How to Play Buffett's Big Bet on America

Last Sunday morning, I embarked on a spirited 60-mile bike ride with a few like-minded 50-somethings. Our route took us along the beautiful Delaware River. The Delaware – named after the Indian tribe that crossed its waters – defines the north-south border between New Jersey and my home state of Pennsylvania. As we stopped to enjoy the view, we heard the unmistakable whistle of a steam locomotive. We looked up and there it was – New York, Susquehanna and Western’s number 142 – a steam locomotive pulling a line of cars along the Delaware.

One hundred years ago, engines like this – and the rails they ran on – were the backbone of the railroads. When it came to freight and passenger transportation in the United States, railroads were the only game in town.

Flash forward to this week. Warren Buffett – one of the most astute investors in the world – just placed a big bet. He’s gone “all in” on America’s future and bought a railroad company. So what does this mean for the railroad industry – and what’s the best way to profit from it?

Warren Buffett: Railroad Bull

“Railroads can [move freight] in a very cost effective way, and they do it in an extraordinarily, environmentally friendly way.

“Burlington Northern Santa Fe (BNI) last year moved a ton of goods 470 miles on one gallon of diesel. It releases far fewer pollutants into the atmosphere, saves enormously on energy consumption, and diminishes highway congestion.”

So said Warren Buffett in a CNBC interview after announcing that Berkshire Hathaway (NYSE: BRK.A) would pay $100 a share for the 75% of Burlington Northern Santa Fe Corporation that it didn’t already own.

Ever the optimist, Buffett said the decision to make the investment was easy:

“Rails last year moved more than 40% of all the ton-miles of goods in the country. They moved more than all those trucks… just the four big railroads. It’s a very effective way of moving goods.

“I believe that this country will prosper and you’ll have more people moving more goods 10, 20, 30 years from now and the rails should benefit. It’s a bet on the country, basically.”

So what makes those lumbering, seemingly endless freight trains so efficient? And are they really an attractive investment right now? Let’s take a closer look.

Rail Freight: From Bust to Boom

In the years after World War II, the advent of cheap fuel and a brand new interstate highway system led to the rise of “18-wheeler” trucks. As a result, the railroads fell out of favor and inefficiencies and waste abounded.

The situation became so grim for the railroad industry that in the 1980s, the ton-miles per gallon rate for freight transportation was one-tenth what it is today. Many carriers went broke. In the intervening decades, 40% of U.S. railroad track was abandoned. Much of it was ripped up and sold for its scrap value.

But what a difference a few years makes:

• With the reality of “Peak Oil,” the nation’s railroads now carry 43% of all freight – nearly 50% more than all the trucks on the road.
• Rail transportation is more than three times as efficient, too. For example, you can move one ton of freight an average of 400 miles on one gallon of diesel. Compare that to trucks, which move one ton a mere 130 miles on a gallon.
• Hauling capacity is relatively cheap, too. The average cost for a new freight car runs about $81,000 – roughly one-third the cost of a new tractor-trailer truck. And you can string as many as 150 of them together behind a few diesel locomotives, which just adds to the operating efficiency.
• Nearly all heavy industries need cheap, bulk delivery. And products from cars to coal are already served by rail. Plus, unlike trucks that have to negotiate city streets and narrow roads, rail lines go under and over them. And they always have the right-of-way.

What’s more… the bulk of the railroad infrastructure is already in place, without the need for much addition. The system has plenty of excess capacity and serves all major cities and towns across America.

According to the American Association of Railroads, there are about 24,000 locomotives and 460,000 freight cars in the United States. They move around on 140,695 miles of maintained track.

Ride the Rails to Profit With Berkshire Hathaway

Burlington Northern Santa Fe isn’t the only railroad that Berkshire Hathaway owns. It also has stakes in Union Pacific Corporation (NYSE: UNP) and Norfolk Southern Corporation (NYSE: NSC). Both stocks rose on the announcement – and both are up significantly since Buffett bought them.

So if you want to jump on board the railroad industry with Buffett, consider Norfolk Southern. Here’s why:

• The company’s 21,000 miles of rails touch nearly all heavy industries in 22 states.
• It serves every major container port in the eastern United States and provides excellent connections to western rail lines.
• Its Crescent Corridor project – an existing 2,500-mile rail network that supports the supply chain from Memphis and New Orleans to New Jersey – is undergoing a $500 million upgrade and expansion.
• Three new terminals will be built in Franklin County, PA, Memphis and Birmingham. Track improvements and additions will result in faster freight transportation, efficiency and reliability. And it’s estimated to generate 47,000 jobs in the five partner states.

In his CNBC interview, Warren Buffett commented that businesses we’ve not yet imagined, run by people not yet born, will continue to fuel the United States. And consequently, he expects rail tonnage to increase, with the railroad industry benefiting.

“America’s best years lie ahead. There’s no question about that,” Buffett told CNBC. And with his full purchase of Burlington Northern Santa Fe, he’s putting his money where his mouth is. The move is a bet on the United States, its citizens and the American spirit.

Nice going, Warren. We need more patriots like you and T. Boone Pickens.

Author's Disclosure: none.

Comments

[Roger Knights:]

Perhaps one aspect of WB's thinking is that the cost of CO2 emission controls will impact trucking more heavily than railroads.

Nov 06 07:51 AM

[Value Added:]

It seems disingenuous that Buffet is "betting on America" - that sounds like political nonsense. Buffet bets on low-risk, high return investments wherever he finds them, anywhere in the world. He probably has some knowledge about BNI's position that is not widely known; either with respect to probable legislation or BNI's markets that most analysts have missed. He is not a man to throw money at sentimentality.

Nov 06 08:51 AM

[bluesmoke:]

As the price of oil rises, I suspect you will see the trucking industry switch over to natural gas.

Nov 06 09:37 AM

[Texas_Techn...:]

I think what WB is betting on is: A US highway infrastructure that is crumbling (you think the cost to "fix" healthcare is high....) while investments are targeted more often towards expansion (priortized by politicians) than fixing what is already there....play that out for 10 years and you have a mess. The railroads continue to expand, and maintain. They prioritize their spending using science (predictive maintenance) rather than politics. As this plays out over the years railroads eventually become the most economical and dependable way to move freight across the county...the interstate system will be a logjam.

Nov 06 10:37 AM

[satyr:]

Value Added, you make a salient point. Not to say that Warren has no heart. But he is a capitialist and is looking for ROI wherever he can find it. He is also as inside government as Goldman Sachs at this juncture (and also inside Goldman Sachs). I would not make the mistake of viewing anything he says or does as altruistic.

Nov 06 12:23 PM

[chris coonan:]

Warren's bet isn't on America, it is on the high price of Oil! RR's will gain, and trucking will lose....even in decline, America will still move goods coast to coast...so it is a safety bet, and one that capitalizes on high oil prices and unfortunately more misery for the typical, penniless American citizen.

It is good Berkshire is investing at home, but that is as far as I would go with it.

Nov 17 07:46 AM

[chris coonan:]

Warren is wise, but he isn't outside of the Plutocracy. As a major holder of Insurance companies, Goldman Sach's, and even DQ (betting on the obesity of America)....we even have DQ in China now. The RR bet was a buy America gesture, but it was also a shrewd chess move.

Nov 17 07:50 AM