Union Pacific Railroad

Union Pacific Railroad is the principal operating company of the Union Pacific Corporation (NYSE: UNP). It is one of the largest and most iconic freight-hauling railroads in North America. Tracing its roots back to the Pacific Railroad Act of 1862 signed by Abraham Lincoln, Union Pacific played a pivotal role in building the first transcontinental railroad, physically and economically uniting the American West. Today, its vast network spans 23 states, primarily in the western two-thirds of the country, acting as a critical artery for the U.S. economy. The railroad transports a diverse mix of goods, from coal and chemicals to agricultural products and finished automobiles. For a value investing practitioner, Union Pacific represents a classic example of a business with a durable economic moat, predictable operations, and a long history of rewarding shareholders, making it a cornerstone of many long-term portfolios.

The single most attractive feature of a railroad business is its massive and enduring competitive advantage, or “moat.” It's nearly impossible for a new competitor to challenge an established giant like Union Pacific, creating a highly favorable business environment.

Building a new railroad from scratch today is practically unthinkable. The costs are astronomical, involving not just laying thousands of miles of track but also acquiring the land rights, building bridges and tunnels, and navigating a labyrinth of regulations. This creates an enormous barrier to entry. Union Pacific's existing 32,000-mile network is, for all practical purposes, an irreplaceable asset that has been built and refined over 160 years. This high capital expenditures (or CapEx) requirement deters any potential new entrants.

In the vast expanse of the American West, there are essentially only two major railroad players: Union Pacific and its chief rival, the BNSF Railway (owned by Berkshire Hathaway). This market structure is a classic duopoly. While they compete fiercely on some routes, in many regions and for many customers, they are the only viable option for long-haul freight. This gives them significant pricing power, allowing them to consistently raise prices slightly above inflation to offset rising costs and improve profitability.

Understanding what Union Pacific hauls and how it measures efficiency is key to appreciating its business model. The company generates revenue by charging customers to move goods across its network.

Union Pacific's revenue is diversified across three main freight categories:

• Bulk: This includes commodities like coal, grain, fertilizer, and food products. These are typically high-volume, lower-margin shipments.
• Industrial: This category covers a wide range of essential goods for the economy, such as chemicals, plastics, lumber, steel, and finished vehicles.
• Premium: This is the highest-margin segment and includes intermodal containers (the big boxes you see on ships and trucks) and refrigerated goods. This business competes directly with long-haul trucking.

If you follow railroads, you will constantly hear about the operating ratio. This is the single most important metric for measuring a railroad's efficiency.

1. Formula: Operating Ratio = Operating Expenses / Revenue
2. What it means: It shows what percentage of revenue is consumed by operating costs. A lower ratio is better, as it signals higher profitability. For decades, Union Pacific and other Class I railroad companies have focused intensely on lowering their operating ratios through technology and disciplined management, a strategy known as Precision Scheduled Railroading (PSR). A consistent, low operating ratio is a hallmark of a well-run railroad.

For long-term investors, Union Pacific checks many boxes: a wide-moat business, a critical role in the economy, and management focused on shareholder returns.

Union Pacific has a long and consistent track record of returning cash to its owners. It achieves this through two primary methods:

• Dividends: The company pays a regular, growing dividend, providing a steady income stream to investors.
• Share buybacks: Union Pacific actively repurchases its own stock from the market. This reduces the total number of shares outstanding, which increases the ownership stake of remaining shareholders and boosts earnings per share (EPS).

No investment is without risk. For Union Pacific, the primary risks include:

• Economic Sensitivity: As a hauler of basic goods, its volumes are tied to the health of the broader economy. A recession will lead to lower shipping volumes.
• Competition: While the moat is strong, it faces constant competition from the trucking industry, especially for time-sensitive and higher-value goods.
• Regulation & Labor: Railroads are heavily regulated and unionized. New government mandates or labor disputes can negatively impact costs and operations.

Union Pacific is the quintessential “toll road” business. It owns a critical piece of infrastructure that the economy cannot function without, and it gets to charge a fee for nearly everything that moves across it. Its duopoly status, immense barriers to entry, and shareholder-focused management make it a prime example of the type of durable, predictable, and profitable company that value investors seek to own for the long haul. The fact that investing legend Warren Buffett chose to buy its main competitor, BNSF, outright is perhaps the greatest endorsement of the railroad industry's powerful and timeless business model.