UNP Reports Negative Economic Impact Due to Low Oil Prices and Strong US Dollar

One of the companies we closely follow for their insight into the overall health of several sectors is Union Pacific Corporation (NYSE:UNP), headquartered in Omaha, Nebraska.  As one of the larger transportation companies in the US, their revenue is directly dependent up the health of other industries, and they provide extensive candid detail into each of those areas in their quarterly earnings calls. 

UNP reported earnings before the open on July 21, and their ensuing earnings call painted a less than optimistic picture of the overall health in a variety of sectors.  There are two driving factors associated with declines and pressures they are reporting: low oil prices and the strong US dollar.  Said CEO Lance Fritz, "A soft global economy, the negative impact of the strong U.S. dollar on exports, and relatively weak demand for consumer goods will continue to pressure volumes through the second half of the year."

For UNP, the only area of growth experienced this year was in Agriculture shipments (up 2%), however that growth was primarily driven by severe harvest delays in South America and by a high demand for corn in Mexico.  Had South America not experienced agriculture problems, even grain shipments would have been down for the year.

The remaining segments were all doom and gloom.

• Total volume was down 11%.
• Carload volume declined by double digits in coal, intermodal, and industrial products.  (Intermodal refers to shipments of the large containers typically carried by rail but then transferred to ship or truck.)
• Automotive was down with finished vehicle shipments declining 10%.

The strong US dollar continued to hurt exports with chemicals, plastics, and fertilizer all down for the year.  With inflation at or near zero in Europe and with the US likely to raise interest rates either at the end of 2016 and most certainly several times in 2017 and 2018, there is little likelihood of any weakening of the dollar for the foreseeable future.

Low oil prices continue to have a significant negative impact.  Rail shipments in that industry were down 23% due to low natural gas prices coupled with high inventory levels.  Lower international coal prices (due to the strong dollar) also contributed to that decline.

The other impact low oil prices continues to have is in the chemical and metals industries.  Mineral volume declined 32% and Frac Sand declined 43%.  Metal (aluminum, steel, etc.) declined 11% due to reduced shale drilling.  Expect to see this ripple through other industries as earnings continue to report through the quarter.

The flooding in Texas had a severe impact on construction shipments, down 4%.  Intermodal shipments (also impacted by that flooding) were down 16%.  We can expect to see that ripple through the trucking and shipping industries as well. 

The forecast for the remainder of the year was not very encouraging, either.  UNP forecasts agriculture to remain strong since there are expectations for a strong US crop harvest and there is continued weakness in South America.  Automotive shipments should also see a boost as the 2017 models come out, and the industry is currently trending well below the projected 17.5 million vehicles for the year.  There are also expectations of a boost in construction and in the housing market as the year progresses. The rest of the industries, however, are still expected to experience headwinds.

• UNP still expects the pressures due to low oil prices and low natural gas prices to continue. 
•  They expect drilling to continue to decline, and with it the demand for metals and chemicals will also decline.
• Intermodal shipment is also expected to experience pressure due to the impact the strong dollar is having on US exports.
• The economy in Europe and China remains weak, adding to global pressures on prices and demand for goods.

This is the first major earnings transcript we've seen this quarter that paints such a gloomy picture of the first half of 2016, however UNP is typically right on the mark in their assessment.  Consider the impacts they are citing in related industries when reading their report, since the effects will be readily apparent as other prominent names report earnings over the next two quarters.

Happy Trading

GE Sees Strong Regional Growth, Large Impact From Oil

General Electric (NYSE: GE) released earnings yesterday, and provided a detailed sector by sector view of how 2015 should develop around the globe.  Confirming the outlook provided by other key global companies, they see strong growth in the US continuing through the next year.  Reading through their transcript, the forecast for India and China appears to be a bit more subdued, and the major drags on the world economy will be Russia, Europe, and Japan.

The two major forces dragging on profits continue to be the strength of the US dollar and the extremely low price of oil.  While the latter is helping a few sectors - primarily aviation and transportation - it is having a much more significant negative impact elsewhere.  In fact, GE is already implementing job reductions, restructuring in certain areas, and the execution of simplification projects all in an attempt to reduce cost structures.  The longer oil prices remain this low, the greater will be the impact.

The impact of oil prices can be felt in other areas as well.  Subsea orders dropped 38%, and orders for drilling equipment dropped 72%.  The decline makes sense, since oil is now trading below the break-even point for most types of extraction.  Expect this area to continue to be depressed well into 2015, and expect to see regional economic pressures in areas dependent upon oil exploration and production.

The one energy area experiencing tremendous growth, however, is natural gas.  Orders for turbo machinery related to natural gas were up 60%, primarily in North America, the Middle East, and Russia.  That's not much of a surprise given the amount of natural gas produced in those three regions.  It's a good indication that there are some plays out there in the exploration and production sector, since those companies were beaten to a pulp in the last quarter.  Scouring that list for companies with a strong natural gas presence should provide an excellent entry opportunity. 

As to the US dollar, there is no indication of weakening on the horizon.  With the ECB's QE announcement on Thursday, in fact, there's further strength being forecast, coupled with a significant weakening of the Euro.  This effect, however, is projected to be manageable.  GE, for example, is forecasting only a $0.01 per share impact in 2015 based on currency exchange.

Aviation continues to be a major success story in the US and around the globe. Passenger Kilometers revenue was up 6.1% internationally and 5.3% in the US.  If the price of fuel remains low, this revenue stream will continue to grow.  Airlines should be a strong play at least through the first half of 2015.  GE confirms what Alcoa told us a couple of weeks ago.  Demand is extremely high, and GE experienced aviation orders up 15%.  Equipment orders are up 8%, primarily from commercial engines.  Again, that confirms what Alcoa was seeing for new aircraft orders, and it has me considering a play on B/E Aerospace before they report this week.

Healthcare is another growing segment in the US, up 9%.  There is significant growth in diagnostic equipment orders for CT, Ultrasound, and MR.  Globally, however, the sector is extremely depressed. There were sharp declines in Japan, Russia, and the Middle East.  China is only expected to see modest growth in this sector for 2015.  It looks like the healthcare plays for 2015 are primarily domestic.

Transportation experienced its strongest growth ever in 2014, driven primarily by a surge of locomotive orders in the US.  That has to be great news for the freight industry, so we'll be taking a hard look at Union Pacific's forecast.  (They released earnings on Thursday, so their transcript is available now.)

An interesting item that came out of their lighting department is the report of 72% growth in their LED business.  LED comprised 27% of their revenues in that department, at a time when they saw a sharp decline in demand for traditional lighting products.  This warrants a closer inspection since LEDs are now being used in a wide variety of consumer products.  A surge in demand for LEDs implies very strong demand in consumer discretionaries as well as in technology, at least in the US.

Overall, the outlook from GE is similar to what we're hearing from other global companies.  The US is strong, China moderate, but Europe, Russia, and Japan are economic millstones.  Look to aviation, transportation, and healthcare for some strong growth.  Consumer discretionary may also provide an opportunity based on hints from the lighting market, but that's going to require a closer inspection.