Riding the Rails: Why BNI Was Berkshire's Best Bet - And Vintage Buffett

The largest acquisition in Berkshire Hathaway history is, in our opinion, vintage Buffett. The Burlington Northern Santa Fe Corp. (BNI) press release spun it as follows:

“Our country’s future prosperity depends on its having an efficient and well-maintained rail system,” said Warren E. Buffett, Berkshire Hathaway chairman and chief executive officer. ”Conversely, America must grow and prosper for railroads to do well. Berkshire’s $34 billion investment in BNSF is a huge bet on that company, CEO Matt Rose and his team, and the railroad industry.”

“Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.”

When you look at this transaction from the perspective of our Fundamentals-at-a-glance research tool, it makes perfect Buffett sense, especially when compared to other major U.S. railroad companies. Assuming Warren believes what he said above, then Burlington Northern was his clear choice. Of the major U.S. Railroads, they have generated the strongest earnings growth, and therefore, the strongest shareholder returns versus their peers. Figure 1 correlates Burlington Northern Santa Fe’s (BNI) earnings results (green line with white triangle) to their monthly closing stock prices since 1991. Notice how the price tracked earnings and then became undervalued in 2008, based on earnings… a perfect time for Warren to buy.

(click each figure to expand)

Fig. 1. BNI 20yr EPS and Price Correlation

In Figure 2, we calculate total shareholder returns, appreciation and dividends since 1991. Note how closely returns correlate to earnings growth.

Fig. 2. (BNI) 20yr Dividend and Price Performance

Figures 3 through 10 repeat this paired information on Burlington Northern Santa Fe’s major competitors.

Kansas City Southern (KSU) generated a very low 2.8% earnings growth rate, since 1991.

Fig. 3. KSU 20yr EPS and Price Correlation

Based on an overvalued ending price, KSU generated appreciation of 7.9%. However, due to their earnings growth, dividends only totaled $37,075.26.

Fig. 4. (KSU) 20yr Dividend and Price Performance

CSX Corp. grew earnings at 6.4%, however notice they were very cyclical since 1991.

Fig. 5. CSX 20yr EPS and Price Correlation

Because CSX started the period more undervalued than they ended the period shareholders enjoyed a 9.4% annualized compounded rate of return, in excess of earnings growth. The 6.4% earnings growth did generate dividends of $120,524.58.

Fig. 6. (CSX) 20yr Dividend and Price Performance

UNP generated a 5.2% earnings growth over the period shown below and were also cyclical in nature.

Fig. 7. UNP 20yr EPS and Price Correlation

Shareholder returns correlated very closely to earnings growth, as did dividends.

Fig. 8. (UNP) 20yr Dividend and Price Performance

NSC Corp. grew earnings at 5.7% and were also cyclical over the years. Stock prices closely tracked the cycles.

Fig. 9. NSC 20yr EPS and Price Correlation


Once again, shareholder returns and dividend income correlated to earnings growth.

Fig. 10. (NSC) 20yr Dividend and Price Performance

Conclusion

A review of the above information clearly validates that Burlington Northern Santa Fe (BNI) has been the best run major U.S. Railroad, based on earnings growth, since 1991. Therefore, Warren Buffett clearly invested in the best of breed, based on operating results and shareholder returns. Also, by investing during this weakness, he was able to acquire them at a fair price, even though he paid a premium to current value. Therefore, we felt it was vintage Buffett.

Disclosure: No holdings in any of these companies at time of writing.

Comments

[Roger Knights:]

Why pay a premium and put all your eggs in one basket? Why not buy a basket of RRs at market prices?

There's a considerable long-term risk in BNI: The port in Mexico's west coast that is being built, in conjunction with improvements to a railroad line from it to Kansas, that is intended to be a low-cost alternative to high-wage US west coast ports. This could divert a good deal of traffic.

Nov 03 05:07 PM

[Plant the s...:]

Excellant analysis. Good objective data, you made your point, I understand Buffet's reasoning and agree that this would be good for the country on many levels.

Nov 03 05:59 PM

[Mad Hedge F...:]

vhi You’ve got to hand it to Warren Buffett, who never does anything half heartedly. The stunning news that he is paying $44 billion for the 73.4% of Burlington Northern Sante Fe (BNI) he doesn’t already own, a 30% premium, had punch drunk traders picking themselves off of the floor. The other rails rocketed, like Union Pacific (UNP), CSX (CSX), and Kansas City Southern (KCSR). The deal is the Oracle of Omaha’s largest in his career, and took the BNI board all of 15 minutes to approve. For me this deal speaks volumes about the long term trends in the US economy as seen by its greatest investor. It screams Commodities! Commodities! Commodities! Rails can only prosper moving bulk freight from the heartland to ports on the three coasts, which foreigners are buying in ever larger quantities at ever higher prices. It also says the coal industry isn’t going anywhere soon, as it accounts for 70% of all rail traffic. Buffet let loose of some fascinating statistics about the enormous productivity increases the industry has accomplished. In the last 25 years, it cut employment from 500,000 to 175,000, while increasing freight by 60% and reducing track by 40%, and now accounts for 40% of the total goods moved in the country. Railroads are the greenest transportation out there, a ton of freight requiring only a gallon of fuel to move 470 miles. When I was growing up, my big goal in life was to become a train engineer. Maybe it’s time for me to revisit that aspiration. And I promise not to text while driving!

Nov 03 07:51 PM

[StockMaster...:]

I recall he was writing naked BNI puts and buying shares this year. Looking back it is pretty obvious he wanted BNI, yet at the time it was too scary for most people to get involved. Hats off to the man, he has guts and sticks to what he believes in.

Nov 03 08:28 PM

[E Nuff Sed:]

Chuck, You did not mention Canadian National Railways. It generates even higher margins and return on equity than BNI. CNI is very strong in agriculture and its network covers the vast Canadian prairie's. It has now access to the Alberta Tar Sands and the uncrowded Prince Rupert port in northern BC from which it can serve the east and midwest via direct rail links.
As the economy recovers it will have tremendous leverage and pricing power and stock price in my opinion can double in 3 years.

Nov 03 09:58 PM

[Thomas Jowers:]

Buffet is my Hero!

Nov 03 10:52 PM

[Denis Gould:]

This deal is a long term de-risking of the Berkshire portfolio by buying a highly stable business. As such it is the opposite of a vote on the future of America and rather a reflection of the long term weak nature of growth in an economy crippled with huge debt and deficits.

Nov 03 11:15 PM

[bobbybutte:]

The only man who has made his investors over 100 billion dollars in his career has put his money where his mouth is by betting on the US

At the precise time everyone else is negative

Vintage buffett

Nov 03 11:43 PM

[Mark Anthony:]

My comment is Warren Buffet has good big picture view, bad timing and bad pricing. Every one in the world has known for two years that Warren Buffett loves railways. He openly talked about it more than two years ago. So why why he picks a time to pay nearly the higest price? Way over-paid.

If he likes railway, Chinese railways are way much better play. The capacity of China's railways transportation is stretched tot he extreme. Whole America's railway system has excessive capacity that is idled.

If he likes commodity and transportation play, he should be buying coal mines, and he should be buying dry bulk shippers. Both sectors are dirt cheap compare with railways.

seekingalpha.com/autho...

I am afraid Warren Buffett is getting too old to calculate relative valuations correctly. There are so many good under-valued assets around at dirt cheap price. Railway will be the last thing I will pick up. It's going to be good, but just not as good as other things.

Nov 04 12:10 AM

[User 464776:]

34 billion is a drop in the bucket to what the real value of BNI is. What many don't realize is the vast amount of rail bed and right-of-way BNI controls. Think about all those vast wind turbines and solar farms out on the plains and deserts... guess where they'll have to lay their transmission lines to appease the environmentalists? Same goes for any expanded fiber optic broadband lines... guess where they'll (as many are already) be laid? Let's not forget about the future proposed high-speed railway systems. With eminent domain problems compounded by never ending environmental studies... guess where the logical choice for the new rail beds for these systems will be? Oh... let's not forget about the old cap and trade b.s. while we're at also. Guess where the easy access CO2 main lines will be located that will off shoot to smaller lines leading to injection wells in the oilfields so coal fired power plants can offload their "carbon credits"? Guess who's gonna pay for all of this?

Buffett ain't no dummy!

Nov 04 01:52 AM

[ozcutty:]

Sorry Warren, can't get exited about these railway businesses. BRK is supposed to grow at 20% not 12%.
i'll stick with my insurance and asset management stocks thanks

Nov 04 07:25 AM

[MikeD71:]

Cynical about this one. My first thought was that Buffett is betting that the country get's railroadED. (Cap & Trade, etc.) That was dealt a blow in VA & NJ last night, however.

Nov 04 08:09 AM

[Peter Cooper:]

No he has got it wrong this time and overpaid in cash that would be better deployed later, see: arabianmoney.net/2009/.../

Nov 04 08:17 AM

[toobad41:]

Rising fuel prices will dictate which mode of transportation for goods and services will survive. Mr. Buffett sees this clearly and has made his move now. It won't be long when we will see fewer 18 wheelers on the highways because higher fuel pricing will not support there use. Sure trucks will still be used but only locally from the rail depot to the business. The sun is setting on the trucking industry. Mr. Buffett sees this.

Nov 04 08:25 AM

[CaptainJJack:]

Overpaid? Chinese Railroads?

I own BNI, and while I bought it at $74 - 80, I sure looked at it when it was over $100, and oil was at $130.

BNI has a relatively high P/B, at around 2.5, but the Chinese railroads have P/B north of 30! And, I would argue there is more than a little political risk involved.

As for Buffet being too old and past his prime, let's see, there are the Goldman warrants, the Preferreds he did with GE and Harley. There is the Wrigley deal, the Mars deal, and the rail car deal (I forgot the name of the family that sold to him) -- all in the last year.

I also own BRK. I don't think he's lost it.


On Nov 04 12:10 AM Mark Anthony wrote:

> My comment is Warren Buffet has good big picture view, bad timing
> and bad pricing. Every one in the world has known for two years that
> Warren Buffett loves railways. He openly talked about it more than
> two years ago. So why why he picks a time to pay nearly the higest
> price? Way over-paid.
>
> If he likes railway, Chinese railways are way much better play. The
> capacity of China's railways transportation is stretched tot he extreme.
> Whole America's railway system has excessive capacity that is idled.
>
>
> If he likes commodity and transportation play, he should be buying
> coal mines, and he should be buying dry bulk shippers. Both sectors
> are dirt cheap compare with railways.
>
> seekingalpha.com/autho...
>
> I am afraid Warren Buffett is getting too old to calculate relative
> valuations correctly. There are so many good under-valued assets
> around at dirt cheap price. Railway will be the last thing I will
> pick up. It's going to be good, but just not as good as other things.

Nov 04 08:48 AM

[epeon:]

I wonder about this one. Is this just another cop buy? First, he paid a substantial premium for BNI. And, he paid that premium after the stock price had risen substantially since March. Secondly, with current government macro policies, the US could be entering a "lost" decade like Japan. I am not optimistic about the US economy over the next five years. We shal see.

Nov 04 08:55 AM

[dealjunkie:]

Buffet knows too much about Chinese investment prospects to take that shot. The Chinese government is everywhere and is there a government anywhere that has been a trustworthy investment partner for an outsider?
DealJunkie


On Nov 04 12:10 AM Mark Anthony wrote:

> My comment is Warren Buffet has good big picture view, bad timing
> and bad pricing. Every one in the world has known for two years that
> Warren Buffett loves railways. He openly talked about it more than
> two years ago. So why why he picks a time to pay nearly the higest
> price? Way over-paid.
>
> If he likes railway, Chinese railways are way much better play. The
> capacity of China's railways transportation is stretched tot he extreme.
> Whole America's railway system has excessive capacity that is idled.
>
>
> If he likes commodity and transportation play, he should be buying
> coal mines, and he should be buying dry bulk shippers. Both sectors
> are dirt cheap compare with railways.
>
> seekingalpha.com/autho...
>
> I am afraid Warren Buffett is getting too old to calculate relative
> valuations correctly. There are so many good under-valued assets
> around at dirt cheap price. Railway will be the last thing I will
> pick up. It's going to be good, but just not as good as other things.

Nov 04 08:58 AM

[Chuck Carne...:]

You are correct on all accounts. I only included U.S. Rails. Currently, I don't own rails, but if I did CNI or GWR would suit me better. However, keep in mind that Buffett doesn't always swing for the fences. He likes what he knows and stays in his comfort zone. He is familiar with BNI management, and I feel likes the dividend as well. CNI is more of a growth story.

Thanks for the question,

Chuck


On Nov 03 09:58 PM E Nuff Sed wrote:

> Chuck, You did not mention Canadian National Railways. It generates
> even higher margins and return on equity than BNI. CNI is very strong
> in agriculture and its network covers the vast Canadian prairie's.
> It has now access to the Alberta Tar Sands and the uncrowded Prince
> Rupert port in northern BC from which it can serve the east and midwest
> via direct rail links.
> As the economy recovers it will have tremendous leverage and pricing
> power and stock price in my opinion can double in 3 years.

Nov 04 09:18 AM

[mbkelly75:]

It is a good article and you are right. We ALL tend to stay in comfort zones and Warren is no different. He stays with what he knows and does VERY well at it. It is a good lesson for all of us to pay attention to. One of the best things I see coming out of this and a good way to see how important this is to him is seeing him split Berkshire Class B (something he has refused to do for a LONG time is split his stocks) to make it available to BNI investors. It also goes a long way to opening it up to a LOT of others. I am pleased to see it happen. CNI is one investment that I am looking at also.
I would not bet against Warren Buffet. He is right far more than he is wrong and has a batting average that would be a lock for the Hall of Fame if he played Baseball instead of running businesses. His is one of my Heroes and always will be a member of the Business Hall of Fame.

On Nov 04 09:18 AM Chuck Carnevale wrote:

> You are correct on all accounts. I only included U.S. Rails. Currently,
> I don't own rails, but if I did CNI or GWR would suit me better.
> However, keep in mind that Buffett doesn't always swing for the fences.
> He likes what he knows and stays in his comfort zone. He is familiar
> with BNI management, and I feel likes the dividend as well. CNI is
> more of a growth story.
>
> Thanks for the question,
>
> Chuck

Nov 04 10:23 AM

[1more4me:]

Seems to be a lot of Buffet Cheerleaders ready to high-five the Oracle but really- Why such a premium?
The position he originally built was around the $75. ps mark in mid-2008. Why did he wait till now to pull the trigger? I'd call it a horrible misstep and a full 6 months late! He's waited till the shares have appreciated 40% from March lows then overpaid another 30% in premium.
In March I piled the full "Safe" 20% of my portfolio into KSU. That has proven a 90% gain since (to BNI's 40%). That as well makes me wonder why did he go with the biggest RR with the least remaining room to grow? The ability to take on future acquisitions of other RR's will be BNI's most valuable ability- and even them your better off in the one being acquired...

Well, I could whine all day but that won't make me money- guess I'm just mad that Mr. Carnevale compared BNI to KSU- as if to shine a bad light on poor lil' KSU.. Since BNI has a 2000% larger market cap, a little less % of debt, and yet still managed a meager 2.8% growth rate... I'm sticking with KSU and going to keep my back-ups as CN and CSX...

Appreciate the effort and good analysis in any case.

Nov 04 10:37 AM

[User 90391:]

Great article. Some interesting comments, yet this is always my favorite: "I am afraid Warren Buffett is getting too old to calculate relative valuations correctly. "

It seems as if every time Buffett makes a big move, I see this comment and I laugh more and more each time. For those of you who know Buffett (as the author obviously does), I am sure you know what I mean.

I think Buffett ideally would have liked to have picked this up in March when prices were depressed, but he wasn't going to pump $30B into an investment when the chances of a depression were still present. Now that he senses we've avoided disaster (at least temporarily), he will begin to deploy the cash he has been sitting on since arguably the mid-80s.

BRK has a constant flow of billions coming in and it's now Buffett's job to deploy that cash in safe, above-average yield investments. At this size, he'll never hit the homeruns that he used to, but he's quite content hitting single (Goldman) after single (GE) after single (BNI) for a .400 average.

One commenter put it best, "BRK is supposed to grow at 20% not 12%." After all we've been through lately, I'm not so sure a safe 12% is that bad.

Nov 04 10:38 AM

[bobbobwhite:]

Yours is the closest to any reply I could make, and you already said it. Buffett way overpaid for his John Wayne-style, early-American patriotism that seems more emotion based than reason based this time. And, relative to railroad transport, America should use its vast NG resources before using coal, and leave coal safely in the ground until tech improves the burning systems necessary to allow cleaner air.

Also, I have noticed over the past few years that Warren is acting more on emotions as he ages. That is a typical aging pattern but is also a dangerous and risky departure for him. I do not think this buy will be a great thing for Berkshire, not terrible, just a ho-hum one over time and certainly not worth the price paid in returns given.

On Nov 04 12:10 AM Mark Anthony wrote:

> My comment is Warren Buffet has good big picture view, bad timing
> and bad pricing. Every one in the world has known for two years that
> Warren Buffett loves railways. He openly talked about it more than
> two years ago. So why why he picks a time to pay nearly the higest
> price? Way over-paid.
>
> If he likes railway, Chinese railways are way much better play. The
> capacity of China's railways transportation is stretched tot he extreme.
> Whole America's railway system has excessive capacity that is idled.
>
>
> If he likes commodity and transportation play, he should be buying
> coal mines, and he should be buying dry bulk shippers. Both sectors
> are dirt cheap compare with railways.
>
> seekingalpha.com/autho...
>
> I am afraid Warren Buffett is getting too old to calculate relative
> valuations correctly. There are so many good under-valued assets
> around at dirt cheap price. Railway will be the last thing I will
> pick up. It's going to be good, but just not as good as other things.

Nov 04 11:22 AM

[JeffDB:]

It may turn out to be a great investment, but one perhaps small downside is that S&P has moved BRK to their "watch negative" list because it reduced the liquidity for the insurance reserves, and concentrated their exposure somewhat, making them a little less secure for insurance purposes in an adverse environment if/when those reserves are needed.

www.zerohedge.com/arti...

Nov 04 01:25 PM

[Dave Shafer:]

Interesting article, even more interesting comments. Some people just don't get what Buffett does, but that's alright because there are many ways to make money. As an owner of B shares of BRK, I am thrilled with the purchase and see it as further proof why Buffett has outperformed everybody else for the last 40+ years.

Nov 04 01:44 PM

[Edward Ulys...:]

Looking a little deeper at Buffett's railroad transaction, one might get the feeling that one had just been sold out. That's why today's commentary at GreatRedDragon.com was:
11/04/09 - Buffett Buys BNI with OPM to Lead NASCO Efforts
Sometimes, things are not as they seem. Hope I'm wrong.

Nov 04 01:58 PM

[valuemodel:]

First, thanks to the author for the analysis, and its focus on the long-term returns in this prosaic workhorse of an industry.

There are many good comments by the readers: it is always good to debate both sides of an issue. I respect Buffett; however, I fall into the camp of the skeptics on this acquisition: the Buffett of the 60s would probably have gone ahead and bought BNI at substantially lower prices a few months ago, in spite of concerns about a depression. He would certainly have been well-acquainted with the company and its management by this point. If I were a reporter, I would have loved to ask him why now? Is he reacting to those like Jim Grant who argue that the economic pendulum must swing as strongly to the right as it has to the left?

For myself, since expectations (a psychological phenomenon) are closely linked to consumption, inflation, etc., I also think about Buffett's charisma, and its potential to "create" events, a kind of self-fulfilling prophecy as it were. A year hence, we may see this as an inflection point in the economy because of the effect of Buffett's statements, especially, “Most important of all, however, it’s an all-in wager on the economic future of the United States.”

On another note, in reference to the news today about GS and Buffett buying tax credits from FNM et al, they might help raise those modest-sounding 12% RORs...

Nov 04 03:42 PM

[ACEMAN:]

Y'alls are missing the real picture perfectly painted by brother Mark Anthony; Buffett is no superman coming to the rescue, he's missed the mark on his valuation and y'all are going to pay for it too! Railroad over capacity, absolutely, righteously correct. It's the coal pipelines that will feed Mid American deals, but at this price it is all wrong. Who benefits here? Massey, Arch, Peabody and utilities generating electricity from good ol' coal? If that is the deal, then he has lost his valuation mind, 'cause if he really wants to make money for his investors he should be invested in Chinese railroads that are bursting at the seems and will now be the beneficiaries of the New Chinese stimulus to increase domestic rails to meet the ever increasing demands for rails to the 400 million folks in China who are about to create 20 new cities. And what do these folks need? They need electricity supplied by coal. And yet China does not have the coal capacity and thus is buying up coal inventory in Australia, Canada, Brazil, South Africa, Chile and Peru: coal and railroads go together like good beignets and hot coffee in
the Café du Monde

Nov 04 07:20 PM

[Jay7:]

if he liked BNI so much he should have bought months ago at its low.....

Nov 05 08:29 AM

[gjg49:]

no one in these comments asked a very important question: why did BNI's board and, most importantly, BNI's management decide to sell the whole company now rather than years from now at a presumably much greater value (i.e. price)?

buffett talks about waiting for people, probably most often private family-owned enterprises, to want to sell their businesses and then scooping them up for what will be the most advantageous circumstances for the sellers, the employees, and the customers of the firm. from the seller's perspective, this deal does not contain any components of what buffett generally seems to practice--well, maybe it will be good for the employees. as examples, recent deals for buffett resolved family issues for privately-owned mars and for the pritzker family with marmon/hyatt--how does BNI reflect any intractable issues that the sellers might face?

so, two questions:
first, if BNI holds such a promise of great long term value, why would BNI's management (not just the ceo, but the promising up-and-comers etc) want to effectively reduce their bets on what they can control, BNI itself, and instead stake their longer term futures on the vast and diffuse BRK empire??

second, why has buffett chosen this time to seemingly break his own very-well-tested modus operandi on acquisitions (yes, he bought all of flight safety and dairy queen, but these were relatively small and had somewhat special circumstances from the sellers perspective) and buy 100% of a large company??

buehler, buehler?? ...anyone, anyone ???

disclosure: i own some brk/b and bought bni last week as a risk arbitrage play.

Nov 09 08:38 AM

[Cinderpath:]

I'd be real careful about CN, the rail-industry's common metric, their (CN) operating ratio for years has been unrealistically low, besting BNI's. How? It's simple CN has a deplorable program of deferred maintenance. (Which has led to a spate of costly derailments and accidents). When CEO Hunter Harrison retires this year, his successor will have to spend tens of billions to bring their infrastructure,track, etc back up to the conditions of its peers, and this will cost investors money. I dumped CN a while ago. . The countries best run railroad aside from BNI is NS. Eventually someone (Canadian Pacific?) will buy KSC to get their Mexican trackage. That's the good bet.

Nov 14 10:38 AM