Warren Buffett's Berkshire Hathaway is Riding the Rails Again

Warren Buffett's Berkshire Hathaway Inc. (BRK.A, BRK.B) – on a railroad kick since early this spring – has purchased 6,000 more shares of Burlington Northern Santa Fe Corp. (BNI), the latest in a series of significant railroad-share purchases made by the Omaha investment firm.

Berkshire Hathaway purchased the shares of the No. 2 U.S. railroad on Thursday, bringing total ownership to nearly 53 million shares – equal to about 15% of the company, according to a new Securities and Exchange Commission filing. In that Form 4 SEC filing, the Buffett-led Berkshire reported that it bought the shares for $79.97 apiece on Thursday. Burlington Northern shares closed yesterday at $81.56, up 67 cents each.

In that same SEC filing last week, Berkshire reported that it has options to acquire another 7.85 million shares of Burlington. If all those options are exercised, Berkshire's total ownership stake in Burlington would climb to 17.2%, according to a CNNMoney.com report.

Berkshire reported in an SEC filing last week that it has options to buy 7.85 million shares of Burlington Northern. If the company exercises all the options, it would increase its stake in Burlington Northern to 17.2%. The 15% stake Berkshire already owns is worth more than $4.3 billion.

Berkshire paid $39.10 for each option with an exercise price of $40 per share, CNNMoney.com reported. That means the company could acquire the Burlington Northern shares at a cost of $79.10 each, well below yesterday's closing price of $81.56 a share. The options give Berkshire until Oct. 3 to decide whether to exercise them. But the company can also extend that deadline by a month to Nov. 2 by paying an additional premium.

The options reported last week are apparently in addition to 7.46 million more that were reported by Berkshire in a Sept. 4 filing with the SEC. Those options, also, expire on Oct. 3.

Warren's Been Working on the Railroad(s)

The so-called "Oracle of Omaha" has been on a major railroad-buying binge since April, when Berkshire Hathaway made its first move on Burlington Northern. In a series of highly publicized moves, Buffett & Co. acquired nearly 40 million shares, or close to 11% of the railroad. Berkshire also snapped up 10.5 million shares of Union Pacific Corp. (UNP), and 6.4 million shares of Norfolk Southern Corp. (NSC).

At the very end of August, investors learned that Berkshire boosted its holdings in Burlington Northern by 2.5 million shares. SEC filings said he also bought a block of 6.8 million shares on Aug. 23 and Aug. 24.And we now know from filings with the U.S. Securities and Exchange Commission (SEC) that Berkshire bought a total of 6.8 million more shares on Aug. 23 and Aug. 24.

On Aug. 27, Berkshire went shopping again, loading on an additional 3.3 million shares at $80 each. Its total stake in Burlington now stands at nearly 53 million shares.

While there's no telling just what, specifically, prompted Berkshire to move so aggressively into the railway sector, Buffett has been one of the shrewdest U.S. investors over the past five decades, so there are a few things to consider …

Buffett Basics

When it comes to successful investing strategies, mimicking the moves of a professional investor with a long-term record of success can be a shrewd move of your own.

Berkshire Hathaway, once a New England textile mill, became the holding company and financing vehicle for all of Buffett's other investments: GEICO Insurance, newspapers, furniture, jewelry and chocolate-candy companies; and major holdings in such firms as Wells Fargo & Co. (WFC), and Coca-Cola Co. (KO). [Indeed, for a book review of the very best Warren Buffett biography out of the many published, please click here].

As a stock, over long periods, Berkshire has been a perennial top performer. Over the past year alone, Berkshire Hathaway's "A" shares are up 25%, compared to about 14% for the Standard & Poor's 500 Index. And over the long haul, the difference is even greater.

As a long-term investor who often views himself as a "partner" of the firms that he buys into, Buffett has long favored very basic businesses that are easy to analyze and understand. Some of his favorite sectors include basic industrials, financial-services, and consumer-goods firms. For the most part, he's steered clear of high-tech companies.

There are as few things as simple, sturdy and time-tested as railroads. A six-year old with an MTH, Lionel or HO-scale train set could tell you just what a railroad does. And for an investor such as Buffett, an asset-intensive business like a railroad is likely a joy to analyze financially.

Buffett on ‘Value'

That last point is particularly important because Buffett also looks for "value," although his definition of the term is much more liberal than his mentor, the late Benjamin Graham, in determining just what constitutes a "value," or bargain, stock. Graham used a rigid, math-based methodology to ferret out stocks that were trading at a steep discount to their true net worth – thus providing a "margin of safety."

Buffett uses those techniques, but has proven masterful at valuing such intangibles as a product line, a specialized customer base, the value of a franchise or brand name, or a dominant market position, which he likens to having a "toll" booth in place on thoroughfare that travelers have to use.

Railroads are definitely not fast growing – and largely unknown – small-cap companies trading at steep discounts to their actual net worth. They're not even trading at super-favorable Price/Earnings (P/E) ratio. But railroads do meet several of Buffett's investing criteria:

• With their massive capital investments in rights-of-way, railways, rolling stock and locomotives, the railroad industry has the high "barriers of entry" that Buffett favors. Let's face it: John Henry, The Steel-Driving Man, isn't going to help hammer down any new railway lines anytime soon.
• The majority of railroad technology has remained unchanged for the last 50 years to 100 years, so there's little chance of some new discovery that could come along and "leapfrog" the existing know-how, rendering the current railways obsolete and bankrupt. [The chance of being "leapfrogged" is one of several reasons that Buffett has traditionally avoided technology-oriented companies].
• The odds are excellent that the current industry giants will remain industry giants. If anything, with the current trend toward consolidation in virtually every major global industry, the roster of large railroad companies may get even smaller.

Railroads Benefit from Global Shipping Boom

Buffett clearly sees that there is also a strong business case for railroad stocks, right now. For one thing, these giants are seeing a growing number of imports coming into the West Coast from Asia. There is a considerable need for the products in question to be dispersed throughout the country, and long-haul trucking, which has been the traditional solution, may be losing favor.

Industry labor shortages, tightening regulatory restrictions, and rising gas prices will likely give railroad companies an advantage over trucking. Ray Kuntz, president of the American Trucker Association, recently said in an interview with the Independent Record that demand for drivers keeps increasing, and finding and keeping good people is a perpetual challenge. "One problem," Kuntz said, "is that people can't legally drive [tractor trailer trucks] until they're 21, and many potential candidates have chosen other work by then."

Another problem is America's weakening infrastructure. The recent bridge collapse in Minnesota was a very tragic illustration of the disintegration of the U.S. highway system, bridges, water-and-sewer systems and other key components of the nation's infrastructure. Indeed, the Minneapolis bridge was just one of 73,518 "structurally deficient" bridges across the country that state and federal inspectors have deemed to be in need of significant repairs. The nation's highways are decaying faster-than-planned, too, due in no small part to heavy traffic that overburdens the roadways.

Then there are high fuel costs. Even if trucks are stuck in traffic they're still on the road and burning fuel. "Congestion costs the industry $8 billion a year, and it's growing at 8% to 10% per year," Kuntz said.
The situation has forced the trucking industry into a serious dilemma. It has been forced to lobby for higher fuel costs. Yes, you heard that correctly.

As Kuntz put it, "Our industry is ready for a fuel-tax increase, [the proceeds of which will be used to finance infrastructure upkeep and repair]. We believe it has to happen before our infrastructure gets in worse and worse shape and congestion costs get higher and higher. It's pretty evident that if we don't do something, we're headed for big problems."

U.S. diesel prices have more than doubled in the past five years, according to the energy department, and with mounting concern about global climate change, more efficient trains should end up pulling more weight.

With an abundance of West Coast rail terminals – and railroad tracks covering two-thirds of the country – Burlington Northern enjoys a big advantage in shipping imported Asian wares to markets all across the United States. In fact, many of the big shipping containers coming into U.S. ports are delivered to shore and then placed directly onto Burlington Northern flatbed railcars. Over the past four quarters, the company's cash flow has totaled nearly $900 million.

In an Aug. 31 filing, Berkshire told the railroad of its plans to increase raise its stake in the company to 25%. That would require the purchase of another 35.4 million shares, currently valued at $2.9 billion. That kind of purchase would depend on "market conditions," according to the notice provided to Burlington Northern.

Related News and Story Links:

• Forbes.com News Report:
  
  Berkshire Hathaway Buys More RR Shares.
• CNNMoney.com:
  Berkshire Buys More Options for Burlington Shares.
• High-End Model Railroading Wares:
  MTH/RailKing Railway.
• Massive Railroad Histories Index and Articles Index:
  
  Railroad Histories Up to 1935.
• High-End Model Railroading Wares:
  
  Lionel 2007

Tags: Berkshire Hathaway, Investment Experts, Railroads, Warren Buffett