(Adds CEO comments, details, updates stock price)
By Lisa Baertlein
July 19 (Reuters) - No. 1 U.S. railroad Union Pacific Corp's second-quarter profit and revenue beat estimates on Thursday but costs related to a tunnel collapse that wreaked havoc on its Northwest service offset much of the gain from sharply lower U.S. taxes, sending shares down more than 1 percent.
Union Pacific's operating ratio, a measure of operating expenses as a percentage of revenue and a closely watched gauge of railroad performance, increased 1.1 points to 63 percent from a year ago due to higher fuel and labor costs. Railroads boost profits by lowering their operating ratio.
"Network performance improved significantly coming out of the first quarter, but a tunnel outage and train-crew shortages created a headwind in June," Chief Executive Officer Lance Fritz said.
A tunnel collapse in Oregon in late May forced the railroad to reroute traffic, which added 4 to 5 days of travel time and sparked a cascade of disruptions and unexpected expenses.
The company, which connects 23 states in the western two-thirds of the United States by rail, warned in April that it was unlikely to achieve an operating ratio of 60 percent in 2019 due to service problems and congestion on its rail network.
Fritz told Reuters on Thursday he was confident the company will hit that target in 2020, primarily through more efficient use of locomotives and crews, increased train sizes and reduced fuel consumption.
Union Pacific's freight revenue increased 8 percent in the latest quarter, driven by an increase in volume and a 4 percent improvement in average revenue per car.
Still, core pricing was flat sequentially, disappointing analysts and investors who expected an acceleration.
"We would have thought contract renewals and a tighter truck market would be having a greater impact by now," Bernstein analyst David Vernon said in a note.
Net income increased 29 percent to $1.51 billion, or $1.98 per share, helped by an effective tax rate that dropped to 22.1 percent from 37.5 percent a year earlier. Revenue rose 8 percent to $5.67 billion.
Analysts, on average, expected profit of $1.95 per share on revenue of $5.66 billion, according to Thomson Reuters I/B/E/S.
Shares in the company fell $1.97 to $139.28.
Rival CSX Corp, which is in the middle of an aggressive turnaround effort, on Tuesday posted a second-quarter profit that topped estimates as its operating ratio fell more than expected to 58.6 percent from 67.4 percent a year ago. (Reporting by Lisa Baertlein in Los Angeles; Additional reporting by Arunima Banerjee in Bengaluru; Editing by Shailesh Kuber and Jeffrey Benkoe)