Is Berkshire’s Burlington Move All About Coal?

I had a feeling there was an energy component to the Berkshire Hathaway (BRK.A) decision to buy Burlington Northern Santa Fe (BNI). And now comes the evidence via coal, a major freight on BNSF’s tracks. But, there is a lot more to this acquisition than just hauling coal.

Warren Buffett has been increasing his energy plays in recent years, both in the U.S. and abroad. He has said repeatedly that he likes energy and power. His chief asset in the U.S. is Mid-American Energy, a major utility company whose CEO is often touted as one of the eventual successors to Buffett at the helm of Berkshire.

On the other hand, Berkshire was on record as hating the railroad business. When I was a panelist on BNN TV in Canada at noon Tuesday, fellow panelist Brian Milner, business columnist at the Globe & Mail in Toronto, mentioned that Charlie Munger, Buffett’s right-hand man at Berkshire, said two years ago he and Buffett hated the fundamentals of the railroad business. Rolfe Winkler has a good post showing that the BNSF acquisition is fully priced. So, what gives – why is Berkshire paying top dollar for a company in an industry with what it used to describe as poor fundamentals?

The answer is coal.

This comes via MarketWatch (hat tip PapaSwamp):

Berkshire Hathaway Inc.’s $44 billion deal to buy Burlington Northern Santa Fe Corp. is basically a huge bet on coal, a fuel that powers Warren Buffett’s power plants at his MidAmerican Energy utility and plays a major role in the railroad business.

While regulatory delays and uncertainty over climate-change legislation has slowed the addition of new U.S. coal plants, plenty of new facilities are expected to come on line in the United States, becoming prospects for future growth for the railroads.

Nine new coal plants have been permitted in the United States and 25 are under construction for a combined generation capacity of nearly 15,000 megawatts, according to an Oct. 9 report by the National Energy Technology Laboratory.

Moreover, Munger’s comments in regards to coal were more to the effect ‘we hated railroads for decades. But we love them now because the industry has consolidated, affording the remaining players monopoly-like rents.’ Given the fact that BNSF gets a quarter of revenues from hauling coal and this is a major feedstock for MidAmerican, there are a lot of synergies.

The Motley Fool talks about Munger’s change regarding railroads in a December 2007 post on Charlie Munger’s 10 Rules for Investment Success:

9. Be ready for change
Accept unremovable complexity.

Investing success requires us to accept inevitable changes. Munger and Buffett hated railroads for decades, but as the times changed, they threw their old thoughts out the door and invested billions. The world around us won’t always conform to our preferences and prejudices, and sometimes our best ideas will prove incorrect. If you aren’t willing to roll with a changing market, you may find yourself fighting a lost cause.

The Wall Street Journal’s Matt Phillips also believes Buffett has waited until the turn to buy these assets as freight traffic is off its lows earlier this year – something Buffett tracks as a proxy for aggregate demand. But, this is not a market call alone. When Berkshire buys a business outright, they are making a long-term investment.

Let’s see how this call turns out because Buffett’s record over the last few years has been less stellar than in the past as ‘largeness’ makes earning high returns more difficult. If you look at the timing of his Conoco Phillips (COP) and General Electric (GE) calls last year, there is ample room for doubt (Berkshire has since rotated out of COP). On the other hand, his Goldman (GS) preferreds are looking quite nice.

Note: Goldman Sachs was also BNSF’s advisor on this deal.

Other sources

Catching up: Buffett bought railroads, J&J, Comcast – USA Today, May 2007

Buffett’s Berkshire buys more shares in railroad – USA Today, Jan 2008

Comments

[Roger Knights:]

This bet also leaves less discretion for Buffett's successor to mess things up. Or affect things at all. Apparently he hasn't found anyone to fill his shoes. This may be a large part of his motivation.

Nov 04 02:08 AM

[John Petersen:]

Regardless of whether it's hauling coal for the short-term or hauling increasing amounts of freight over the long-term, BNSF should be very good for Berkshire. The development of North American rail was stunted by the development of the highway system. In a world where minimizing waste is important, rail will become critical. Several years ago I was delighted when my son-in-law quit his job at the airline and went to work for the railroad. This is just one more case where all things old are new again.

Nov 04 02:51 AM

[Freya:]

If the Chinese Coal aspect was the motivation, we should be looking at the coal companies more intensely.

Nov 04 03:23 AM

[H.J. Huneycutt:]

I think saying it's a "bet on coal" is an oversimplification. BNSF does depend on coal for a good chunk of their revenues, but growth is coming due to (a) consolidation in the industry, (b) a better operating environment for railroads, (c) higher oil prices, (d) problems associated with funding for the highway system that could potentially undermine the subsidizes that have benefited truckers for decades, and (e) environmental favoritism.

In essence, rail will grow because the future outlook for trucking is questionable at best. The trucking industry can't compete nearly as effectively in a world with $4/gallon gasoline and increasing tolls and fees.

As far as coal goes, BNSF is in the best position because Western coal tends to be cleaner than Eastern coal; but really, all BNSF has to do is maintain its current coal shipments. Coal doesn't have to see radical growth for the company to grow significantly over the next two decades.

Nov 04 04:58 AM

[Mad Hedge F...:]

bhy You’ve got to hand it to Warren Buffett, who never does anything half heartedly. The stunning news that his Berkshire Hathaway (BRK/A) 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, so you can kiss Cap & Trade goodbye. 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 04 06:23 AM

[GeoEnergy:]

Although coal may be a major short term reason for the purchase on BNI, this decision is likely a bet on the future of transportation in the US. In effect, this is a bet against oil and trucking.

Nov 04 06:54 AM

[chap08:]

I agree with H.J. Huneycutt above - think about what's going to happen to the trucking industry.

A smaller factor, but something worth considering, is the information value that Buffett is buying. He has said in the past that rail freight traffic is his most important economic indicator. A side benefit of owning BNSF is that he gets this information earlier and in more detail. You get to see the order flow that leads to the traffic, instead of just historic data on traffic. If you are running Berkshire Hathaway, then having your favorite economic indicator earlier and in more detail is worth a few $.

Nov 04 07:28 AM

[jerrydd:]

Coal is dropping in the US as it's now down 20% over the last few yrs to only 43% of US generation from 53%.

Coal plants are being canceled everywhere and many have been shut down or converted to NG cogen plants. Here in Fla they have canceled 4 coal units, instead going to solar, wind or NG cogen.

Betting on coal isn't a good bet now.

Nov 04 07:43 AM

[john s. gordon:]

Freya - BN makes lots of money hauling PRB subbituminous low-sulfur coal downslope to chicago etc. markets.
however the low energy content of that coal makes it noncompetitive in pacific rim countries. japan, china get lots of coal from australia, indonesia, philippines which are closer to market.
> jack

Nov 04 08:43 AM

[toobad41:]

I agree with most of the comments above. Transportation in the future will rely heavily on the rail system. Not just for coal but for all of industry and commodities in general. I have indicated in other blogs that the sun is setting on the trucking industry and the railroad will be up the slack. In fact, I have seen it in my own community where rail transportation has increased tremendously and the trains move at speeds of 60 mph through town. All of the cars are stacked two high with shipping containers.

Nov 04 08:44 AM

[vini:]

I think that Buffett's play is on rail growth that will increase because of the environmental benefits of using rail transport over trucking and air transport. It will be much quicker and most efficient to focus initial alternative energy funding at modifying railroads before trying to convert all the trucks to natgas or ethanol (they still haven't even switched from corn ethanol to switchgrass or some other source that is more efficient than corn). And it will be quicker than any innovations in airplanes. It is most efficient to complete the railroad conversion to electric and to build new electric rails by focusing the majority of the infrastructure funding at that.

Buffett vocally supports a Democratic government that will be spending on alternative energies and infrastructure, and he increasing his positions in every business that has links to government. Goldman and rail are obvious choices for him. And with the spending, the economical benefits of rail become more important as the commodities and oil prices inflate further when interest rates go up.

I was accumulating bni last year. I would have bought all of burlington northern if I had the money. It is the best investment in the US that is both short term (2 to 4 years) and long term (15 to 25 years), in my opinion. I'm so jealous of Buffett for owning bni.

Nov 04 12:15 PM