Intrinsic Value and Warren Buffett's BNSF Purchase

I’ve been hearing a lot about Buffett’s recent purchase of Burlington Northern Santa Fe (BNI).

Whether the choice of a partial stock deal means that Buffett considers Berkshire (BRK.A) shares to be overvalued, or whether Buffett is going “all in” in American stocks and commodities, or is he just making a last hurrah of asset allocation before retiring? Maybe he is simply bearish on the entire economy.

Whatever the reason, it will be easier to just wait until Buffett says something.

In the meantime, let’s take a look at whether Buffett is getting a good deal on BNI or paying a reasonable price.

Back in August, as I went through each of Warren Buffett’s stock picks in the Berkshire portfolio, I posted the following on BNI:

Burlington Northern Santa Fe Stock Value

Burlington Northern Santa Fe is a holding company and engaged primarily in the freight rail transportation business.

• Impressive FCF growth previous four years, and especially last year
• High capex, but latest annual result was extraordinary
• Lower sales and margins, but improved efficiency in returns and turnover
• CROIC is on the low side at 3%
• Top line growth is also above average at 14%
• Debt to equity ratio is above 200%, which isn’t uncommon for capex heavy companies

I came to the conclusion that the intrinsic value of BNI was $80-$140.

When I first calculated the intrinsic value of BNI, I chose to be conservative and reduced the latest year FCF by a significant amount as it was just too good compared to previous years. Not knowing about the details of BNI, I just left it at that and concluded that the intrinsic value had been reached at $87.

If I now go back to the intrinsic value calculator and leave the FCF number as is with a default 11.6% growth rate and 9% discount rate, the stock price calculation shows the following:

DCF Intrinsic Value: $104.30

Benjamin Graham Value: $102.67

From these numbers I can conclude that:

• Buffett is either paying a small premium to the intrinsic value of $87. About 15%, and not the 25-30% people are led to believe based on the closing date price of the announcement.
• ... or Buffett is paying a fair price for a company that will generate future cash for Berkshire Hathaway.

Typical Old School Buffett

Whatever the reason for the purchase, one thing is clear: The purchase of BNI wasn’t a cheap one. But like his investment in See’s, it could turn out to be one of his best ideas. He didn’t overpay by too much so the margin of safety should still be there.

Price is what you pay, value is what you get. - Warren Buffett

Disclosure: No holding.

Comments

[Dzog:]

This is my first commenting here - please consider this should the following may not be so very clear.

I haven't read anything related to the properties which BNI own
- Do these properties exist in areas that may be worth accessing (for precious metals/fossil fuels) and other hard assets that will become of value (in the event of hyper inflation or devaluation of the USD)?

As I understand it, Warren is most often a VERY long term guy - such being the case, it may be something to consider.

When I've heard that the Chinese (also VERY long term oriented) have invested many of their dollars in Brazil, the only country that has had major finds of proven oil reserves since 2002 (Norway too – although currently under dispute).

So, my point is I think all these valuation models mentioned above may be missing this dimension and Warren may be completely on top of it.

Nov 06 02:59 PM

[E Nuff Sed:]

The key asset Buffet looks for is "a wide moat". Railroads have the widest moat there is. Second, Warren is also looking to leverage - not financial leverage - but economic leverage.

Ask the question - which companies will leverage the improving economy the most- answer: companies which own capital. Like railroads, steel plants, heavy industries etc. This is as the man himself said - an all in bet on the "recovering" American economy and a $44 billion dollar snub to the bears.

Nov 06 03:47 PM

[Texas_Techn...:]

BNI property holding are primarily right-of-way on either side of their tracks....or rail yards in metropolitan areas...probably not sitting on oil or gas reserves. Most of the other real estate was taken in the 80's when the former BN holding company spun off the rail company and kept all the other assets (except for the $3.5b in debt it let the RR keep).
With that said, the rail right-of-way is where most of your major telecomm companies run their fiber...and it does have potential for other similar business models (pipelines, electric lines, etc.)...but the value of all that is not worth $40+b.


On Nov 06 02:59 PM Dzog wrote:

> This is my first commenting here - please consider this should the
> following may not be so very clear.
>
> I haven't read anything related to the properties which BNI own
>
> - Do these properties exist in areas that may be worth accessing
> (for precious metals/fossil fuels) and other hard assets that will
> become of value (in the event of hyper inflation or devaluation of
> the USD)?
>
> As I understand it, Warren is most often a VERY long term guy - such
> being the case, it may be something to consider.
>
> When I've heard that the Chinese (also VERY long term oriented) have
> invested many of their dollars in Brazil, the only country that has
> had major finds of proven oil reserves since 2002 (Norway too – although
> currently under dispute).
>
> So, my point is I think all these valuation models mentioned above
> may be missing this dimension and Warren may be completely on top
> of it.

Nov 06 03:50 PM

[CaptainJJack:]

Warren already owned a substantial block of BNI before he made his $100/share bid. I am guessing his cost basis, overall, is in the mid 80s.

For that he gets to own the whole company. Paying a premium to control the whole deal is VERY common.

I own BRK and BNI, and I think this was a very, very good deal long term.

In the short run, I see it as okay, but not great. Since I've owned both BNI and BRK for years, I can wait

Nov 07 09:01 AM

[Perki:]

I believe most of the Burlington legacy railroad mineral rights were spun off in the 1970's to Burlington Resources. I think BR ended up as part of Conoco-phillips.

The motivation to buy seems fairly simple:
He wanted a "big" acquisition, to move out of USD and into hard assets. Railroads are a dependable but boring business, and when you have an extraordinary manager like Mr. Rose, who can squeeze a bit of extra profit out of it, you have a profitable situation with stable returns.

Restructuring LT debt with the better credit rating of Berk, and you already have a nice reduction in interest expenses.

Asset heavy companies do well in inflationary environments, railroads can increase market share, vis-a-vis trucking, in times of high petroleum prices.

Nov 07 10:44 AM

[long_on_oil:]

BNI management knows they are being acquired by a hands off owner so that is appealing to them. I love reading these Buffet articles where everyone is a mind reader. You can bet one thing and that is Buffet knows exactly what the intrinsic value is and he will not overpay for the acquisition.
We owners of BRK know this, that is why we own BRK in the first place. We have not kept BRK the past 2 years for the capital gains, that is for sure. If you were to put BNI together today you can bet it would cost way more than $200 a share. Heck, you couldn't purchase 32,000 miles of right of way and lay the tracks for that.

Nov 07 11:52 AM