So I thought I’d do a little number crunching on Buffett’s Burlington Northern Santa Fe (BNI) deal. What does that tell us? That Buffett is paying a full price for a business with mediocre returns on capital. That he’s betting on growth, not value.
Valuation (based on share prices of $100 for Burlington, $59 for Union Pacific (UNP), and $48 for Norfolk Southern (NSC)):
Enterprise Value to 2010 unlevered free cash flow (think of this as a better version of P/E):
- BNI = 29x
- UNP = 24x
- NSC = 18x
Return on capital employed (based on 2010 operating income and year-end ‘10 balance sheet estimates.
- BNI = 11%
- UNP = 10%
- NSC = 10%
(I’m using Stifel Nicolaus estimates for 2010)
The cash flow characteristics of the business don’t seem fantastic. BNI poured 68% of operating cash flow back into capital expenditures from 1999-2009. That’s cash flow that doesn’t go to shareholders.
Nor are the returns fantastic. Because operating a railroad requires so much CapEx, the return on capital employed is only mediocre.
As an asset, railroads do seem very well-positioned. And Burlington Northern particulary so. Increasing fuel costs hit truckers harder than railroads, so that works in their favor.
And as my Reuters colleague John Kemp points out: “Burlington’s track and rights of way are perfectly positioned to benefit from a massive expansion of the country’s coal-fired output in the next 20 years, coupled with ‘carbon capture and store’ technology to curb the carbon-dioxide emissions.”
Burlington has track carrying clean coal out of the Powder-River Basin in Wyoming and Montana. PRB coal has lower sulfur content than Appalachian coal. To the extent we increase coal-fired power generation in the U.S., we’re likely to do it on a “clean” basis, giving PRB coal (and those who ship it) a competitive advantage.
But again, given the high price he’s paying, Buffett needs a lot of things to go right for this deal to generate meaningful returns for shareholders.
