Union Pacific Corporation Presents at Barclays Industrial Select Conference, Feb-20-2013 08:55 AM
Union Pacific Corporation (UNP)
February 20, 2013 8:55 am ET
Executives
Robert M. Knight - Chief Financial Officer and Executive Vice President of Finance
Analysts
Brandon R. Oglenski - Barclays Capital, Research Division
Brandon R. Oglenski - Barclays Capital, Research Division
It sounds like everyone can hear me. So good morning, everyone. I know we have a couple people walking in just now. But I'm Brandon Oglenski, senior transportation analyst at Barclays, and I'm delighted to have Union Pacific with us today. And actually, this is the first transportation company to participate at our Industrial Select Conference, in the history of it I believe. So we're honored to have you guys. Joining us from the company is Rob Knight, CFO; Michelle Gerhardt, Head of IR; and Mary Jones, the Treasurer of the company.
So I'm going to hand it over to Rob for just a couple of few remarks, but I just want to set the stage here a little bit. Rob's been the CFO of the company now for nearly 9 years. He's been with the Union Pacific organization for over 30. He's seen a lot of changes. And in his tenure as a CFO -- I'm just going to make this really easy for you. Revenues are up 70%. Operating earnings have more than doubled. EBIT margins have improved by 20%, and returns have more than doubled. And more importantly, the stock is up some 300% to 400% depending on the date you pick. So very easy for the next 9 years, I'm sure, but I think the audience is here to figure out how that momentum continues for the next foreseeable future for the company.
With that, I'll open it up and...
Robert M. Knight
Well, great. Thanks for the nice introduction. It's a pleasure to be here to tell our story. We're real proud of what Union Pacific has accomplished. Just for those of you who may not know us all that well, we are the largest freight railroad in the United States. We're in the western half of the United States. We have a very diverse portfolio group. We have 6 very strong business groups ranging from a very strong Chemicals business, Autos, Industrial Products, Ag Products, Intermodal and Autos. So we are not just kind of a 1-commodity or 2-commodity railroad. We have very strong 6 balanced, diverse group. And what enables us to have that strong balance is our -- the diversity of our physical footprint, our franchise itself. Again, we touched some -- most of the fastest-growing states and communities in the United States in the West. We are the only railroad that crosses and interchanges at the 6 railroad crossings in and out of Mexico. So as Mexico business and economy starts to show very strong signs of life, we're in a great position to capitalize that on multitude of types of freight. We, of course, serve all the West Coast ports, and we interchange with all of the rail partners in the U.S. in the East, as well as the rail partners in Canada.
So we've got kind of a nice franchise, if you will, some of the strengths of Union Pacific. And Brandon talked about some of our financial accomplishments, but digging a little bit deeper, if you look at our Chemicals franchise, again, we have a very strong physical footprint in the Gulf Coast. I'm sure we'll talk much more about this. But with low natural gas prices, that's a real strength of ours. It's always been a strength of ours, but it's proving to be very strong for us. If you look at what's happening with all the shale activity -- and I'm sure we'll get into that a little more as well -- you couldn't overlay a better franchise on top of what's happening with all the diverse plays in the shale world right now than the Union Pacific physical footprint enables us to move the sand and the materials that go into the process, as well as unit oil trains coming out of the various formations to various destinations, very strong.
Look at our Autos franchise, again, second to none in the western part of the United States. And as Mexico -- as I mentioned earlier, as Mexico's economy and more the investment goes into Mexico to further develop the capability by producers to produce more vehicles in Mexico with the intent of shipping them into the United States, that's a significant win for Union Pacific because of our physical footprint. We have 42 distribution facilities in the western half of the United States to deliver just finished vehicles to the dealership network. Those are assets that are not easily replicated.
One of strength -- another strength of Union Pacific's franchises are what we call our manifest network. That's -- that includes sort of all the 1Z/2Z carloads if you will. I talked about Chemicals. That's part of our manifest network, but it goes much beyond that. It's all the construction materials that go into highway construction, housing construction. So as housing shows and is clearly not anywhere near the peak levels that we used to experience, but it is off the trough. We're in a great position to capitalize on that from a volume standpoint. In fact, housing, all in, represents about 9% our total volumes today. That could double if housing starts get back to the traditional levels of starts. So it's a meaningful piece of our business.
So again, in summary, going to the announcement [ph] turn it back over to you, but in summary, what differentiates Union Pacific, we believe, is the physical footprint we've been running extremely efficient. We've been investing in our business where the returns are there from a capital standpoint, and that's how we've been able to take 20 points off our operating margin in the last 9 years and accomplished the significant financial achievements that Brandon talked about.
Question-and-Answer Session
Brandon R. Oglenski - Barclays Capital, Research Division
Well, thank you, Rob. And before we get really deep in the discussion here, I want to turn to our ARS system here, which I think a lot of you have already sat through the first presentation here. But I'd like to start with the first question just to set the stage for the audience. I want to pull a cinnamon on Union Pacific here. And so if we can go to the first question, let's just pull here, do you currently own the stock? There's 3 or 4 very simple questions here. Yes, I'm overweight. Yes, I'm equal weight. Yes, I'm underweight or no, I'm not currently in Union Pacific shares. So if we can go ahead and vote now.
[Voting]
Brandon R. Oglenski - Barclays Capital, Research Division
All right. Well, it looks like we have a pretty interesting crowd here. It looks like you have current shareholders and a lot of folks that aren't involved that potentially could, so I'm interested here, we have lot of potential buying power in the room I think. Why don't we go to the second very quickly? So this is going to be what is your general bias towards Union Pacific shares right now? Are they positive, negative or neutral? If we can go ahead and vote on that.
[Voting]
Brandon R. Oglenski - Barclays Capital, Research Division
So a lot of positives but still some neutrals out there. So I think we're probably going to talk through some of the aspects or challenges right now with coal and grain but some of the more positive aspects. And maybe if we can go to the third question as well, I think it'll really frame the discussion today. And this will -- this question is really about earnings growth. And in everyone's opinion, through cycle EPS growth for Union Pacific is going to be above peers, in line with peers or below peers?
[Voting]
Brandon R. Oglenski - Barclays Capital, Research Division
Okay. Well, we got a lot of bullish expectations here but I think probably rightly so given the opportunities in front of us. So I think Rob, I just want to open this up and obviously, if there's questions from the audience, just raise your hand at the right time. We'll definitely try to keep this interactive with everyone in the room. But you guys have come out with some pretty aggressive financial targets by 2017, a sub-65% operating ratio, and I think the quote is that we're not stopping below 65%. There's still a lot more to go. Pricing's been a big driver of the upside in the last 10 years for the company as you've re-rated some contracts that were well below market. The understanding of the market that a lot of that has already been done, so what's the next leg of upside for Union Pacific outside of just pricing and maybe some aspects of the story that we've overlooked?
Robert M. Knight
Okay. Maybe let me go back a little bit to 9 years ago when we had the worst operating ratio in industry at 87% or actually, it's over 87%, and that's when we started the whole focus on financial turnaround here. And so you look at how did we go from 87% operating ratio to the 67.8% that we reported in 2012, so a 20-point reduction in those 9 short years. It was a combination of productivity; providing good service, which allowed us to improve our pricing capability; and we always want volume. But what's interesting, if you compare our volume levels to where they were in 2004 to where they are today, actually, we're about 5% -- we're still about 5% lower volume today. Now that's -- that makes it more difficult to squeeze out the productivity. But if you look at the overall drivers, it was combination of pricing and productivity. And I guess I would say, Brandon, what's going to take us then from the 67.8% that we reported in 2012 to our refreshed guidance of sub-65% by 2017? It's going to be the same attributes. We believe that there's still a lot of productivity in our story. As you've heard me comment before, it's not generally home runs, but it's a lot of singles that are still out there. And how we do that? Well, volume is always our friend, but we're going to use that as an excuse to not get productivity as we haven't the last 9 years. We certainly are betting and we certainly made the comment that our volumes in 2013, assuming the economy has something like a 2% industrial production number that when you add it all up, we'd expect our volumes in 2013 to be on the positive side of the ledger. And as you know, that's what the headwind of coal having some difficult challenge, particularly in the first quarter, because we didn't see the falloff last year until late in the first quarter and the challenge that we have with a difficult comp of Ag probably for the first half of 2013. So even against those headwinds, we think that with a 2% industrial production that we will have positive volume growth, all in, for our business. And that helps with the productivity story. But I don't see it -- what's going to get us from here to there, the sub-65%, as being really any different. The slope of the line, clearly, is a little bit not as steep going from where we are to where we're guiding. But the attributes or the drivers that will get us there, I don't think are really that much different than what we've seen in the past. Again, it's a lot of bunt singles on the productivity story. I think you get the pricing story, and we've given guidance that we think our pricing -- your comment is that we've taken a lot of pricing over the last several years. That's true. Our services dramatically improved over the last several years. It continues to have opportunities to further improve, but the way we look at our pricing is we want to price to market. We don't want to take and we won't take any business that's not at least at a re-investable level. And we have great capability of understanding that in every carload move. And with that, we're comfortable saying that we expect to get over this planning cycle. Certainly as far as we can see, inflation plus kind of pricing is still a part of our story as we look forward. I'm very confident that we can still achieve that. At the same time, there's a lot of productivity initiatives out there and just some examples, technology is a big part of our industry and not just homegrown but frankly more important or equally important are all the suppliers that support the rail industry are constantly coming up with new, better technology that allows us to run more efficient operations at a lower cost. Examples would be technology that allows us to detect engine failures in our locomotives before they happen. So we're able to get certain things fixed in a more efficient way or technology that allows us to identify potential cracks in wheels or rails so that we're able to identify those way earlier than the cycle than maybe we used to in historical terms, those kinds of technologies. More fuel-efficient programs enable us to be far more fuel efficient both from a technology standpoint but also from a manpower standpoint in terms of operating our locomotives. The distribution of locomotives in the train, which is called DPU, allows us to squeeze out more efficiencies. So the story goes on and on and on in terms of productivity opportunities that we see. So that's all going to be part of it. And just one final comment, when you said we're not going to stop there, that's what you'll always hear me say. When we were at 87% operating ratio, we gave guidance that we were shooting for mid-70s kind of operating ratio. We got there a little earlier than we had projected. Then, we said we expect to get to low-70s. We got there a little earlier than expected. Then, we said 65% to 67%. We hope to get there earlier than we had projected at that point in time. So our point is, our message is that's our next step. We've given a sub-65% operating ratio guidance target by 2017, but it's not -- we don't look at it as an endgame. We look at it as sort of a next step. We're going to get there as efficiently as we can and as early as we can. I mean, we're not planning at stopping there, but as we look out at all factors, we think that's a reasonable guidance that we've given as the next step.
Brandon R. Oglenski - Barclays Capital, Research Division
Well, if the economy is a little bit slower over the course of this next cycle -- and I'm not sure that anyone has a good answer to where the growth rate's ultimately going to be, but is there a temptation there that maybe, hey, volume just hasn't been as good. We need a little bit more for productivity. Maybe we lessen a little bit on the pricing guidelines. Take a little bit more volume and maybe not quite accomplished what we had thought. I mean is that a risk here? Is there...
Robert M. Knight
Yes. And I get your point. In fact, if you look at the history of the rails, that's sort of the trap that they have historically fallen into, we certainly have in our deep, dark history, and that is to think that you want to chase volume for volume's sake. But one of the things that we're very much aware of, again, we have a very good capability of understanding the costing on every move that we have. We're not going to take any business that's not at least at a re-investable level. So we understand the returns that are required by each move, and that's sort of our line in the sand, if you will. First, the way we approach it is repricing to market, and hopefully, the market is higher -- EBIT higher than that minimum re-investable level. But one of the things that we have learned, I think, over our history here that has enabled us to be as successful as we have in the last 9 years is we understand the very question you're asking and that is not to fall into that trap of not just chasing volume for volume's sake. But we understand that returns of every piece of business we bring on. And we're not afraid to back off on our capital spending if, in fact, if we thought the economy was going to be soft for a long period of time and the capital investments that we're determining right now didn't have with it the appropriate returns to justify that capital investment. We won't make the capital investment. So that's sort of the lesson learned if you will. We're not afraid to walk away from business if it's not capable of paying its share of the freight that's required for us to earn the returns on the capital dollars that we're investing. And so it's a constant balancing act, but we're well aware of avoiding that trap.
Brandon R. Oglenski - Barclays Capital, Research Division
Well, I think near-term, there's still persistent concerns about coal headwinds, and obviously, the ag markets have been a little bit more challenged in the last couple of years, which is an important segment for your company. But even with those headwinds last year, you're able to generate very positive traction on the earnings front. What were some of the things outside the legacy repricing contracts that you have that really enabled you to manage those volume declines effectively?
Robert M. Knight
Yes, I mean, so just for folks who may not know the details on that, our coal volumes, which is our largest volume commodity of our 6 business groups I talked about, were off 14% last year, which is pretty material slip. We didn't see that coming into the year but the -- as we wrapped up the year, they were off [ph] 14%. But when you look at our overall volumes as a company, our volumes were roughly flat, so that falloff of coal volume was offset by other strength. And where did that come from? Well, the whole shale activity grew significantly for us, and in fact, our all-in shale-related moves, that's the oil train sand and the components that go into the process, almost doubled off of a low base but still they almost doubled. That was a nice positive. Auto showed some strength. It stepped up. Again, I talked about that being one of our franchise strength. Chemicals, another franchise strength, showed some very strong signs of life, again, given the low natural gas prices. Housing started to show some signs of life. Our Mexico trade was up 5% last year on our overall volumes being flat, so Mexico showing a greater strength. So how did we turn in great financial results in the phase of that coal challenge and as you mentioned, the ag challenge, which was driven by the drought? By the way, the drought hit us pretty severely. I think that's going to continue into the first half of this year. So you're right. Those are the 2 headwinds we have. But we improved our overall margins as a company by 3 points. Our operating ratio improved by 3 points, which was significant when you consider that 14% falloff in coal. Well, the way we did it was running efficient operations, squeezing out all the productivity we can. So business that stepped up, that grew in place of that coal falloff carried with it nice margins, so the whole new shale play, if you will, the housing, the autos, all carried with it nice margins because we were able to run it efficiency, price it appropriately and squeeze out productivity along the way. When you add it all up, I think what it shows and just one of the things that we're also very proud of is that we have stamped our foreheads to be agile. We know that we can't predict with great accuracy exactly what the economy is going to bring, so we can't project with great accuracy exactly what each volume will reach the line of track is going to be. We have to play the hand that the economy deals us, and that means being agile. We have to be able to think on our feet and react accordingly, and our operating team has done a nice job of doing that, like it's all doing business where appropriate, squeezing out productivity where appropriate. At The same time, providing good service enabled us to get 2012 to be reported on all-in for [ph] price of about 4.5% all in, excluded about 1.5 point of the legacy. So back off [ph] the 1.5 legacy, so you roughly have about [ph] 3% underlying price [indiscernible] .
Brandon R. Oglenski - Barclays Capital, Research Division
[Indiscernible] talk about [indiscernible]
[Audio Gap]
[indiscernible] high level, what are you seeing in that void [ph] [indiscernible] ...
Robert M. Knight
Yes, I think, it's -- I guess I can summarize it by saying there's a lot of enthusiasm. Folks are willing to step up. That makes significant -- customers are making significant capital investments [ph] in their infrastructure whether it be that chemical row as you talk about and you look at the multi-billion dollar investments that are being made in the Gulf, those are multi-year plays, of course, but there's no way that's not a good new story for Union Pacific when you see in the Gulf coast. Mexico, a lot of the offshoring to nearshoring activity that's taking place in Mexico, again, we have 2/3 of the market share of all business that wants to go in and out of Mexico. So regardless of kind of what the traffic ends up flowing from and to, we'll be in a great position. If you add on top of that, then, the autos investments in Mexico, which, again, is a great new story, there's multi-billion dollars of investments that have been announced that will take place over multiple years in Mexico. We have 90% of all market share of the autos business moving in and out of Mexico. So that's a great new story regardless where the plants end up being located. We know that they're going to ultimately want to move cars to the western half of the United States, and we're in a great position to do that. So I guess I would say that with the low -- the prospects of low energy prices in the United States, we are seeing a lot of enthusiasm and a lot of real dollars going into capital investments with our customer base, which can only serve us well.
Brandon R. Oglenski - Barclays Capital, Research Division
Well, indirectly in the shale energy plays, I know your company's moving a lot of frac sand and drilling pipe into the region, as well as moving the crude out of the various regions, but you do not directly serve the Bakken region. So how is the crude by rail working for Union Pacific right now?
Robert M. Knight
Great. In fact, what's interesting, it's a great story. The Bakken, as I think most people know, is the most developed of the formations, but there's a lot more coming, and I'll talk more about those in a minute. If you look at the Bakken, it's currently served by 2 railroads, and neither of those 2 are Union Pacific. But of all rail unit trains of oil coming out of the Bakken, we handle about 60% of all of it. Why is that? Because right now, that 60% wants to go to St. James, Louisiana, which we serve. So we're picking up most of that with our interchange partners in the Kansas City area and taking it down to the Gulf. So that's, today, been a big part of our unit oil train business. But if you look at the Niobrara and then the Eagle Ford, I mean, all those formations are coming on stronger, which is -- or right in our sweet spot. If you look at where they physically are, they're right in the sweet spot of our network to serve both any unit oil trains that want to go to various destinations. And I would just describe it right now as everyday of the week, there's new discussions taking place about different origins and different destinations for that traffic. Most of which is right in our sweet spot, so we're going to -- we're in those discussions. That's the oil trains. The sand, then, it wants -- needs to go into those formations for whether it's oil drilling or gas drilling. Typically, it's coming from the upper Midwest. Again, we're in a great position to take that from origin to destination to all these different formations, not the Bakken but to other formations that want that sand. And it's a -- sand is, again, part of our manifest network. It's something that is a strength of ours, aggregates of sand, et cetera. So it's a real win for us. If you look at just 2012, Brandon, I know you know this, but our oil train traffic grew by about 300%. And as I mentioned earlier, when you add in, then, all the sand and the materials, et cetera, it nearly doubled to be about 4% -- all in be about 4% of our total traffic, so still relatively small, but the upside looks pretty bright to us. And folks ask all the time what happens when the pipelines get more established. Well, our thesis, our belief is that the pipelines will ultimately get constructed. And by the way, we'll handle most of the materials that go into that construction process because that's, again, right now our sweet spot. Whether it's the pipe or the aggregates that go into that part of the business will be a win for Union Pacific. But what we believe and what we're hearing from the producers is that even with the assumption that pipelines are built, they'll still want to have a growing level from today's levels, a growing level of unit trains to hold the oil. Why would they do that? Well, it gives them flexibility to not be locked in to any one destination. It gives them the ability to play the arbitrage to take a certain percentage of that oil to different destinations. I don't think this is necessarily the driving force, but we're significantly faster to market. I mean, we're actually able to move the product much faster than pipe. I don't think, again, that's the driver nor the arbitrage is the driver. But there are various advantages that rail offers in that equation, which is why our belief, albeit at a slower growth rate, but we believe over the planning horizon that even with the assumption of pipelines being constructed that we're going to see a growing demand and growing opportunity for Union Pacific to haul unit oil trains out of the shale formations.
Brandon R. Oglenski - Barclays Capital, Research Division
Well -- and with that, I just want to see if there's any questions from the audience because I know crude by rail has been a pretty big topic. I think we have one here in the back.
Unknown Analyst
Could you maybe elaborate on some efforts to get crude either from the Permian or the Bakken out to California? And are there real estate constraints about bringing unit trains into the refinery complex over there? Do they have enough space to be able to take unit trains?
Robert M. Knight
Well, there's a lot of talk right now, as you know, about moving product from various formations to the West Coast at different refinery locations. Again, that's -- we are a West Coast railroad, so most of that's going to be right in our sweet spot as I mentioned. The constraining items are going to be constructing rail and loading facilities at those refineries. But that's not an insurmountable spend. It's not an insurmountable piece of construction, if you will, in railroad terms. That investment, for the most part, will be not ours but will be the refiner's or the producer's or some other player in there. And there's your typical permitting timelines on the front end of that, but those are sort of, I guess I would say, standard operating procedure types of investments to survey a new refinery. So I don't see those as gating items. You're well aware, I'm sure, of the railcars. There's about 1.5 years back order on the railcars, but again, I don't think that's hurting the business right now. But they're -- the good news is if you look at the orders that have been placed for railcars, again that's not our capital investment. That's the producer's or other's capital investment. They are aggressively still placing orders for those cars, which is also a positive sign. So end of the day, there's multiple locations, multiple interest in taking not only Bakken, but there's even talk about maybe tar sands coming down to West Coast refineries and all the -- Colorado and the Texas formations, some of that wanting to go west. Again, we're in a great position regardless of where they end up wanting -- whichever refineries on the West Coast they ultimately want to take it to.
Brandon R. Oglenski - Barclays Capital, Research Division
And is this a business that ultimately you might be willing to put some capital into?
Robert M. Knight
Oh, yes, we would where it makes sense. Again, one of the beauties of our businesses is our capital investment, for the most part, goes into the network itself and locomotives. I mean, the beauty of that is those are fungibles. So if a business, any particular business doesn't materialize as expected, we can shift those or use those assets for other business that wants to grow. That typically is where our investment dollar goes. If there are certain filling up the network or doing sitings to support growth or like we're talking about the shale, we're certainly willing to do that. I mean, that's just kind of part of our typical capital evaluation process.
Unknown Analyst
How will you put out the timeline on there [ph] ?
Robert M. Knight
There's a lot of interest. I can't really put a timeline on it, so just sort of stay tuned. I mean we -- our projection, our assumption is it's going to be a continuous growth over our planning assumption, so I think it's just going to be a continuous story.
Brandon R. Oglenski - Barclays Capital, Research Division
You also have a question up here.
Unknown Analyst
Just a simple question. You said [ph] if 4% of your total traffic is related to this whole shale process, how much that is the 1Z/2Z site moves you're talking about? And how much of it was really unit-train-efficient processes?
Robert M. Knight
How much of this -- of the 4%, how much is the manifest? I'd say 40% of it roughly.
Unknown Analyst
I mean getting as [ph] you said it was a high-margin business but maybe because it's relatively new. Probably a lot of the pricing measures you can take kind of not happening yet just because of the newness of it.
Robert M. Knight
I'm sorry, I didn't understand the question.
Unknown Analyst
My question is because it's a new business, is there a lot more productivity to gather this in the future than you have now?
Robert M. Knight
Yes, I mean, because it is a new business, it has a couple of attributes going for it. One, we've been able to price right out of the gate to market, and that -- when you hear us talk about legacy, that's -- doesn't apply to this shale business. That's a plus, but yes, sure, any new high-growth, fast-growth type of business like that. Well, it's efficient when it runs in unit trains, so that in and of itself is very efficient. There's no doubt that as time goes on and that demand is with us a while, we're able to squeeze out more bunt singles, if you will, on the productivity side. [indiscernible] ...
Unknown Analyst
So when this gets around [ph] 4% of your business to 8% of your business or 12% of your business, then the margins on that 4%, would be higher [indiscernible] ...
Robert M. Knight
We would expect, as we would any growth opportunity, to squeeze any additional margins. One of the things that we are doing, which is partly shale related, party broader than shale and that is redirecting a lot of our capital dollars into the southern part of our network. If you look at our map, right now our -- northern part of our network and the western part of our network are way underutilized based on carload volumes, but the southern part of our network is nearly fully utilized. So for quite some time now, we've been redirecting capital dollars down to the South to stay ahead of that growth. And if you look at what's driving that growth in the south, it's shale is a lot of it. Intermodal traffic is doing strong in the south. A lot of construction activity broadly is taking place in the south, and the south is where we interchange in and out of Mexico. And as I mentioned before, our volumes in and out of Mexico have been running multiples of what our overall volumes have been. So you add it all up, our southern story actually is a positive one, and we are redirecting capital dollars down to support all these.
Brandon R. Oglenski - Barclays Capital, Research Division
We'll go, I guess, to this side of the room.
Unknown Analyst
You've get a lot of good opportunities going on. I haven't heard the word intermodal come up. And can you give us a sense of where that might play out over the next 5 years?
Robert M. Knight
Yes, the question's on intermodal. We think over the next 5 years that intermodal will be on the faster, higher-end of our volume growth story. We also think it'll be on the higher end of our margin improvement story. For those of you who may not follow us as closely, intermodal is one of our largest commodity groups. It's about 50% domestic, 50% international. But if you look at the opportunities that we've done some studies to evaluate what's the amount of freight that wants to ride or could be susceptible to ride on the rails and move from the highway, which is our whole focus in terms of growing the domestic part of our intermodal business, we currently, all in, international and domestic, haul about 3 million -- just over 3 million units a year today. But we've identified between 7 million and 10 million annual units of intermodal susceptible freight that's on the highways in the West. So that's kind of the target audience if you will. But we're not trying to just open the speculative [ph] and bring on all of that business. What we're mindful of -- back to our earlier discussion -- is only bring on the business that has the characteristics that fit our network and that will drive -- will enable us to price it appropriately to drive returns in the positive direction, so it's got to help average up our returns. And that's how we look at intermodal. So bottom line is we think there's a great growth story with intermodal and a great margin expansion story. And if the margins aren't able to expand, then it's volume we may not want. It's got to be at that re-investable level or higher or it's not business that's worth on taking. But we feel very good about that as we look out over the planning period.
Brandon R. Oglenski - Barclays Capital, Research Division
Well -- and maybe if I can just follow up and we'll come right back to the audience. But you've gone through a significant couple of years or few years of repricing a lot of your domestic and international contracts on the intermodal side. Your growth rates have been a little bit less than some of your peers. Has a lot of that just been customers readjusting to the new reality that they have to pay a fair price? And is the growth opportunity now really looking forward as you've gone through that process?
Robert M. Knight
Perhaps. You're exactly right. We're real proud of what we've done over the last several years. We renegotiated what we used to talk a lot about in these fourth-party contracts, which basically were old legacy contracts that basically prevented us from really pricing to market. We talked a lot about our desire and our ambition to get those behind us. We have done so. So we're able to price now more freely to market, which enables us to move core price and recover rising fuel prices in those countries that we weren't able to recover for us. That's enabled us to improve our margin significantly. But again, it's -- our approach is we price to market but at a minimum of re-investable levels. And if the business isn't there with the softer economy, I think you could probably argue that's impacted intermodal a little bit. It's a business that we're not willing to chase or put on our network if it doesn't have those characteristics. So we're very confident and very pleased with the progress that we've made in our intermodal business, both margin expansion and growth prospects, both in reality. But also as we look forward, we think there are significant opportunities for us to continue to grow that at a measured pace.
Brandon R. Oglenski - Barclays Capital, Research Division
Okay. And we'll come back to the mic here, and then we'll come to you.
Unknown Analyst
Just sticking with intermodal, what portion of the opportunity that you see in intermodal will require specific capital investments in the network to capture? Or what portion of that is broader opportunity in the market?
Robert M. Knight
I think most of that is the broader market opportunity. If you look at our network, again, as I said, if you look at the west, we're way underutilized from the capacity that we already have, and a lot of intermodal's going to be in the West side. The South, I mentioned, we are reinvesting. So the big capital spend that we have underway right now that touches the intermodal franchisees is out Sunset Route, which we're double tracking from Los Angeles to El Paso. We're 2/3 complete with that project. We're staying ahead of the curve, if you will, in terms of where we think the volumes are. But that's finishing that out. It's certainly on our radar, and that would be something that we invest. But I'd say -- and we've made -- as you probably have heard, we've made various intermodal terminal expansion announcements, Santa Teresa, New Mexico is one that's underway right now. Couple of years ago or a few years ago, we did the large Chicago area intermodal terminal. We've done them in various Texas locations. So we feel like they've got the network and the physical footprint there though clearly the additional capital spending, but it's, all in, our capital guidance that we've given of 16% to 17% of our revenue we expect. That's not how we build our capital plan. As we look forward, we'd expect to spend anywhere from 16% to 17% of our revenue on capital, and that includes both replacement spending and growth capital spending, and that's -- that intermodal growth story is embedded in that capital number.
Brandon R. Oglenski - Barclays Capital, Research Division
Come over to this side, please?
Unknown Analyst
I had a question back on the shale growth you mentioned in 2012 that was close to a double. What sort of the range or growth you're looking for in 2013 for that business?
Robert M. Knight
Yes. We haven't given guidance on 2013 because there's so many moving parts. We did give guidance last year that we thought, all in, we'd expect to see again coming off of a low base in 2011. We thought 2012, all in, would roughly double, and that's what we saw. We haven't given guidance -- specific numbers for 2013 other than to say we see growth, and the reason for that is there's so many moving parts here that we'll see. Now that's -- again, it's off a higher base. We have said it's going to be a slower pace. Clearly, that's what we saw in 2012. I'd call it a steady improvement growth is what we're expecting.
Brandon R. Oglenski - Barclays Capital, Research Division
One more up front here.
Unknown Analyst
Who are your top 3 intermodal partners?
Robert M. Knight
Our largest intermodal partner is Hub, who we have a long relationship, and beyond that, I'd say there's a whole host of others.
Brandon R. Oglenski - Barclays Capital, Research Division
Okay. If I can just move this conversation along a little bit, you -- the rail industry for a long time has talked about, look, we need to get this business to a re-investable level. And obviously, your return on invested capital, on your reported numbers at least, has improved pretty significantly. I think last year, you were above 14%, but on a replacement cost basis, which I think you would make the agreement as the right way to look at the business and I think a lot of folks would agree, the returns are much lower. So how much more do we have to go on the returns aspect of the story that can make it that much more appealing to some of the folks [indiscernible] ?
Robert M. Knight
Yes. if you do just roughly -- if you do the calculation on the replacement basis, our returns rather than 14% would be closer to 7%, about half of the reported. So what that says is we do have a room to go. When we started this whole turnaround, by the way, our reported number was like 4% 9 years ago. So we crawled [ph] from 4% to 14%, but on a replacement basis, we're still only at about 7%. And our story and our communication, which we spend a lot of time in Washington and other locations communicating this, is that the right way to look at it is the replacement look, and that is the 7%. So in terms of constraints or risks in Washington around doing something to us and to the industry that essentially would cap our returns, I mean, nobody wants to see that. And the reason why nobody wants to see that is that would -- our shareholders would demand that we scale back our capital spending if the returns were capped. So we're going to work hard on making sure the lawmakers understand that. Frankly, I think our customer base will line up as well and say, whatever you do, the rail -- the freight rail system in the United States has never been better than it is today. They're all stepping up making significant capital investments, which is a part of the story for the future service to continue at the pace that it's on. It's not broken, don't fix it. And we agree with that summary that we don't want to see anybody constrain our ability to earn or growing returns because that only will result in a lower capital base, perhaps a smaller railroad with fewer jobs. And Union Pacific alone has hired about 25,000 employees in the last 5 years, mostly high-paying union, American jobs. We pay our own way. I mean, it's a great story. We're 2/3 more fuel or environmentally friendly than other modes of transportation, so it's a wonderful story for our economy. So don't muddle with it that -- don't do anything that will prevent the incentive that the industry has to make those capital investments going forward. So longer answer than what you asked but sort of getting into the Washington point, but we'd say we still have sizable room to go when you look at it on a replacement basis.
Brandon R. Oglenski - Barclays Capital, Research Division
Well, arguably with the improving the turns picture, even with capital spending continuing that levels was I think 16% to 17% of revenue is the outlook here. But that would argue cash flows are going to start to look better and better as you drive this improvement, right? So maybe before we discuss that, we can go to the fourth ARS question, which is regarding cash flow because I know there's been some discussion with investors whether or not this industry should be more of a buyback or more of a dividend payer. So if we can queue up the fourth question, I think this should be a pretty interesting response. So in everyone's opinion in the room, what should Union Pacific do with excess cash? I'm not sure the first 2 categories really apply to the railroads. There's not that many M&A targets out there, but share repurchases #3. Dividends is #4. Debt pay down is #5, and internal investment is #6. We can go ahead poll real quick.
[Voting]
Brandon R. Oglenski - Barclays Capital, Research Division
Wow. We have some pretty significant response about share repurchases and dividends here. So I think this is a good lead-in, Rob, to discuss what are your priorities with distribution to shareholders looking forward?
Robert M. Knight
I mean, that's kind of what that response says. It's a balanced approach. First of all, you're exactly right. Our main focus is on generating the cash to begin with, and we do believe that over the planning horizon, the pie is larger. While the guidance over capital spending is 16% to 17% on a growing revenue base, the absolute capital spending is likely to grow under that set of assumptions. But again, the pie is growing even larger, so we believe that there would be even more cash available for us to return to shareholders. Now how do we look at it? Again, we have a stated 30% dividend payout that we just achieved in 2012, and we want to stick with that. So we would expect that dividends will continue to grow with earnings, and beyond that then, with the excess cash, we look to share repurchases and be opportunistic in our share repurchase program, which, in fact, is what we've done on the last several years. So it's kind of a balanced approach for what we do with our cash.
Brandon R. Oglenski - Barclays Capital, Research Division
And judging by the response, I think that's what this room is looking for. So are there any more questions from the audience? Happy to -- we have time for probably one more. I think we have one in the back here.
Unknown Analyst
Just a quick question, Rob. One of the things that shows up in the numbers, if I'm not mistaken, on the volume side, we have loads that you don't originate. You are earning revenue ton miles on those loads, so I'm talking about Bakken loads for example. Is that bias, the revenue per load either up or down if you don't report the originated load?
Robert M. Knight
I think to better understand the question, you're asking is because we don't originate the oil train moves out of the Bakken, we pick it up from a partner. Does that bias our...
Unknown Analyst
The revenue per load.
Robert M. Knight
Revenue per load, no. What biases and you do -- mix is always a big part of our story, and because we are more diversed than other rails, I think mix can be a swing factor in looking at average revenue per car analysis whether you're looking at a company wide or whether you're looking at it by business group, there's mix within mix. What does impact the average revenue per car look -- that you're looking is the length of haul. But the fact that we don't originate it really has nothing to do with it. What has everything to do with it is how many miles we're taking it.
Brandon R. Oglenski - Barclays Capital, Research Division
Okay. And before everyone leaves here, I think, Rob, we'd love to poll with the audience on the last 2 questions to see where everyone sees fair value in the shares. So this is really asking on a price earnings ratio, for this year, where does everyone see Union Pacific shares trading. Historically, the railroads have traded that 13x band roughly. So the options here are less than 10, 10 to 12, 13 to 15, 16 to 18, and the other 2 are a little bit higher than that. So if we can go ahead and poll the audience very quickly.
[Voting]
Brandon R. Oglenski - Barclays Capital, Research Division
Looks like folks are still bracketing us in the 13 to 15, but it's interesting to see that 30% of the audience is looking for 16 to 18. I think that's going to be really reflective as the return in this business continue to grow. And maybe if we can just ask the last question here, so this is really asking, what is the most significant investment issue for Union Pacific Corporation in your view? Is it core growth, margin performance, capital deployment or execution and strategy? If we can go ahead and quickly vote.
[Voting]
Brandon R. Oglenski - Barclays Capital, Research Division
So there you have it, Rob. I think folks are pretty interested in the story, especially with all the good things you have going in your network even outside of coal and grain. So I just want to thank you again for participating at our ISC event.
Robert M. Knight
Great. Thank you.
Brandon R. Oglenski - Barclays Capital, Research Division
Happy to have everyone here.
Robert M. Knight
Thank you.
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