has added earlier INDUSTRY OVERVIEW Union Paci ic is a part of the Rail Transportation industry. The industry comprises companies that operate railroads across the United States. The industry includes larger railroads, known as Class 1 railroads, regional and local line haul railroads that carry freight and passengers. The industry is a transport industry which deals with the transport of goods and does not include scenic or sightseeing rail transportation, street railroads, commuter rail or rapid transit.

The major drivers for the industry are total trade volume, world crude oil prices, industrial production (output). Demand from coal, automotive, and intermodal goods. The major suppliers to the industry are diesel fuel, and locomotive and freight car manufactures and maintainers.

The major demand drivers are coal, chemicals, automotive, agriculture and intermodal transport.

The major players in the industry are UNP, BNSF, CSX, and NSC.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 3

The Industry is in it’s growth phase as compared to a few decades earlier in which the industry was mature and growing at a slower rate. In the last ive year the industry grew at a faster rate of about 5% primarily due to capital expenditures on the par of major irms to expand network, increase locomotives, and increase freight cars. The industry has a few businesses with 4 major players. The industry maintains a net pro it margin of approx. 17.3% on average including both private and public players.

In the services provided Bulk Freight makes up most of the services. Bulk includes various business such as Coal, Agriculture, Chemicals, and Industrial Products. The percentage of bulk has dropped comparatively compared to earlier due to the repaid increase in demand for rail transport from Intermodal. Intermodal is focused from carrying goods across the ports and the mainland for import‐export purposes. Intermodal includes Automotive, and Tradable goods. Intermodal business originate from the West Coast Ports, East Coast Ports, and the Gulf Ports.

Rail Transport, also known as Barge, is the most cost‐effective but have limited routes for transport, but trucks are the most versatile but costly route. Hence, trucks and incorporate smaller volumes but barges are primarily used for bulk shipping and intermodal transport. Moreover, barges are considered more effective for connecting major terminals while trucks are better for much more smaller and concentrated terminals. Additionally, barges are most fuel ef icient form of transport. In a recent report from UNP management for every $1 of fuel it takes to transport 1 ton, in a truck, from point A to point B, it takes $.25 of fuel, in a railway.

Two major commodities which incorporate bulk transport are oil and coal. Oil has recently used rail transport because pipe‐

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 4

Coal demand and concurrently production has been steadily declining in the past years. However, coal contributes to a signi ‐ icant portion of rail transport. In a recent report from UNP coal expects to contribute 40% to US’s energy consumption mar‐ ket in the next 5 years which will help increase production and increase Coal transported by railways. Moreover, most of the Coal transported is by rail transport.

As the population grows, population centers grow, wages increase, and consumer spending increase it will driver up demand for goods. The railways industry is laggard and usually improves in line or after the economy has improved.

In the recent years due to increasing fuel prices more and more companies have transported goods from railways. Due to these features railways have been able to exploit pricing and thus drive up bottom line revenues.

Some important points to note from the industry structure is that irms within the Rail Transportation industry have a high capital expenditure and require to continue the same to expand their network, locomotives, and freight cars to support cli‐ ents with various demands and geographies. Additionally, the revenue of the irms depends on multiple businesses which support the economy. Hence, a strong or growing economy is necessary to support the industry. Moreover, the industry is primarily local, regulated, unionized, and pricing conscious. The services offered to clients are generic, hence, the value prop‐ osition to the irms is the frequency of delays, time for delivery, and type of bulk freight that can be carried.

Overall, the $82.3 billion dollar industry is expected to grow at 3% over 2015‐2020 with 1%, 3.8% and 3.5% growth rates in 2015, 2016, and 2017. By the 2017 the industry will be valued at $88.41 billion. Additionally, The industry is highly employee focused a strong backbone for the economy.

In a recent report from Association of Ameri‐ can railroads, every 1 job generated by the rail transportation industry it will help to sup‐ port 4 jobs in the economy. In 2015, the na‐ tions major freight railroads plan to spend $29 billion—highest ever– BSNF leading the way with $6 billion in capital expenditure.

Moreover, the support ef iciency the railroad industry expects to add 15,000 jobs. Overall, the nation has 140,000 miles of railways sup‐ porting 180,000 well paying unionized jobs all over.

Current volumes state that the traf ic volumes are approaching pre‐rescission levels. Hence, railroads are increasing capacity to support future expansion.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 5

We also observe that demand for US rail transportation has increased substantially in the last year. Intermodal transport fol‐ lowed by agricultural production and frack sand have contributed to the increase. Intermodal transport has increased with the rapid increase in trade with Mexico. Agricultural production was at record levels in 2015 which help drive demand. Addi‐ tionally, a strong composition of oil well drilling and maintenance is frack sand which helped in increase in freight demand.

There are various factors which have contributed as key external drivers and movers to the industry performance. The major factors are Total Traded Volume: The total trade volume forms an important factor in rail volumes. The industry is sensitive to import and export volumes. Imports, such as motor vehicles, are often placed in containers and transported by rail. Many exports, such as farm products, are transported by rail from production centers to ports. Hence, when import and export trade volumes rise, demand for the industry’s services increase, boosting industry revenue. The total trade volume is ex‐ pected to be at record levels in 2015, 2016 and 2017 growing at 4.6%, 5.1%, and 5.4% respectively, setting the overall trade volume at $5353.70 billion in 2017 up from $4619.90 billion in 2014. Union Paci ic is strongly positioned to connect various mining areas, production centers, population centers and ports to exploit opportunities in increases in trade volumes.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 6

World Prices of Crude Oil: Crude Oil is a major production of diesel fuel. Crude Oil prices primarily drive fuel costs for industry operators. Usually, industry operators often implement surcharges to mitigate luctuations in the price of fuel.

Industry operators pass the additional costs of fuel to the customer. Various irms, speci ically, Union Paci ic have contracts with a two months lag that affect luctuations in fuel prices. They lock in contracts with customers two months in advance to avoid sudden change ‐ increase or decrease– in crude prices. Consignors, such as Union Paci ic, will face strong bene its of the fall in fuel prices decreasing their diesel costs by almost 25‐30% Year on Year. Moreover, customers bene it from lower fuel prices because surcharges will be removed or reduced due to lower prices.

Ibis world estimates WTI per barrel prices to be around $53.33, $65.77, and $71.16 for 2015,2016, and 2017. However, in my model I estimate prices to be around $60, $65, and $75 WTI per barrel based on various EiF estimates in other models by analysts.

Industrial Production Index: The industrial production index measures the output from the mining, manufacturing, electric, and gas industries. The industrial manufacturing sector is the largest user of the industry services. As manufacturing output increases the demand for long distance freight rail increases. The industrial index is expected to increase in 2015, 2016 and 2017 by 4.1%, 3.3%, and 4.4%. Union Paci ic transports coal, chemicals, and industrial products from various pro‐ duction, mining and manufacturing locations to population centers. These industries form a core part of UNP’s portfolio of services. As manufacturing output increase the company is a good position to exploit these opportunities. The Index has a base year of 2007 output levels, the index is expected to increase to 115.90 in 2017 from 104.10 levels in 2014.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 7

Agricultural Output: Agricultural production had strong growth levels in the year 2014 growing at 1.2%. The indus‐ try will slightly decline in 2015 by –.6% due to current surplus levels and grow at historical rates at 1.5% and 1.4% in in 2016 and 2017. Consignors such as Union Paci ic will transport agricultural produce from the point of production to the point of sale. Due to the surplus and growing volumes agricultural transport is expected to continue momentum in the years to come.

Coal Mining Demand: The mining industry is expected to grow in the next few years although it faces challenges.

The growth forecast is to be modest due to economic slowdowns in the rest of the world. More of the demand will come from US companies increasing coal as a source of their energy. In a recent report from Union Paci ic, Coal was set to contribute 40% of US energy output, up from the current 35% levels. Hence, as demand will increase so will mining and transport of Coal. The commodity is almost entirely transported by rail hence rail consignors stand to bene it. Union Paci ic’s exposure to call is huge and constantly decreasing. But as Coal production does well so does Union Paci ic. Cosigners, like Union Paci ic are in a better position than their peers because they transport Coal from places such as Powder River Basin which have cheaper manufacturing costs and can sell Coal at a cheaper rate. Hence, luctuation in volumes may not affect such con‐ signors.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 8

Current Performance Summary: The industry has made a comeback over the past few years. Increase in fuel ef iciency, growing demand for bulk freight transportation and a lower car‐ bon footprint have resulted in greater demand for the rail transportation industry’s services. Recent luctuations in the price of oil have also made rail transportation more competitive compared with other forms of transport.

However, this may not hold true in the years to come. In the early recovery phase, the speedy growth of oil prices led to strong growth of the industry.

In the middle years oil prices began to stabilize and growth stabilized.

Future Performance Summary: The US economy is expected to do well domestically. The US dollar has been growing steadily which has made imports cheaper than before. With emerging markets such as Mexico increasing will increase the imports into the US of various in‐ dustrial products and increase US exports of various consumer products into Mexico. Moreover, trade from countries such as China, Japan and India will bring more traf ic to US ports. Transport by railways will bene it from the increase in from the ports to mainland and vice‐versa.

The industry is expected to face a period of growth and volume, with most consignors having diversi ied into other product lines than Coal, luctuations in coal production may not impact industry volumes. Strong capital investments, constructive locations of terminals, increase in trade volumes, increase in US oil production, and increase in agricultural production the industry is expected to do well in the coming years.

Top line growth is expected to be supported by bottom line increase in margins with stabilizing wages, and decrease in die‐ sel prices.

COMPETITORS

The railroad transportation industry is primarily composed of 4 major players which include Union Paci ic, CSX Corporation, Norfolk Southern Corporation, and Burlington Northern Santa Fe Corporation. Union Paci ic and BSNF lead the market con‐ tributing 29.6% and 28.3% to the overall revenues.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 9

RAIL NETWORK IN THE US BY CONSIGNOR

Burlington Northern Santa Fe Corporation (BNSF): BNSF is based out of Fort Worth, TX. It operates one of the largest railroad networks in North America through its subsidiary BNSF railway. It covers 32,500 route miles, 28 states, and 2 Canadian provinces.

This network covers the western two‐thirds of the United States, stretching from major Paci ic Northwest and Southern California ports to the Midwest, Southeast, and Southwest, as well as from Gulf of Mexico to Canada.

BSNF services include transport of Consumer Products, Industrial Products, Coal, and Agricultural products. BNSF is current‐ ly a private company and forms a part of the Berkshire Hathaway group. BSNF revenues are $23.3 billion for 2014. BNSF has net pro it margin of 16.65%, one of the highest in the industry and is spending $6 billion in Capital Expenditures for 2015.

CSX Corporation: CSX Corporation and its subsidiaries are based in Jacksonville, FL. The company serves 23 states, District of Columbia and 2 Canadian provinces. It has 31,365 track miles un‐ der operation.

CSX services include transport of coal, chemicals, automobiles, minerals, agricultural products, consumer goods, foods, met‐ als, forest and paper products, fertilizers, and phosphates. CSX revenues were at $12.8 billion for 2014. The irm has a pro it margin of 15.21% and is spending $2.5 billion in Capital Expenditures for 2015.

Norfolk Southern Corporation (NSC): NSC Corporation is head‐ quartered in Norfolk, VA. The railroad’s consists of 21,000 miles under operation in 22 states and District of Columbia.

Major services include transport of coal, coal, coke, iron ore, chem‐ icals, metal, construction, agriculture, consumer, paper, clay, and forest markets. NSC’s revenues were $12.18 billion for 2014. The irm has a pro it margin of 17.21% due to its diversi ied holding portfolio and is spending $6.6 billion in Capital Expenditures for 2015.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 10

Kansas City Southern Corporation (KSC): KSC is headquartered in Kansas City, Missouri.

The company has 6000 miles under operation. The company has two subsidiaries Kansas City Southern Railway Company located in the United States and Kansas City Southern De Mexico SA de CV located out of Mexico. It’s Mexico subsidiary is one of the largest regional railroads in Mexico. The company also owns 50% stake in the Panama Canal Railway Company located out of Panama.

The company’s services include transportation of agriculture, consumer products, and chemical products. The company had revenues of $2.6 billion with net margin of 19.5% driven by a diver‐ si ied portfolio. The company budgeted capital expenditure of $6 billion for 2015.

PORTERS FIVE FORCES

Threat of Competition ‐ MODERATE ‐ Most of the railways are regionalized and operate in speci ic regions or territories.

Each of them have their own unique set of clients, unique geographies and support unique industries. West of Mississippi Union Paci ic and BSNF compete with each other iercely across various population centers. The competition exists over price, and newer clients. However, with rising demand and limited rail volumes each of the consignors have enough of vol‐ ume reducing idle times to the lowest levels since the recession in 2008.

Threat of New Entrants ‐ LOW ‐ The railroad industry is capital intensive and is very well regulated. Hence, although new railroads can compete on a extremely small level on a larger scale the threat of New Entrants in negligible. Moreover, devel‐ oping ef iciencies, hiring employees, and developing client relationships take time which it make it dif icult for new entrants to develop a competitive position in the industry. The new entrants are at a disadvantage when it comes to product offerings and bulk transport which work across larger population centers located at a distance from each other.

Threat of Substitutes ‐ LOW ‐ Historically, the threat of substitutes has been lower due to the fuel and pricing ef iciency of railways. To transport bulk transport across various geographies trucks are not an appropriate solution. Moreover, the speed and reach of railways is tough to be matched by other modes of transport. The risk and security provided by railways is bene icial as compared to other modes of transport. As pointed by other EiF analysts, trains can carry one ton of good at roughly 450 miles per gallon which is unmatched by other modes of transport. Due to the current decrease in diesel prices it makes it much more economic to transport goods by trucks, but it can only cannibalize smaller customers in which arena most larger consignors, such as Union Paci ic, don’t compete.

Power of Suppliers ‐ MODERATE ‐ Suppliers supply locomotives, steel, and freight cars to consignors. There are not many suppliers who are in a strong position. Hence, consignors need to adhere to suppliers when it comes to pricing and delivery of these contracts. However, suppliers mostly supply to a single consignor hence consignors can de ine terms such as time‐ lines and speci ication to suppliers. Suppliers are rarely switched or changed because relationships with consignors, such as Union Paci ic, have been established over decades.

Power of Buyers ‐ MODERATE ‐ Buyers have a moderate power to dictate terms for the transport of goods. Buyers have the power to choose over consignors and even litigate on pricing problems. Moreover, buyers sign into ixed contracts with men‐ tioned surcharges and delivery speci ications such as time of delivery and charges. Hence, volatility in prices can be negotiat‐ ed by suppliers with the consignors.

INDUSTRY RISK RATING

The industry risk rating comprises various forms of risk such as structural risk. Growth risk and Sensitivity risk. The overall industry risk is a weighted average with preference given to sensitivity risk at 50%, and growth and structural risk at 25% each.

Structural risk will be low for the industry over the next few years. The industry is in growth phase which means higher net and operating margins, large expansion opportunities and assistance provided by the government. Moreover, industry reve‐ nue will continue to grow, additionally increasing transparency and decreasing volatility in earnings of consignors.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 11

Risk ratings run from 1 to 9 in which 1 is expected to be the lowest risk, such as government treasury and 9 is expected to be the high‐ est risk ‐ newly formed industry in the early stage of its lifecycle.

Structural risk is expected to be at 3.45 which is lower as compared to other industries.

Growth risk is expected to be moderate over the outlook period.

Growth risk measures the risk in revenue growth for the next few year over the last few years. As the industry is expected to grow at a moderate but slower rate than the last few years growth is moderate.

Growth risk is expected to be 5.10 with is above average as compared to other industries.

Sensitivity risk is forecasted to be medium‐low over the outlook period up from low a few years earlier. There are many fac‐ tors contributing to the sensitivity such as world oil prices, total trade volume, agricultural production, and coal output. As the total traded volume increases over the next few years the sensitivity risk will be lower but it may be impacted by volatili‐ ty in crude oil prices and coal production.

Overall, Sensitivity risk is expected to be around 4.61 which is higher as compared to other industries.

RAILWAY REGULATION There are various ongoing regulations which could impact the industry. Some of the regulations and risks have been men‐ tioned below ‐ Price Caps ‐ Some rail shippers have asked the government to assist them in reaching price against some consignors. The bene it of price caps will diminish the potential of rail con‐ signors to charge high prices during times of increasing vol‐ umes. A counter argument cited was that the rail network in the United States Is largely privately owned. Private compa‐ nies and their shareholders bear the brunt of rail expendi‐ ture. Hence, although price caps may help shippers it will be worse for the company and the economy on whole Expansion of Capacity ‐ Shippers complain that capacity expansion have not been in line with increasing demand.

Shippers have asked the government to increase rail capital spending to support increase in volumes. A factor cited was that capital expenditures are a function of net income. As the bottom line increases so does capital expenditure.

Positive Train Control (PTC) ‐ Railroads are releasing a huge investment to implement nationwide interoperable Positive Train Control Technology. Railroads cite that railroads in the US are safer compare to their global counterparts, yet the gov‐ ernment wants them to implement a safety mechanism.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 12

As shown in the chart train collisions are the lowest since the 1980’s. However, the government argues that to bring further ef i‐ ciency and decrease collisions it will be better if railroads imple‐ ment safety regulations such as positive train control. PTC is de‐ signed to automatically stop or slow a train before a certain type of incident occurs. The industry has spend $5 billion is PTC so far, but due to the deadline of FY 2015 approaching fast consignors are in‐ creasing the pace at which the implement the new technology.

Major problems faced by consignors in implementing PTC is to oblige to various federal speci ications in implementing the system.

Moreover, the complexity of the issue makes it dif icult to gauge the bene it of implementing such a technology. In a recent earnings call

by Union Paci ic management cited that for every $100 spent on PTC, the company’s sees a $1 bene it.

Most of the railroads will not meet the deadline in place to implement the PTC regulations. Railroads believe that the govern‐ ment will give them an additional deadline to install, test, and approve the system and educate employees about the new technology.

PTC was initiated by the government in 2008 and was to be implemented, tested, and approved by all railroads by 2015.

However, it is likely to government will extend the time given to the railroads to implement the system.

Union Paci ic plans to spend $450 million, BSNF plans to spend $1.13 billion, CSX plans to spend $300 million, and NSC plans to spend $250 million. KSU has not given any estimates for PTC spend for 2015.

Hazmat Regulations ‐ Railroads have a tremendous safety record for moving hazardous materials. In fact, 99.997 percent of all rail hazmat shipments reach their destination without a release caused by a train accident.

In 2015, federal government is expected to inalize regulation for transport of certain hazardous materials, federal tank cars, and oil shipments. In 2014, railroads voluntary entered an agreement to increase standards for oil transportation.

Railroads welcome the change and are looking forward to implement any safety measures by the government in 2015.

Crew Size Regulations ‐ This is an important regulation which can affect the number of employees who operate a train.

Usually, trains have two member crews. However, the government is mandating that all trains have two people crews. Rail‐ ways were under the impression that due to increase in safety from PTC, crew sizes could be decreased to one person.

The decision by the government will increase or decrease number of employees in an already heavily labored and unionized industry.

Other Regulations ‐ Various regulators are currently in talks with consignors about news regulations. Streamlined Infra‐ structure spending will help build capacity to support increasing volumes and remove the red tape necessary to obtain licenses. Moreover, de ining speci ic standard for truck freight and weight limits will inhibit and hurt the rail indus‐ try. Hence, the industry will ight any move to change truck speci ications. The railways industry invest six times more in the US economy compared to any other manufacturer. Railways, usually spend 18% in capital expenditure as a percentage of their revenue compared to 3% in other manufacturing industries.

Hence, the railways industry is talks with the government to provide incentives or alter tax rates provided to various consignors.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 13

FIRM OVERVIEW AND SEGMENTS

Union Paci ic can trace its foundations back to 1862 when it was formed under the act of Congress entitled Paci ic Railroad Act of 1862. The act was approved by President Abraham Lin‐ coln. The railroad was build to provide services for the con‐ struction of railroads from the Missouri River to the Paci ic as a war measure for the preservation of the Union. Currently, the railroad operates out of Omaha, NE. The irm operates across a network of 32,000 miles, 23 states, and serves all 6 Mexican gateways, gulf ports and paci ic ports. The irm employees 47,201 employees and has 8000 locomotives. The irm has a market share of 29.60% making it the largest railroad in the United States. The irm operates and competes in the rail trans‐ portation industry.

Union Paci ic’s revenue comes from various divisions. The company’s divisions are divided as Intermodal, Agricultural Products, Industrial Products, Coal, Chemicals, and Automotive. Over the years the share of the intermodal, chemicals, and industrial products has been growing; however, the share of the coal and agriculture units has been slowing. In the last year the share of intermodal was 19.9%, industrial products at 19.5%, coal at 18.3%, agriculture at 16.7%, chemicals at 16.2%, and automotive at 9.3%.

Agricultural Products ‐ Involves transportation of grains, commodities produced from these grains, and food and beverage products. The Company accesses most major grain markets, linking the Midwest and Western US pro‐ ducing areas to export terminals in the Paci ic Northwest and Gulf Coast Ports, as well as Mexico. The company serve signi icant domestic markets, including grain processors, animal feeders, and ethanol producers. The business soared last year due to a lourishing harvest.

Automotive ‐ The company is the single largest carrier of automotive west of Mississippi River. Union Paci ic operates 40 vehicle distribution centers. The railroad’s extensive fran‐ chise serves ive vehicle assembly plants and connects to West Coast ports, Mexico gateways, and Gulf of Mexico for both import and export shipments.

Chemicals ‐ The Company’s chemical shipments include four broad categories: petrochemicals, fertilizer, soda ash, and other. Petrochemicals include industrial chemicals, plas‐ tics, and petroleum products, including crude oil and liquid petroleum gases. Fertilizer movements originate in the Gulf Coast region, the western U.S. and Canada for delivery to major agricultural users in the Midwest, western US, and abroad. Soda ash originates in southwestern Wyoming and California, destined for chemical and glass producing markets in North America and abroad. Other shipments include sodium products, phosphorus rock and sulfur. Last year the chemicals business soared due to increase in petroleum production and rise in demand for fertilizers.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 14

Coal ‐ Union Paci ic supports the transportation of coal and pe‐ troleum coke to independent and regulated power companies and industrial facilities throughout the U.S. Coal traf ic originat‐ ing in the Southern Powder River Basin (SPRB) area is the larg‐ est segment of Union Paci ic’s coal business.

Industrial Products ‐ Union Paci ic’s network facilitates the movement of numerous commodities between thousands of origin and destination points throughout North America. The company services construction products, minerals, consumer goods, metals, lumber, paper, and other miscellaneous prod‐ ucts. Commercial, residential, and governmental infrastructure investments drive shipments of steel, cement, and wood prod‐ ucts. Oil and gas drilling generates demand for raw steel, inished pipe, frac sand, stone and drilling luid commodities. Lum‐ ber shipments originate primarily in the Paci ic Northwest and western Canada and move throughout the mainland for use in new home construction and repair and remodeling.

Intermodal ‐ Intermodal business includes two segments international and domestic. International business consists of im‐ port and export container traf ic that mainly passes through West Coast ports served by Union Paci ic’s extensive terminal network. Domestic business includes container and trailer traf ic picked up and delivered within the mainland for trucking companies to pick up at junctions and deliver to end customers.

The chart bellows origination and low of various Union Paci ic service products across the western two‐thirds of the United States.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 15

GROWTH DRIVERS

Strong US Economy ‐ Based on a mar‐ ket watch report US Economy will growth will be around 3% in 2015 and will continue to grow at this rate over the next few years. The growth is ex‐ pected to be fastest than 2005. Key con‐ tributors to US GDP are Home care pro‐ viders, Home builders, Landscaping ser‐ vices, Real Estate Sale and Brokerage services, New Car Dealers, Generic Phar‐ maceutical Manufacturers, and Oil and Drilling Gas Extraction. Over the next few years all these contributors are ex‐ pected to grow, increasing the demand for various services provided by railroads.

The increase in growth will impact automobile volumes, industrial product volumes, and automotive volumes. Hence, in‐ crease in volumes will contribute to increase in transportation by rail. Union Paci ic’s franchise is a perfect position to exploit the increase in volumes. The company since recession has grown capacity, network, and employee base which will assist the company to be a good position to cater to the growing needs of the clients.

Energy/Coal‐ In a recent report from Union Paci ic’s management coal is expected to form 40% of US energy requirement up from the current 35%. Almost all of the coal is transported by rail. Hence, increase in coal volumes will increase rail transpor‐ tation. Moreover, Union Paci ic obtains most of its coal from Powder River Basin, which has one of the cheapest coal mining costs. Hence, Union Paci ic will face a substantial increase in Coal Volumes.

Higher US Dollar ‐ A higher US dollar is good for trade, especially for imports. Union Paci ic serves the west cost and gulf coast ports across the United States. An increase in the dollar will increase trade from Mexico. With Union Paci ic being the only railway that serves all 6 gateways to Mexico, an increase in trade will bene it Union Paci ic volumes.

Pricing Power ‐ Most of the other railways are investing heavily to expand their network and improve ef iciencies. Union Paci ic has consistently invested in its franchise since recession due to which it holds a pricing advantage compared to its competitors. The pricing advantage will last for a few more before other competitors get up and running to match Union Paci ic’s operating ef iciencies. Union Paci ic even cites diversi ied pricing strategies across various product lines to over‐ come risks in case of loss to competitors in one product line.

Innovative Products and Bene icial Customer Relationships ‐ Union Paci ic prides itself with strong relationships it has established with its customers. It’s approx. 10,000 customers have been helpful in withstanding the company through vari‐ ous downfalls from 2002‐2007 and have been instrumental in driving new demand towards the company. Union Paci ic has adopted to the changing needs of its clients with innovative solutions, for example, in the last few years Union Paci ic has of‐ fered robust solutions for transportation of petroleum products and petroleum inputs, such as frac sand.

Fuel Prices ‐ Low diesel prices contribute to increased operating margins. The company stands to bene it 25‐30% decrease in fuel price costs due to the recent drop in fuel prices. Moreover, lower fuel prices decrease surcharges which will help customers to increase the number of goods transported by railways. Hence, the company will expe‐ rience strong bottom line growth.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 16

MEXICO GDP GROWTH RATE

Pioneer in Positive Train Control (PTC) Investment ‐ When most of the other companies suffer from more capital expenditures into PTC and lower Free Cash Flows, Union Paci ic has consistently spend in Positive Train Control which provide the company bene its to fo‐ cus on maintenance and up gradation of it current rail network.

Mexico Growth ‐ Union Paci ic owns 26% in Ferromex Mexico which is a private rail consortium that operates the largest railway in Mexico. With Mexico’s GDP expected to grow at 3.5%, according to a report by inancial times, rail transport will bene it with the in‐ crease in volumes and lower fuel surcharges.

Operating Margins Expansion ‐ The company expects to decrease its operating margins by to 40% in the years to come due to lower fuel pric‐ es and better employee management. Moreover, the new CEO was in‐ charge of Union Paci ic operations which will bene it the company to derive bottom line growth.

Debt to Value ‐ The company currently sites low debt to value over the course of its operation. Compared to its competitors Union Paci ic has the capacity to increase debt in its portfolio to help with capital expendi‐ tures and manage dividend payouts.

FIRM RISKS

Other than the industry risks cited before, some company speci ic risks are ‐ Steel Supply Risks ‐ Union Paci ic relies on a single domestic and international supplier for all of its steel suppliers. A small number of steel supplier is a strong power to the supplier in case of increasing volumes in the industry.

West Coast Ports Risk ‐ The West Coast port shut down in the late half o f 2014 and reopened in the irst week of April. The shut down built a huge amount of congestion at the ports. Moreover, many of the ships were sent to the east coast ports due to the shutdown of the west coast ports. West coast ports have proved second time in the decade that they may not be as reliable as their eastern counterparts. Due to the problems faced, Union Paci ic lost 22% intermodal volumes in the irst half of quarter 1 of 2015. However, the iasco is over and trade is set to in‐ crease 8% Year over Year on the west coast ports.

WEST COAST PORT INTERMODAL RAIL LINES

Panama Canal Risks ‐ Union Paci ic can expect to face more intermodal competition once the Panama Canal project is inished such that larger container ships can skip West Coast ports. Still, the West Coast ports will remain the fastest way for containers from Asia to get to Chicago (up to 2 weeks faster than the all water route). Also, the container ships keep getting bigger so even after the project is inished there will be plenty of container ships that don't it through the canal. Union Paci ic expects the project to decrease intermodal volumes at cur‐ rent levels by 3%. The project is unlikely to be completed in the few years to come.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 17

FIRM MANAGEMENT

President and CEO; Lance M. Fritz ‐ He was elected president and CEO of icer of Union Paci ic on February 5, 2015. He is also a part of the irm’s board of directors. Prior to the current position he served as the executive vice president of Operation and vice president of labor relations. With Mr. Fritz as the CEO Union Paci ic can expect better operating margins through ef iciencies which can bring bottom line growth. Moreover, with labor negotiations in progress Mr. Fritz is the best person equipped to handle any new outcomes.

Robert M. Knight; Chief Financial Of icer ‐ He was named CFO of the company in February 2004. He began his career with the company in 1980 and has held variety of positions including serving as vice president and general manager– Energy and Automotive. In 2014, Knight was ranked No. 2 in the Wall Street Journal of the top Performing CFO’s in the S&P 500. Moreover, he was named No. 1 CFO in the Airfreight and Surface Transportation sector in the Institutional Investor 2014 and 2015 rankings.

INVESTMENT RECOMMENDATION

Pro’s to Recommendation Strong US Economy ‐ The US economy is expected to grow at a better rate than ever since recession. With economic grow increases demand of various products, both industrial and consumer as well as raw materials. The Union Paci ic franchise is in a perfect positon to leverage the opportunity through its diversi ied product offerings, strategic customer centered loca‐ tions, and strategic pricing.

Returns vs SPX ‐ Although the year to date returns have not been satisfactory, Union Paci ic has historically returned 39.2% since we have purchased the share compared to the S&P 500 index which has returned 16.2%. Union Paci ic was the highest return share for the EiF in 2014. Moreover, the stock adds a higher diversi ication to our current Industrials sector. Overall, compared to the S&P 500, Union Paci ic is in a strong position for long term growth.

Higher US Dollar ‐ Due to the rising dollar import volumes will increase which will impact Union Paci ic’s automotive and intermodal business. Moreover, due to the monopoly in terminals and network of the company in both service sectors the company will bene it from premium prices compared to its competitors.

Mexico Business ‐ Union Paci ic stands to bene it from its Mexico operations. As the Mexican economy grows so will the business for Ferromex Mexico.

Con’s to Recommendation Lower Oil Production ‐ As the oil production decreases so will the number of carloads of oil shipped decrease. More‐ over, carloads for raw materials such as frac sand will also decrease. However, as Oil forms a small portion of the portfolio, only 5%, management expects lower volumes to be overcome by traditional price increases. Price increases are possible be‐ cause pipelines are not place, trucks are not feasible, and railways are the best mode of transport.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 18

West Coast Port Shutdown ‐ West Coast ports have resumed operation, and management estimates that the loss in business will be overcome by increase in Year on Year volumes. Moreover, a lot of inventory still holds at West Coast Ports, and hence all revenue has still not been lost.

Rapid Competitor Expansion ‐ BNSF has been increase capital expenditures at almost 30% its gross revenues to build tech‐ nology, network, and improve ef iciencies. However, Union Paci ic still commands a premium franchise, yet the growing threat of BNSF looms ahead.

Regulation and Unions ‐ The railroad industry is highly regulated. Any new regulation always poses a risk to the in‐ dustry. The Positive Train Control technology is a risk and will affect margins. Moreover, new regulations such as increasing the size of truck tonnage can always pose a risk to the industry on whole and Union Paci ic. New talks with Union began in early 2015. Any new outcomes in De ined Bene it payments or Salaries can affect the irm margins. However, the company has cited only positive outcomes from the negotiations.

Summary Based on our irm and industry overview, I strongly suggest that we hold Union Paci ic. The company will bene it from the strong US economy over the next few years, higher trade volumes, rise of it’s Mexico business, competitive pricing power, and highly valued customer relationships.

However, the company may face risks when it comes to lower oil production, shutdown of west coast ports, and rising BNSF network. However, with Oil forming only 5% of Union Paci ic’s portfolio, the reopening of west coast ports, and earlier made strategic expansions, the franchise aims to bene it in the years to come.

Moreover, stronger return to shareholders through share buybacks, and increase in dividends. Overall, we should maintain our exposure in Union Paci ic at the current 3% level. We even, ind support to gain anywhere between 5% to 9% upside in the stock with the help of DDM and FCFE analysis.

DDM and FCFE evaluation supports holding Union Paci ic because by both the models the share is undervalued

HOLD

Lastly, Analysts have repeatedly suggested holding their existing portfolio in Union Paci ic, moreover, the current recommen‐ dation puts Union Paci ic as a Buy.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 19

RATIO ANALYSIS

BSNF values have been obtained from the BNSF 10‐K. Although, BSNF is private, yet it iles its 10‐K with the SEC. The 10‐K is not as robust as similar irms in the industry but helps us gauge the operating and pro itability values the irms commands compared to its industry competitors.

Pro itability Ratios ‐ Compared to its competitors Union Paci ic held the highest net pro it margin. The reason for the high net pro it margin was lower interest expenses and better management of non –core assets. Union Paci ic has consistently focused on managing the bottom line by constructively improving operating margins and maintain a lower debt to capital compared to the industry.

Moreover, by better management of core assets and using the same as a value proposition for current growth the irm has been able to give the best return on its assets. Additionally, by constant share repurchases and increasing dividend payout values the irm has been able to provide the best value to its shareholders. The irm has one of the highest Return on Equity in the industry and almost 3 times the value of its closest competitor BSNF.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 20

Operating Ratios ‐ Union Paci ic strategically manages the relationships it has with its customers. Hence, the receivables turnover has been competitive when compared to its competitors. Moreover, the best use of its assets over years of operating ef iciencies have helped the irm improve its asset turnover. Additionally, the industry is in a growth phase which has assist‐ ed irms to better their asset turnovers.

Liquidity Ratios ‐ Compared to its competitors Union Paci ic has strategically managed its cash by maintaining a higher li‐ quidity and quick ratio. The irm maintains ample amount of cash to hedge against luctuations in working capital which may arise in the course of railway operations.

One such example will the be shutdown of the West Coast Ports which helped the irm hedge or resist the shutdown due to ample amount of working capital.

Moreover, with fewer suppliers Union Paci ic has been swift in managing its liabilities which have also bene ited in higher current and quick ratios. Lastly, in the last quarter of 2014, Union Paci ic’s franchise grew by 13% which helped boost cash values.

Debt Utilization ‐ Heavy manufacturing, and transportation are largely debt funded industries. A irm will always have a competitive advantage compared to its peers when it can manage its capital structure. Union Paci ic has been increasing its debt strategi‐ cally to fund its capital expenditures. The irm has relied on its low borrowing during the recessionary period to fund capital expansion in the later years.

Compared to the industry Union Paci ic has historically had lower debt to equity and debt to value ratios and will continue to do the same. In a recent management guidance report the irm expects to increase its debt to value to around 40% to fund its capital expan‐ sion plans. The entire railroad industry is increasing its borrowing to fund expenses towards new regulations and network expansion.

The increasing growing rate of the company has contributed to better interest coverage compared to competitors.

Valuation Ratios ‐ In the last year the company’s valuation took a boost with prices hitting peaks of $124.52. The recent price increase can be attributed to the company beating analyst earnings estimates and the company being the most attrac‐ tive railroad to invest in with the acquisition of BNSF. In the early part of the year the stock traded at a premium compared to historical values.

Other ‐ Since 2012, the company’s credit rating has improved unmatched by any other competitor. The company has a lower cost of capital due to its premium credit rating. Moreover, the company’s bankruptcy probability has decreased even further with the Z‐score being the highest since recession.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 21

ASSUMPTIONS

Revenue –Union Paci ic divides its revenues across various segments for US and Mexico combined, these are, Intermodal, Industrial products, Coal, Agriculture, Chemicals, and Automotive. Moreover, another segment which includes leasing reve‐ nues is known as Other Revenues.

Freight Revenues are calculated by the multiplication of Carloads by the Revenue Per Unit or Carload. In my estimations, I have estimated the revenue for each seg‐ ment. My estimates are based on historical and man‐ agement guidance.

Carloads/Unit Volume Estimates: Intermodal ‐ Due to the recent crisis in the west coast ports I have estimates Intermodal volumes to be lat Year on Year for 2015, and increase at 5% based on analyst guidance over 2016 and 2017.

Industrial Products ‐ I have estimated volumes to grow at a slower rate than before due to the lat to modest increase in industrial output over the next few years.

Coal ‐ Production will decline over the next few years, but coal will from a large part of the energy composition in the US. The shift will be due to the cheap coal available from various mining areas such as the Powder River Basin. I have estimate coal volumes to be lat next year and grow at a slower rate in the years to come.

Chemicals ‐ Due to oil rigs shutting down and oil production decreasing, the volumes from petroleum and petroleum products will negatively impact the volumes of the chemicals segment. Hence, I have estimated slower growth in 2015, and modest growth in the years to come.

Automotive ‐ Due to decrease in fuel prices and the US economy growing at a faster rate since recession, automotive transport will increase and command a larger portion of the irm’s volumes. Moreover, automotive transport from various southern cities to the north east will boost the segment’s volumes.

Agriculture ‐ The surplus from the last years and better harvest estimates will impact agriculture volumes. Volumes are ex‐ pected to stay at historical averages.

Revenue Per Unit/Carload Estimates: Intermodal, Industrial products, and Agriculture‐ Due to company’s strong franchise and terminals at customer of loading/loading points the company has always been able to price competitively compared to it’s competitors. Moreover, the company will continue to gain the pricing advantages until its competitors build their net‐ works and improve operating ef iciencies.

Coal and Automotive ‐ Union Paci ic is one of the largest railroad service provider for the coal transportation and one of the largest for automotive transport. However, due to the pricing pressures from customers and clients the company will have lat to low pric‐ ing increases Chemicals ‐ Mostly all Oil and Gas drilling companies use railways to transfer their products. The lack of pipelines make rail‐ ways the most cost effective source for transportation of oil and gas. Hence, railways can have a pricing advantage compared to other forms of transport.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 22

Other Revenues ‐ I estimated other revenues as historical average and decreased it by 20 basis points for 2015. I kept it constant for 2016, and 2017.

Transportation Fuel Costs ‐ Due to recent drop in crude oil prices the management expects a sav‐ ing between 25‐30% in fuel expenses. The saving will bene it customers by decreasing surcharges and bene it the company by increasing operating margins. For my estimates, I have estimated, based on models by other EiF analysts, fuel prices per barrel to be around $56.91, $64.17, and $73.33 in the years 2015,2016, and 2017.

Moreover, the irm has shown better operating values by decreasing or keeping it’s barrels used lat in the last 5 years. I have estimates locomotives to grow at 2.38% year on year. Based on 2014 ef iciencies of fuel used per barrel, I have estimated the barrels used in 2015,2016, and 2017. Based on the increase in barrels I have calculated fuel expenses. I have added a 20% increase to the price estimates for volatility in prices.

Salaries Wages and Employee Bene its ‐ For 2015, the irm es‐ timates to add 5700 employees, for 2016, and 2017 I have esti‐ mated 2014 growth rates which is 1.63%. Management estimates and even further decrease in employee growth because of the Positive Train Control technology which will have 1 person manned cargo from 2 person manned cargo. However, the change in number of employees is under regulator approval.

Interest Expense ‐ I have estimated total debt to grow 100 basis points lower each year than the previous year. 2014 was the year in which management ramped up borrowing. Considering 2014 values as my base values, I calculated the total debt expense for the remaining years. Management has guided a Debt to Capital ratio of 40% in the years to come due to which the total debt to increase. The current cost of debt for the irm is 5.09%, I in‐ creased the interest expense by 25 basis points each year to estimate interest expense.

Share Repurchases ‐ Management has guided share repurchase amounting to 120 million shares since 2014 till December 31,2017. Management repurchased 33 million shares in 2014. I have esti‐ mated 33 million, and 32 million for 2015 and 2016, and 22 million shares in 2017. Moreover, my share repur‐ chases were based on price estimates for those years.

Valuation Estimates ‐ Most of my valuation estimates are from Bloom‐ berg and other analyst estimates.

Price to Earnings ‐ I have estimates price to earnings have been around 18x, 17.75x, and 17.5x times for 2015, 2016, and 2017. As the company and the industry is in a growth stage the estimates my estimates can be consid‐ ered compared to historical averages.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 23

Beta ‐ Although, I refereed to various analyst’s I performed a regression and used beta values for Union Paci ic vs S&P 500 subtracted from the risk free rate. Compared to other analyst estimates my beta esti‐ mates are higher at .94 Earnings Per Share– My earnings per share values are in line with other analyst esti‐ mates for 2015, and 2016. However, I revised my numbers for 2017 to re lect earn‐ ings per share at around $7.74. Management has not guided on the ways in which it will continue to improve operating ef iciencies and thus margins for that far ahead.

Hence, I my EPS estimates are about $0.7 lower than analyst estimates.

Risk Free Rate ‐ I used the 30‐year treasury rate at 4/2/2015 which was 2.52% Market Premium ‐ I used the historical market premium at 5.7% CAPM ‐ I used CAPM to calculate the cost of equity. With beta at .94, market premium at 5.7%, and Risk Free Rate at 2.52%, I got the cost of equity, using CAPM, to be 7.89% Bond Buildup Method ‐ Other than CAPM I even used Bond Buildup Method to calculate the Cost of Equity. Railways, require huge amount of debt which makes Bond Buildup method a good value to use when calculating the cost of equity. I estimated the cost of debt for FY 2014 which was 5.09%. I used a 4% premium. The Cost of Equity came to be 9.09%.

Almost, 130 basis points difference between CAPM and bond buildup method affects the valuation of stock moderately.

Other Estimates Depreciation ‐ For the year 6459, management guided depreciation to be around 6 billion, for the remaining years, I took esti‐ mates based on historical Depreciation to PPE values.

Equipment and Other Rents ‐ Historically, management has guided decrease in equipment and other rents. I considered a 20 basis reduction year on year from 2015 to 2017 based on 2014 numbers. The value was calculated as a percentage for gross revenue.

Purchased Service Materials ‐ I used the percentage of gross revenue on 2014 values for the years and for 2015, and kept them constant for 2016, and 2017.

Other Operating Expenses ‐ I decreased the number based on percent‐ age of gross revenue values for 2014, by 10 basis points year on year based on management guidance of improvement in operating ef iciencies.

Dividend Payout Estimates ‐ Management has guided increasing dividend payout ratio to 35%. I consistently improved to number year on year to bring it to 35% in 2017. In both 2015 and 2016, I assumed a 100 basis increase from the year prior.

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 24

Current Portion of Long Term Debt ‐ Based on management guided estimates of the debt schedule, I have estimated the cur‐ rent portion of long term debt. Management guided $406 million, $606 million, and $1065 million to mature in 2015, 2016, and 2017 respectively.

Property, Plant and Equipment ‐ I have estimated PPE to grow at the 2014 growth rate of 5.77% for the years 2015, 2016, and 2017. I felt 2014 was a crucial and rightful year for estimation since management increased it strategic capital expenditures that year.

SUMMARIZED REVENUE ESTIMATES DATA

TRANSPORTATION FUEL ESTIMATES DATA

INTEREST ESTIMATES DATA

SHARE REPURCHASE ESIMTATES DATA

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 25

INTEREST EXPENSE DATA

INCOME STATEMENT

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 26

BALANCE SHEET

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 27

CASH FLOW STATEMENT

CAPITAL EXPENDITURES I took Cap Expenditures for 2015 as $4.3 bil‐ lion which were management guided values.

Further, I in the railroad industry companies use capital expenditures as a percentage of gross revenue. Management, has guided capi‐ tal expenditures between 16 to 18% of reve‐ nues for the next 5 years.

I went with 2015 values of 17.3% of gross revenue.

FY Year

Capital Expenditures (In billions of USD)

% of Gross Revenue

2010

2.48

14.6

2011

3176

16.2

2012

3738

17.9

2013

3496

15.9

2014

4346

18.1

2015

4300

17.3

2016

4582

17.3

2017

4871

17.3

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 28

DDM ASSUMPTIONS AND MODEL

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 29

P/E AND EPS SENSITIVITY ANALYSIS

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 30

PEG, PVGO AND ALPHA VALUES

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 31

FCFE ANALYSIS

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 32

CURRENT NEWS

Union Paci ic (UNP: NYSE)

By Stifel Nicolaus ($109.79, April 10, 2015) We are upgrading Union Paci ic from Hold to Buy and assigning a $120 target price (or 14.5 times our 2017 earnings‐per‐ share estimate of $8.30), which shows 11.3% potential upside from the close including its 2% dividend yield.

We are upgrading Union Paci ic (ticker: UNP ) in conjunction with our irst‐quarter 2015 preview on our space. We now see attractive risk‐adjusted upside potential in the shares for the irst time in a while. The company’s strong management team has a track record of performance and operational excellence. We believe the company’s network provides a sustainable growth, given that it touches all six Mexico and U.S.A. gateways, West Coast ports, and the growing economic regions in America.

We believe Union Paci ic’s recent sell off is overdone. We don’t believe the news from Kansas City Southern ( KSU ) is as meaningful given Rob Knight’s earlier announcement regarding volumes; we also note that corrections in Kansas City South‐ ern’s guidance are not uncommon. Union Paci ic’s volumes are down 2.3% irst quarter year‐over‐year, segmented into com‐ modity carloads down 2.5% in the irst quarter year‐over‐year, and intermodal containers/trailers down 2.1% in the irst quarter year‐over‐year. The commodity side represents 59% of total volume, with coal and chemicals representing nearly 50% of the segment.

The chemicals business is up in the irst quarter year‐over‐year, while coal is down 8.1% in the irst quarter year‐over‐year on a relatively mild winter in Union Paci ic’s region and a strong U.S. dollar; we expect coal to rebound closer to normalized levels after adjusting for softer exports due to the strong U.S. dollar. The intermodal container and trailer business repre‐ sents the other 41% of total volume and had been adversely affected by the West Coast port strike in the quarter. We expect more‐normal operations through the year to return to growth versus contraction.

Union Paci ic is close to fairly valued on an absolute basis, in our view, but undervalued on a relative basis to the broader S&P 500, when compared to trailing ten year adjusted trading statistics. As of the close April 9, Union Paci ic had been trad‐ ing at a price‐to‐earnings of 14.78 which sits just above the middle of their historical trading range. However, this re lects a 6.9% discount to the broader S&P 500, which sits toward the bottom of its 10‐year relative trading range. Union Paci ic is also trading at a discount on an absolute and relative basis, in relation to historical trading ranges, when compared to the broader railroad space.

Our 2015, 2016, and 2017 estimates remain unchanged at $6.45, $7.30, and $8.30, respectively. Our EPS estimates are driven by total year‐over‐year revenue increases of 6.2%, 8.6%, and 8.8%, respectively, and overall operating ratios of 62.2%, 61.5%, and 60.7% over the same period of time. ‐‐ John Larkin ‐‐ John Engstrom ‐‐ Roxanna Islam Comments: E‐mail online.editors@barrons.com

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 33

CURRENT NEWS

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 34

CURRENT NEWS

Union Paci ic aims to be the irst railroad to haul LNG

Posted Thursday, March 19, 2015; By Russell Hubbard UNP has applied for permission to haul lique ied natural gas, which would add another combustible cargo to a U.S. rail network already being criticized for transporting ethanol and crude oil through populated areas. The Omaha‐based railroad said the application for a permit from the Federal Railroad Administration is in response to a request for lique ied natural gas transportation from an existing customer.

Union Paci ic operates 32,000 miles of track in the western United States, which is home to many natural gas production and storage in‐ stallations. If Union Paci ic is granted the permit, it would be a irst. The Association of American Railroads said none of the six other Class I freight railroads are hauling lique ied natural gas.

The permit application coincides with a major bump in railway ethanol and crude oil cargo, which has attracted heavy opposition after a fatal oil train explosion in Canada in 2013 and three oil train ires so far this year in the United States and one in Canada.

“The timing for U.P. is awkward given recent accidents and mounting public apprehension,” said Joseph Schwieterman, a transportation sciences professor at Chicago’s DePaul University. “I am sure there will be pressure for a go‐slow approach on it, but the fact is that rail‐ roads are the best bet to get signi icant amounts of natural gas to market given the decades it takes to permit and construct pipelines.”

Details about the application are secret. A Federal Railroad Administration spokesman said application and supporting materials are not available for public inspection during the review process. “Federal law limits our disclosure” of which customer is requesting transport of lique ied natural gas, Union Paci ic spokesman Aaron Hunt said.

Lique ied natural gas, or LNG, however, is a well‐known commodity. Liquefying the fuel — which most often moves via pipeline, truck and ship — compacts it enormously. That makes it attractive to shippers and those who want to store large quantities. Lique ied gas takes up 1/600th the space of the gaseous form. The liquid gas can then be converted back into its gaseous state for use or further shipment in pipe‐ lines.

Union Paci ic’s permit request comes as U.S. natural gas production is climbing, up 37 percent since 2000. Part of the boom is the conver‐ sion of coal‐burning electric plants to natural gas. There also are 128,000 vehicles in the United States running on compressed natural gas, up 12 percent since 2010.

“It has only been a matter of time for the railroads to get in on the natural gas boom,” Schwieterman said. “It is a fast‐growing industry with fast‐growing logistical needs.”

But some people are holding back. Eddie Scher, an of icer with ForestEthics, a California‐based lobbying group that advocates the gradual elimination of fossil fuels, said that transporting another lammable cargo on the rail network is a very poor idea.

“The rail system in America was built to connect population centers, with trains going through every downtown in the country,” Scher said.

“It was never designed to haul hazardous materials, and in fact, you could say that if you were to design a rail system for hazardous materi‐ als, the one we have is the opposite of the one you would design.”

Scher said federal safety rules are already out of date for oil trains and their tank cars, with millions of gallons of oil a day riding the rails, up from nearly zero only ive years ago, courtesy of skyrocketing production from new ields in Montana and North Dakota.

“To entertain the idea of new and potentially more dangerous cargo makes no sense at all,” Scher said.

Hauling dangerous cargo is nothing new for Union Paci ic and other railroads, which haul chlorine, explosives and sulfur.

Safety is a main point of emphasis for every cargo, said Hunt, the Union Paci ic spokesman. The national train accident rate has fallen 42 percent since 2000 and 79 percent since 1980, according to the railroad association. At Union Paci ic, derailments have fallen about 7 per‐ cent since 2010, to three for every million miles of train travel.

“We have the same goal as everyone else, and it’s in the best interest of our customers, shareholders and the communities where our em‐ ployees and their families live, work and play to operate as safely as possible,” Hunt said.

Contact the writer: 402‐444‐3197, russell.hubbard@owh.com

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 35

CURRENT NEWS

Union Paci ic is the most admired railroad in the country

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 36

REFERENCES

Hoovers Ibisworld Union Paci ic Website Wall Street Journal Bloomberg Valueline Yahoo Finance Reuters Association of American Railroads Morning Star Forbes Statistica Nasdaq Seeking Aplha New York Times KSU, CSX, BNSF, NSC Annual Reports Operation Life Saver Progressive Rail Roading Statistica UNP Fact Sheets, Annual Report, Investor Calls Union Paci ic Website Omaha.com

UNION PACIFIC CORPORATION VALUATION (SPRING 2015) 37