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Buffett’s Burlington buy – passengers, not freight?

|Includes:Burlington Northern Santa Fe Corp. (BNI), BRK.A, CNI, CSX, FDX

ST. LOUIS (Alpha Found) — We have been surprised by the limited attention paid to the passenger rail strategy  that may lie behind Berkshire Hathaway’s [BRK.A], aka Warren Buffett, $44 billion takeover of the 77% of Burlington Northern [NYSE:BNI] that it did not already own.

BNSF indirectly ferries tens of thousands of rail passengers a year thanks to its ownership of track that is leased to government rail monopoly, Amtrak. We think part of Buffett’s bet may be based on a long range view of a new era of high speed rail travel.

We certainly don’t agree with some of the analysis suggesting that Buffett is betting on moving bulk commodities to the West Coast to feed China. It’s a stretch to think mined products (coal, copper etc) are a primary reason for the deal given that mining growth in the US is dying because of political opposition. There is a case to be made for farmed products, but it’s not very strong unless crop yields multiply and the barge business fails.

Similarly, we disagree with views that this is a bet America will be consuming more Chinese products, or adding China spawned intermodal traffic. Import consumption will grow – slowly for a good while – but there is plenty of current capacity to handle it. The intermodal transport is on the verge of a revolution as the Panama Canal widening project moves to completion. That project’s goal is specific – bypass intermodal transport in the US with post-Panamax vessels which are becoming a larger portion of the global container shipping fleet.

There is little reason to dwell on the coal business that dominates BNSF’s income statement at this time. We expect that to decline because it’s about coal fired power generation. The decline will be rapid, perhaps precipitous, if cap and trade becomes law. That would be a superb irony for a railroad that is marketing its green credentials!

Passenger rail renaissance

BNSF as a passenger hauler may seem unthinkable now given Amtrak’s special privilege to suffocate competition and harm customers who subsidize it via taxes siphoned off in Washington. However, America has fallen embarrassingly far behind the rest of the world in high speed rail travel. There now seems to be momentum developing, at least behind the scenes, to incentivize the development of new tracks and trains that would bring the US into the current century.

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Burlington Route Zephyr. St. Louis Transport Museum. (NYSE:C) Alpha Found

That doesn’t necessarily mean derailing Amtrak and its special interests. Amtrak can be left to own the Northeast Corridor, but it is likely that it will have to compete on equal terms in other markets.

BNSF would be ideally positioned to take advantage of a shift in the rail landscape, especially because it is so far from Amtrak’s home base. We see the change unfolding in two primary ways.

Firstly, the development of high speed, high frequency intercity trains over distances of 200-500 miles.

These trains would focus primarily on revenue from commuter traffic in distant dormitory suburbs of large cities. But it’s not hard to see business and tourism traffic following quickly as the trains defeat mid-range air travel.

Secondly, the development of rail hubs that mimic airline hubs to address the infrastructure bias that leaves large parts of the country without direct routing between major cities. Whilst commercial airlines presently serve this role, they do so inefficiently at distances of 500 miles and less.

Hubs would allow smaller trains (in terms of coaches) to run enabling good yield management and, therefore, high margins. The proposed high speed rail upgrade between St. Louis and Chicago would be a prototype provided the politicians don’t parasite it too much.

Other factors pushing toward a passenger rail renaissance include environmental, infrastructure, and congestion pressures.

The environmental issues are obvious, even with the bogus ‘carbon footprint’ removed. However, a more important driver may be state and federal highway dollars. It is simply cheaper per mile to maintain, police and service rail than road. With budget pressures only mounting in future years, we foresee traditional highway expenditures being increasingly diverted to mass transit.

For presently freight-focused rail companies a long-term move into passenger handling should be relatively straightforward. Capital expenditures would be relatively light, and we would expect a lot of cost-sharing on key infrastructure like passenger terminals and even electrification to replace diesel locomotives.

Passenger services would also provide a smoothing opportunity for revenue and earnings. That’s because mass transit gains business in weak economic conditions when freight struggles. Overall, the opportunity to take market share away from airlines is a better reason for freight haulers to consider the passenger market. There is also a very good case to make for taking market share away from Fedex and UPS in certain markets.

Timing? We would say a horizon of 15-20 years is reasonable to expect to see the envisaged passenger model taking shape. With the right incentives, it could be visible and viable within 10 years. But we just do not see the political will to achieve that.



DISCLOSURE: No Positions

Stocks: BNI, CNI, CSX, FDX, BRK.A