Union Pacific’s CEO strays in pursuit of profits

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Union Pacific Corp. is doubling its goal to increase its operating profit margin to 45%, about 5 percentage points from where it is this year. Increasing profit margins are usually a good thing; They keep investors happy and provide cash to reinvest in the company.

But when a company’s service is admittedly poor, and customers and industry regulators are vocal about its business practices, it’s probably not the best time for that company to trumpet its power to drive record-breaking profits.

This comes at Union Pacific after Chief Executive Officer Lance Fritz reiterated his aim for a 55% operating rate, which is just the opposite of an operating margin, during an analyst call Thursday to discuss the railroad’s third-quarter earnings. Shippers who heard the webcast might have had to lift their jaws to also see that Union Pacific reported it was able to deliver just 58% of its truckloads on time.

“We believe 55 is achievable. We don’t think this sacrifices the service product,” Fritz said on the call. “That was a goal we set ourselves for this year. We thought it was quite doable this year and then a whole lot of things happened that made it difficult.”

If Union Pacific were an airline, consumer complaints would be too strong for regulators to ignore, and passengers would look to another airline. The airline would most likely look to incur additional spending to ensure pilots and planes are available to improve service.

However, railroads usually have only one main competitor and count on many loyal customers. Trucking chemicals, metal, coal, grain and other goods is expensive. Rail is often the only sustainable option. And when Union Pacific is the only railroad to have tracks near a factory, that facility owner has little or no leverage to push back the price and poor service. That allows railroads, not just Union Pacific, to focus more on profits than service. This means that while Union Pacific can’t get a car to a customer’s rail yard on time about half the time, the railroad will continue to raise prices. Union Pacific has clarified that it will keep its prices above its own inflation rate, which is expected to be around 5% this year.

Railroads often argue that they charge much higher profit margins than trucking companies or airlines because they have to invest heavily in their networks. There was a time when railroads had to invest heavily to reverse decades of neglect before deregulation in 1980 saved the industry. That era is over, and capital expenditures as a percentage of revenue have been trending downward for several years. Now those profits are mostly returned to shareholders. Union Pacific spent $7.9 billion on share buybacks and dividends in the first nine months of this year.

The bottom line is that railroads talk a lot about improving service, but rarely do it. Something always breaks things—floods destroy railroad tracks, wildfires burn down a bridge, a train derails on a mainline, an ice storm paralyzes Chicago or Dallas. The service will always suffer, even if the profits don’t.

This year, the drop in service was self-inflicted. Fritz admitted that the railway was understaffed and even had to cancel business due to a lack of train staff.

“We operated the network closely,” said Fritz. “We’ve had issues with our crew availability and we’re digging our way out of it.”

Union Pacific said it was solving the labor shortage problem by hiring 1,408 workers. The Omaha, Nebraska-based airline is also having to pay its workers more as the railroads collectively try to secure a labor agreement with 12 unions that still has the potential to turn into an industry-wide strike. Under the deal brokered by the Biden administration through a Presidential Emergency Board (PEB), Union Pacific would have had to pay workers $114 million in bonuses and pay increases dating back to July 1 in the third quarter. It is clear that, in the end, the bill for these higher wages and other rising costs will fall on the hauliers. “We’re fighting quite substantial inflation. You see it in the PEB, but it’s generally seen in our services and inputs,” Fritz said on the conference call. “We have to get over that with the price and we expect to do that – we’re confident that we will.”

That’s plenty of confidence amid a slowdown in freight traffic, which truckers like Knight Swift Transportation Holdings are calling for. According to KeyBanc Capital Markets, spot prices for trucks fell by a third last week compared to a year ago. Inventories are bloated and package demand is easing, suggesting consumer demand is easing.

If Union Pacific can push through fare increases despite falling truck prices, it could draw the attention of the Surface Transportation Board, the independent agency that regulates railroads. Railroads often point to long-distance transport as a competitor when hauliers argue that the railroad industry lacks competition. Although there are six major railroads in North America, the reality is that there are only two competitors in each of three major regions of the United States and Canada. Union Pacific, for example, competes primarily with BSNF Railway Co. in the western United States.

Aside from price, the other two main levers Union Pacific can use to increase profit margins are improving efficiency and increasing volume. Union Pacific lowered its target for volume growth this year from 5% to 3%. The railroad, while not yet providing forecasts for 2023, sees some tailwinds in volume, such as: B. more movements of coal, cars and building materials for highways and other infrastructure.

The efficiencies are where customers get nervous. Union Pacific has cut staff, closed rail yards, and grounded locomotives in recent years. Hard work is also underway to build longer and longer trains, reaching 9,483 feet, or nearly 2 miles, in the third quarter. These productivity strategies can undermine service, and shippers are dependent on how much Union Pacific is willing to pull this efficiency lever.

Maybe shippers wouldn’t shy away from price increases if the service was great. They know from experience not to count on it. Fritz would be as persistent in improving Union Pacific’s on-time performance as he was in increasing profit margins.

More from the Bloomberg Opinion:

• Railroads get off track worrying about margins: Thomas Black

• Customer demand is there. Supply is still not: Brooke Sutherland

• UK rail strike sets a cautionary tale for US workers: Clive Crook

This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.

Thomas Black is a Bloomberg Opinion columnist covering logistics and manufacturing. Previously, he was responsible for US industrial and transportation companies and Mexico’s industry, economy and government.

For more stories like this, visit bloomberg.com/opinion

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