SIVY ON STOCKS from CNNmoney.com
October 29, 2001

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Iron horse

The lousy economy is masking steady improvement at the nation's largest
railroad Union Pacific.

By Michael Sivy

NEW YORK (CNNmoney) - As October draws to a close, the stock market is
being forced to digest some nasty news. On the economic front, there were
negative earnings forecasts and fears of a massive debt default in
Argentina. Reports of new anthrax cases and the growing belief that the
U.S. has lost the initiative in Afghanistan further undermined investor
confidence. In addition, many mutual funds that close out their fiscal year
on Oct. 31 were "window-dressing" -- dumping losing stocks that they don't
want to have in their portfolios when they next report to shareholders.

The overall result was that the stock market opened lower on Monday and
fell throughout the day. At the close, the Dow was down 275 points, or
nearly 3 percent, while the Nasdaq was almost 4 percent lower.

Still, nothing has really changed. Eventually, the economy will turn, and
many top-quality growth stocks with great franchises and strong financials
are clearly cheap. Among them: tech leaders, such as Applied Materials and
Microsoft; health-care giants, such as Pfizer and Johnson & Johnson;
depressed entertainment stocks, such as Disney; and top financial services,
such as Citigroup, MBNA and Fannie Mae.

STOCKS TO CONSIDER
Applied Materials
Citigroup
Fannie Mae
Johnson & Johnson
Microsoft
Pfizer

There are less-glamorous stocks, however, that are advancing under the
radar, particularly cyclical businesses that have been reducing their costs
and are now poised for big earnings gains when the economy finally
rebounds. A good case in point is the railroad industry -- and particularly
the nation's largest railroad, Union Pacific.

The current company was created in 1996 when the old Union Pacific acquired
Southern Pacific. The merger was a strategic masterstroke on paper -- and a
practical disaster. Difficulties integrating the two railroads went far
beyond the usual post-merger stumbles. Rail traffic jams in Texas became a
mess that took years to sort out. As a result, Union Pacific's share price
has yet to surpass its 1996 high -- in fact, it is currently 30 percent
below that level.

Nonetheless, the company has slowly been getting its act together. Traffic
problems have been resolved, and much of the excess overhead resulting from
the merger has been eliminated. Because business remains weak, however,
very little of this progress is evident.

Today Union Pacific (UNP: down $1.18 to $50.25, Research, Estimates)  is
the largest U.S. railroad, both in track miles and in freight revenue. The
company's rail network covers the western two-thirds of the country with
major links both to the East Coast and to Mexico. Union Pacific's customer
mix is highly diverse, including low-sulfur coal and agricultural products.

Revenues have basically been flat this year. Lower costs and cheaper energy
prices have offset this top-line weakness, allowing Union Pacific to post a
4 percent earnings gain in third-quarter results, which were announced a
couple of weeks ago.  And analysts expect these trends to continue through
the first quarter of 2002.

As the economy improves next year, however, earnings could shoot ahead at
better than a 20 percent annual rate and continue to grow in the low teens
over the next five years. At a current price of $50 a share, Union Pacific
trades at only 12 times next year's projected earnings. Moreover, cash flow
is more than double net income. That means plenty of cash will be pouring
in to improve the company's balance sheet from a B+ to an A. Relative to
cash flow, Union Pacific's stock is about as cheap as you can get -- and
the upside leverage in a recovery is considerable.

###

Read all of Michael's columns at:
http://money.cnn.com/markets/sivy/

To subscribe or unsubscribe to Sivy on Stocks, go to:
http://money.cnn.com/email/

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