Fitch Ratings has affirmed
Fitch has also affirmed the Short-term IDR and CP ratings at 'F1'. The Rating Outlook is Stable.
UNP's ratings are supported by the company's strong financial flexibility, FCF generation and franchise strength. Shareholder-focused capital deployment that leads to leverage sustained near 3.0x, which is towards the high end of 'A-' rating threshold, and cyclicality in volumes, and therefore cash flows, are the main rating constraints.
Fitch has withdrawn the LT IDR on
Key Rating Drivers
Rating Considerations: The ratings for UNP reflect its strong business profile, supported by its leading position in the oligopolistic rail market afforded by its large rail network. It also has strong financial flexibility due to its highly profitable operations, the resiliency of its cash flows and ability to unlock significant cash flows by reducing share repurchases if needed. Fitch also considers UNP's leverage profile, including expectations that adjusted debt/EBITDAR will be sustained at 3.0x or mildly below, which falls around the high end of Fitch's 2.5x-3.0x rating sensitivities.
Leverage Sustained at or Sub-3.0x: Fitch believes UNP may allow adjusted debt/EBITDAR to approach 3.0x over the next few years but is unlikely to allow leverage to drift materially higher as it continues to prioritize maintaining a strong investment grade rating with a healthy balance sheet. Leverage has climbed to the high-2.0x over the last few years, despite improvements in profitability, as the company balances shareholder returns with its balance sheet. While leverage has increased, Fitch believes UNP would stem share repurchase activity in a downturn rather than allowing leverage to rise materially. Fitch views the current financial policy of shareholder returns in excess of FCF generation, driving higher debt balances, as a limiting factor for the rating.
Buyback Focused Allocation Strategy Retains Financial Flexibility: UNP's consistent generation of sizable FCF, which Fitch calculates after dividends, represents a key credit strength supporting the 'A-' rating. Fitch expects UNP to generate FCF in the
Strong Business Profile: UNP owns and operates one of the largest
Margins Temporarily Lower in 2022: Fitch expects profitability to be modestly lower in 2022, largely reflecting the rise in fuel prices and of service challenges across the industry. The impact of higher fuel costs should moderate through a mixture of catch up in pricing and moderating fuel prices. Meanwhile service challenges have led to lower than expected volumes and therefore operating leverage due to capacity constraints and high costs associated with temporary efforts to maintain service levels. EBITDA margin in 2022 is likely to decline to about 50%, from 53% in 2021, before recuperating over the next couple years. Benefits from actions to improve service levels should start to materialize in late 2022, however; other variables such as a deep downcycle in freight rates are risks to the forecast.
Derivation Summary
UNP is the second largest North American railroad in terms of both revenue and volume and is considerably larger than the next largest railroad. The company's largest competitor is
In terms of Fitch-rated peers, UNP is rated two notches higher than
Key Assumptions
Revenue growth in the low-double digits in 2022, primarily due to higher yields. Growth moderates to the low to mid-single digits as yield growth moderates;
EBITDA margins decline to about 50% in 2022 due to challenged service levels and cost inflation. Margin then improve with recovering service levels and moderated inflationary pressures;
UNP continues to raise its dividend on an annual basis;
FCF margins remain above 10%;
We assume that the company continues to pursue debt-funded share repurchases, with buybacks and debt issuances sized to maintain leverage near current levels.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
A shift to a more conservative financial policy leading to total adjusted debt/EBITDAR sustained below 2.5x;
A demonstrated commitment to a more conservative capital allocation strategy including a more FCF linked share repurchase policy;
Continued ability to price at least in line with cost inflation and demonstrate margin strength through business cycles.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A less conservative financial policy leading to adjusted debt/EBITDAR sustained above 3.0x;
A shift in capital allocation strategy leading to increased levels of debt funded share repurchases;
Regulations or policy changes that negatively affect the industry.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
Comfortable Liquidity: UNP maintains solid financial flexibility through its CP program, and cash on hand. As of
Issuer Profile
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
(C) 2022 Electronic News Publishing, source