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Why Berkshire is undervalued with the purchase Burlington Northern Santa Fe

|Includes: BNI, Berkshire Hathaway Inc (BRK.A), BRK.B

In the long term, BRK is undervalued because of the positions it has. But the one that really makes it undervalued is Burlington Northern Santa Fe (BNI) railroad.

Railroad industry was one the most proficient industries since it inception in the mid-1800s to the 1950s when it experienced a decline that made it into nearly a defunct industry subsequently. What caused the decline in railroads in the 1950s were two factors.

The Interstate Highway System was built under the Eisenhower administation, arguably the largest public works project in the history of mankind exceeding that of the Panama Canal, the Suez Canal, the Hoover Dam, Transsiberian Railroad, The Chunnel, the Pyramids, etc.  Petroleum was very cheap back then because even domestic supply was more than enough to meet (an ever increasing) demand at that time. In fact, the United States used to be major oil exporter until later in the 1960s. So, as a result trucking freight was more efficient and flexible than rail transportion.

Another factor was the advent of the jumbo jet for airlines. Again, with fuel being relatively cheap at that time, passengers prefer a much faster way to get from point A to B.

These evolutions had major socioeconomic impact in almost every way. Even Major League Baseball franchises that havelong been located mostly in the northwestern United States and only went as far as St. Louis before, expanded to new virgin markets further westward. New teams formed in those areas or were absorbed into the MLB. 

America relied on cars more than ever because of the socioeconomic circumstances which also includes the emergence of suburban communities (the so-called "white flight") in the 1950s. With the expansion of the middle-class in the 1950s, not only could people could afford cars during the boom times, they were also essential when living out in the more distant suburbs.

In the background of all this, came the emerging auto insurance market. This is where Buffet really made his fortune more than Coca-Cola or any other investment. If I am correct on this, Berkshire Hathaway gradually bought up shares of Geico in the 1980s and 1990s until Buffet purchased it entirely.  Why?

The United States has the largest auto insurance market in the world by far in which Geico is one of the largest. The average American is much more likely to own a car or two than own a home, a life insurance policy, or have health insurance. And as far I know, all 50 states in the Union requires auto insurance with a car. And with such relatively low overhead and the amount of float such a business produces, the cash flow of and cash float available to Geico (and BRK) is enormous which allowed Buffett to make large investments in stable and undervalued companies such as Coca-Cola and American Express.

Now, with the high cost of petroleum these days because of the high demands of globalization (and global industrialization), railroads are experiencing a industry revival in freight transportation and possibly even in passenger transportation. (Greyhound might get too expensive for some people). 

We could be seeing a renewed rise in railroads that can have the same kind of major socioeconomic impact as the Interstate Highway System, the jet airliners, and even the internet and wireless communications have had on our society.

That's the true hidden instrinic value railroads like BNSF has in the long term for which Warren Buffet bought out and that can best increase the considerable returns for a firm with the market cap size of BRK. 

Ironically, Buffett, who basically made the car-related industry the cornerstone of his fortune, is now betting on another transportation system for the future because of the changing socioeconomic circumstances. Like his 100% purchase of Geico, he has the same vision and is also making the same kind of commitment to BNSF, in which he sees parallels with as he did with Geico decades ago relative to its respective circumstances. Even to a point that he split BRK's Class-B shares, a practice that he has long objected to to accomodate BNSF shareholders and avoid capital gains taxes.  

So, why BNSF? BNSF runs most of the lines west of the Mississippi River, a region that the fastest growing in the United States (along with the southeast). Cities like San Diego, Denver, and Phoenix are projected to be among the largest in the United States with L.A. overtaking New York as the largest in the country. With the future looking more towards Asia and the Pacific rim as the place for commerce, the western states are going to expand rapidly.



Disclosure: No positions on any of the firms mentioned