Union Pacific Gets Back on Track - ' Laying Track '

Laying Track

More than anything, the embarrassing outcome at Fenix illustrates Union Pacific's—and every railroad's—severe limitations. About 20 percent of a railroad's revenue has to be poured back into its system for track upgrades as well as car maintenance and purchases. That's a fixed cost, and an expensive one: The cost of capital for railroads is 11 percent, while their return on investment is only about 7 percent. Add to that the amount of debt that railroads have to take on to cover capital expenses—Union Pacific's current ratio (current assets divided by current liabilities) is a meager .64 and its debt-to-equity ratio is an alarming .83—and it's easy to see why it would be difficult for a railroad ever to play in the same league as high-tech high-rollers backed by venture capital and equity offerings.

"Union Pacific needs revenue first just to cover its basic costs of doing business—that's a huge issue for railroads before they can consider using capital for other purposes," says John Gallagher, an associate editor at Traffic World, a weekly publication for the freight transportation industry. "There's no doubt that UP has gotten the message that it has to change, and it is changing. But it is still restrained in some ways by industry realities and an old culture."

Despite the Fenix setback, most railroad experts remain bullish on Union Pacific and continue to admire how aggressively it has adopted technology. ABH Consulting's Hatch says he believes the railroads—and especially UP—are already taking market share from trucks, but with the economy as weak as it is, it's less obvious because the amount of overall shipments isn't growing. "When we have a 12-month period of 2 percent growth, UP revenue will grow 3.5 percent or more, and that will be faster than trucks," says Hatch.

That's the sentiment of UP management as well. Executives at the railroad realize that the timing couldn't have been worse to branch out into an expensive area like technology. But making these difficult moves now, they believe, will put them in a position to take advantage of the expanding economy and an upsurge in capital expenditures by other transportation companies when they occur. "We have great opportunities in Mexico and in our core regions of the U.S. as we emerge from the recession and shipping picks up," says Bryan. "To get more and more of this business we must be service sensitive, and to be service sensitive you need technology and systems. We've got that."

For UP, this strategy entails significant risks, but to be considered a risk-taking company is high praise enough. Which is what makes UP so intriguing right now: The next few years will either be a period of remarkable transformation or, well, another train wreck.

Jeffrey Rothfeder writes frequently about business, security, environmental and technology issues.