When in Doubt, Follow the Leader: Warren' Been Working on the Railroad

By Jason Simpkins
Staff Writer

Warren Buffett’s Berkshire Hathaway Inc. (BRK.A, BRK.B) has been on a railroad kick since early this spring. This run along the rails by the so-called “Oracle of Omaha” began in April, when Berkshire Hathaway made its first move on Burlington Northern Santa Fe Corp. (BNI), the nation’s second-largest railroad. 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, we learned that Berkshire boosted its holdings in Burlington Northern by 2.5 million shares. 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 on another railroad buying binge, loading on an additional 3.3 million shares at $80 each. Its total stake in Burlington now stands at 52.1 million shares.

There’s no telling just what precisely has motivated Berkshire’s buying spree, but here are a few things to consider …

Background on Berkshire

When it comes to successful investing strategies, mimicking the moves of a professional investor with a long-term record of success is not a bad approach.

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 is a perennial out performer. Over the past year alone, Berkshire Hathaway’s “A” shares are up 24.4%, compared to about 10% for the Standard & Poor’s 500 Index. And over the long haul, the difference is even greater [see accompanying stock-price chart].

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.

And 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.

Buffett also looks for value, although he defines that much more liberally than did his mentor, the late Benjamin Graham, who used a rigid, math-based methodology to ferret out stocks that were trading at a steep discount to their true net worth – and that had a “margin of safety,” besides. Buffett uses those techniques, but has proven masterful at valuing such intangibles as a product line, a specialized customer base, the value of a brand or franchise, or a dominant market position.

Railroads may not be the fast growing – and largely unknown – small-cap companies trading at steep discounts to their actual net worth, or at extremely favorable Price/Earnings (P/E) Ratios. But they 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 very high 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 “Keep on Trucking”

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 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.

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 is instrumental in the transportation of imported Asian goods. In fact, many containers coming into U.S. ports are delivered to shore and then placed directly onto Burlington Northern flatbed cars. 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.

Companies that Berkshire takes such a liking to normally experience a rush of popularity among the investing masses, whether it’s sustained or not. In this case, it might not be a bad idea tag along for the ride, even if you want to ditch the rest of the bandwagon jumpers for a quick profit.

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