Finding Opportunity in Buffett's Burlington Northern Buy

Remember a few weeks back when Burlington Northern Santa Fe (BNI) and Union Pacific (UNP) sank the transports and the Dow on warnings that the economy was not steaming ahead after all? BNI's stock derailed that day, but Warren Buffett, who owned a major stake in the company, demonstrated why he is the greatest investor of all-time. While the world was selling BNI like it was the plague, America's Grandpa was putting together a plan to buy the rest of the company's outstanding shares.

Buffett Buys Burlington Northern Outright

Remember that old adage: "Buy into fear and sell into greed?" As well-known as it is, it remains mostly misunderstood. It seems it goes against human nature to walk toward danger, but the answer to the riddle is found deeper within that philosophy. It is precisely because what seems dangerous is not always really so bad that opportunity exists. Our savings, however, is so important to our security-centric mindset that we cannot bear the risk of losing, and so we lose out.

Buffett's big trick is that he thinks differently. He considers first the long-term, you see, and until they invent the Star Trek transporter, there will be a need for traditional transportation methods. Buffett, acknowledging this, saw a wonderful opportunity to take a greater stake in a key transportation company that supplies a fantastic economy.

Berkshire Hathaway Inc. (BRK-A), Buffett's investment vehicle and conglomerate, agreed to acquire Burlington Northern Sante Fe on Tuesday, by acquiring the 77.4% of the company it did not already own. The deal, valued at $44 billion when including the $10 billion in debt obligations that Berkshire will take on, prices Burlington Northern at $100 a share. The acquisition price represents a 31.5% premium to the prior day closing price of $76.07. That's a nice short-term windfall for BNI investors. And isn't it just so Buffett-like to set the acquisition price at $100 even? Buffett called the deal an "all-in wager on the economic future of the United States." You gotta love this guy.

Buy Railroads, Sell Truckers

Buffett likes railroads for the long-term because of what's going on in energy. As demand for oil and its distillates likely fires in the years ahead, truckers like J.B. Hunt (JBHT), Landstar System (LSTR) and Con-way (CNW) face an economic impact four times more expensive than the railroads, according to Buffett. If this is truly the case, you could expect market share gains to ensue for the railroads, and at the expense of the truckers. Market share gains are often drivers of P/E expansion as well, and they certainly are drivers of earnings growth. Therefore, railroads should produce better than recent earnings growth and share price appreciation. Add to that the whammy of prospective economic recovery, and you have something worth owning. As a result, you might find strategic investors and profiteers alike seeking to buy railroads now. Thus, the shares of all the segment's stocks should rise.

This deal places the P/E of Burlington Northern at 18.2X BNI's estimated 2010 earnings of $5.51. Union Pacific's relative P/E ratio is 13.1, according to Yahoo Finance and its data providers. CSX (CSX), another major rail player, sees a P/E of 13.1 as well. BNI's P/E was 13.8 before this deal was effected, and the slight premium probably had a lot to do with Buffett's growing interest, in every respect of the phrase.

While we do not offer investment advice here, another investment idea might be to play the market share trend by buying the railroads and selling the truckers, though economic recovery benefits all players, including the truckers. However, you negate that factor by evenly matching the two sides of the deal, or you might overweight the rails if you believe in the economic driver.

Now, keep in mind that Buffett's reasoning ignores the possibility of changes in technology. While expecting the transporter beam to become reality any time soon might be far-fetched, it is possible the truckers might find another way to fuel the big rigs and regain competitiveness. However, that does not seem to be soon coming either. The power train of a big truck seems a big stretch to be run by electric, natural gas, hydrogen fuel cells or any other prospective technology anytime soon. However, if that does become reality, you can sure bet Buffett will be buying truckers, or whichever segment adopts new cost effective technology.

Disclosure: No Positions

Comments

[PON:]

Mr. Kaminis, your position is interesting, but fairly one-sided. Think about your favorite big box retailer, grocery store, or other merchant. How many of them deliver goods directly to their retail sales floor via rail?
Think about your favorite e-commerce (.com) website. How does that wonderful online purchase get to your home? Are there train tracks coming up your driveway?
When is the last time you went to buy something, and needed it "right away"? Will you get that same level of service from a scheduled rail service?
I personally find Mr. Buffett's purchase of the BNSF timely, smart, and very strategic. As you state, he is capitalizing on the issue of our nation's infrastructure and placing bets on future growth strategy. I think he's spot on.
But to go the extra step to "play the market share trend by buying the railroads and selling the truckers" is short sighted. We need a holistic solution that benefits all constituents. We need a solution that is environmentally sound, while allowing for flexibility and nimble supply chains. This solution will include planes, trains, autos, trucks, and mass transit options. Yes, perhaps the days of long-haul "10-4 good buddy" are in their golden years, but don't count trucks out just yet. If you do, I'd be happy to help you with those train tracks in the driveway.

Nov 03 02:01 PM

[Annualgain:]

I agree with PON. Rail has its advantages, but only for certain kinds of goods. Rail has always been cheaper when measuring cost per mile, but its on-time performance has been lousy compared to trucks and airfreight. If a manufacturer has to idle its plant or a retailer has to leave shelves empty because of the poor service that rail has always provided, saving a few cents per mile is just not worth it.

Since 1910 market share has gone to the highway and away from the railway. Airfreight has also taken share as manufacturers get better at using just-in-time inventory.

However, the more commodity-like a good is, the more it make sense to use rail. That's why coal represents about 25% of rail volumes, and grains/ag are another large chunk. These goods will never leave the railways.

High value, high margin goods are just the opposite. You don't see many MacBooks delivered via rail.

Good luck with your market share play, Mr. Kaminis.

Nov 03 02:43 PM

[IntermodalFan:]

Mr. Kaminis:

While I agree with most of what you wrote re: Buffet's play on the BNSF, I do think it's unfair to lump in JBHT as a traditional "trucker" when they've spent the last 20 years building what is arguably the industry's premier intermodal offering and that division now accounts for the vast majority of its growth and 55%+ of its operating income. Certainly Hunt bought into the rail/intermodal business as a long-term growth opportunity long before Mr. Buffet began accumulating his stake in BNI and it's now paying off for their shareholders.

p.s. Annualgain would be surprised at how many high-end goods move in intermodal service today -- everything from high-end flatscreen TVs to most digital devices and the current railroad intermodal services in many cases are highly comparable to single-driver, over-the-road options.

Nov 04 04:20 PM