Berkshire's Railroad Of Bonds

| About: Berkshire Hathaway (BRK.A)

Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) just issued new 30-year bonds with a 4.5% coupon. In this article we will check out how the new issues compare to Berkshire's subsidiary, BNSF Railway.

Last year it was difficult to find quality long-term bonds with over 4% yields. However yields are now reversing course:

^DJI Chart

^DJI data by YCharts

Berkshire's newest bonds yield more than lower rated Burlington Northern Railroad Co. mortgage bonds, issued in 1990. Though, as you will see Burlington's highest yield bonds, with large premiums, still outpace Berkshire.

credit rating price yield
Berkshire Hathaway Inc Del Sr Nt 4.5% 2043 Make Whole Call (cusip: 084670BK3) sinking fund protection Aa2/AA+ 98.89 4.56%
Burlington Northrn Rr Co Cons Mtg 3.2% 2045, Qrtly Cpn (cusip: 121899CH9) call protected, sinking fund protection A1/BBB+ 78.00 4.50%

The 2043 Berkshire bonds are new issues, issued Jan. 29th and dated February 11th 2013. Take a look at the differences between owning ten of each:

total cost total annual coupon payments ten years of coupon payments
(10) Berkshire 4.5% 2043 $9,939 $450 $4,500
(10) Burlington Northern Rr Cons Mtg 3.2% 2045 $7,850 $320 $3,200

So the Berkshire bonds would cost over $2,000 more and pay about $1,300 more over ten years. They also offer a higher credit rating. However, for the longer term investor, searching for an investment related to Berkshire, the Burlington bonds are less expensive.

Acquiring BNSF

Burlington Northern resulted from the merger of Great Northern, Northern Pacific, Spokane and Portland & Seattle railways with Chicago, Burlington and Quincy railroads in 1970. Twenty-five years later Burlington merged with Atchison, Topeka, Santa Fe railways to become Burlington Northern Santa Fe (now BNSF Railway).

Berkshire bought Burlington Northern Santa Fe in 2010:

The purchase, the largest ever for Berkshire, will cost the company $26 billion, or $100 a share in cash and stock, for the 77.4 percent of the railroad it doesn't already own. Including his previous investment and debt assumption, the deal is valued at $44 billion...

Various reports cited Burlington's $10B in debt would be assumed by Berkshire. Berkshire sold off other railroad investments to avoid conflict and just sold remaining short-lines last year to satisfy regulations.

Tilson Funds generated a fascinating report that shows Berkshire's railroad, BNSF, is producing strong earnings before taxes:

Q3 11 Q4 11 Q1 12 Q2 12 Q3 12
Burlington Northern Santa Fe $1.2B $1.4B $1.1B $1.2B $1.5B

Last year BNSF issued an additional $2.5B in corporate bonds.

The railroad operator last sold bonds in February (2012.) Its $625 million of 4.4 percent securities due March 2042 traded at 101.3 cents on the dollar for a yield of 4.32 percent yesterday...

Here is Burlington's highest yield bond on the market, and two sets of bonds issued last year:

credit rating price yield
Burlington Northn Santa Fe Cp Deb 7.29% 2036 (cusip: 12189TAD6) call protected, sinking fund protection A3/BBB+ 136.34 4.70%
Burlington Northn Santa Fe Cp Deb 4.4% 2042, Cond Put Change Of Control, Cont Call 09/15/41@Par, Make Whole Call (cusip: 12189LAJ0) A3/BBB+ 100.59 4.36%
Burlington Northn Santa Fe Cp Sr Deb 3.05% 2022, Cond Put Change Of Control, Cont Call 12/15/21@Par, Make Whole Call (cusip: 12189LAH4) A3/BBB+ 101.81 2.81%

Notice Moody's rates these BNSF bonds lower than Burlington's mortgage bonds, A3 versus A1. While S&P rates both the mortgage bonds and these bonds BBB+. The 2036 bonds, issued in 1996, yield more than Berkshire's new 2043 corporate bonds. Though it would take 5 years for the 2036 Burlington bonds to recoup their premium.

The 2042 and 2022 Burlington Northern Santa Fe bonds are callable, unlike Burlington's 2045 quarterly coupon mortgage bonds. Investors who have a reason to keep $780 invested until 2045 at a 4.5% yield might prefer the higher rated Burlington bonds to the more expensive 2036 bonds with the 4.7% yield.

The investor who wants the

  • higher credit rating (Aa2)
  • higher yield (4.56%)
  • no premium regardless of call features ($98.89)

might prefer Berkshire's new 2043 bonds.

Here is an example that uses the Burlington 2045 bonds, the new Berkshire 2043 bonds and an income fund that holds Berkshire Hathaway Class A stock, such as Boulder Growth & Income Fund (NYSE:BIF) or Boulder Total Return (BTF) (both these funds trade at steep discounts to their NAV.)

portfolio size 3.2% Burlington 2045 quarterly coupon 4.5% Berkshire Hathaway Boulder Growth & Income or Boulder Total Return total / %
$50,000 $825 $1,950 $250 $3,025 / 6%
$250,000 $1,650 $3,900 $350 $5,900 / 2.3%
$1M $2,475 $4,875 $450 $7,800 / 0.78%
$5M $5,775 $11,700 $750 $18,225 / 0.36%

One reason investors might like the Burlington bonds is because of the Berkshire connection. This was a major acquisition for Berkshire, however now Berkshire investors are faced with uncertainty given Mr. Buffett's secretive transition plans. Theoretically another leader could shed the railroad, though its profitability would beg the question, why?

Few people have the skill and willingness to make the investments that Berkshire has made. Often a company will hit a point where the "needs" of the executives outweigh the "needs" of shareholders. Ironically Berkshire proved executives prosper far more when they place shareholders' interests first.

Imagine for a moment Jim Corzine, the CEO of MF Global, had been in charge at Berkshire. Or any one of the traders who have lost major institutions and shareholders billions. These so called "rogue" traders make bets that require the market or a company to rise or fall in the space of a few days or months. Time and time again such bets on margin have led to financial ruin.

All the while there are profitable businesses that require more patience. Berkshire's common stock has seen a dramatic 40% profit in the last year and a half. Here investors expect to see 45% in 10 years (providing no default or call if applicable). Those who believe higher grade bond yields will approach 5% in the near future would certainly wait. Those who have profit to spare and consider Berkshire and its subsidiaries quality investments might consider these now.

If you have any thoughts on Berkshire and Burlington Northern Santa Fe please leave a comment below.

Disclosure: I am long BRK.B, BIF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long Berkshire bonds and am considering the new 2043 bonds and the Burlington mortgage bonds, and BTF. This article is not a recommendation to buy or sell. Please consult a financial adviser to determine a proper allocation (if any) to meet individual financial objectives.