Railroad Play Burlington Northern Hauling Gains for Warren Buffett's Berkshire

By Jason Simpkins
Associate Editor
Money Morning

Warren Buffett is working on the railroad – again.

Last month, the iconic investing guru once again displayed his enthusiasm for railroad stocks by adding to his already sizeable stake in Burlington Northern Sante Fe Corp. (BNI). After picking up 7.85 million shares of Burlington in early October, Buffett’s Berkshire Hathaway Inc. (BRK.A, BRK.B) last week added another 825,000 shares to its holdings at a price of $79.65 apiece

Buffett has been bullish on railroad stocks for the past year. Buffett made his first move on Burlington Northern in April 2007, acquiring nearly 40 million shares – close to 11% of the railroad. That August, Berkshire went shopping again, loading on an additional 3.3 million shares of Burlington. He added another 6,000 in September.

Buffett continued the trend in 2008, adding 10,300 shares of Burlington to his holdings over a two-week period that ended Jan. 22.

With the purchases made last month, Berkshire’s total stake in the Fort Worth, Texas-based railway has climbed to 18.9%.

And Burlington Northern hasn’t disappointed. Just last month, the second-largest U.S. railroad reported a 31% increase in third-quarter profit. For the three months ended Sept. 30, the company reported net income of $695 million, or $2.00 a share – a 31% increase from the year-ago results of $530 million, or $1.48 a share last year. Revenue jumped 20%, reaching $4.91 billion.

“While we are all concerned about the current financial and economic situation, we continue to be optimistic about the future of our diverse franchise and we remain confident about our long-term prospects,” Matthew K. Rose, the company’s chairman, president and chief executive officer, said in a statement.

Warren Buffett is confident, as well, though not to long ago, Buffett himself wrote off the entire railroad industry as a poor investment.

Warren and I have hated railroads our entire life,” Charles T. Munger, the vice chairman of Berkshire Hathaway, said last year. “They’re capital-intensive, heavily unionized, with some make-work rules, heavily regulated, and long competed with a comparative disadvantage versus the trucking industry, which has a very efficient method of propulsion (diesel engines) and uses free public roads. Railroads have long been a terrible business and have been lousy for investors.”

The reason for the change of hear can be attributed to three factors, says Burlington Northern’s Rose.

I refer to it as a ‘three-legged’ stool,” Rose told BusinessWeek. “Fuel, congestion on highways, and carbon.”

Burlington Northern On Track

Diesel prices have more than doubled in the past five years, and trains use only just a quarter of the fuel that trucks do. Even with the recent decline in oil prices, Rose says railway transit will maintain an advantage over trucking as long as crude stays above $25 a barrel. 

Just to be on the safe side, Rose acquired 200 fuel-efficient locomotives from General Electric Co. (GE). The engines burn 20% less fuel than their predecessors, BusinessWeek reported. Additionally, Burlington Northern next year will become the first company in the industry to deploy a hydrogen-powered locomotive.

More fuel efficiency not only shields Burlington Northern from high oil prices, it also gives Rose an extra bargaining chip when it comes to dealing with more environmentally conscious businesses.  For years now, Burlington has provided potential customers with data showing exactly how much more carbon-friendly their hauls would be if they used trains instead of trucks.

For instance, a train carrying 100 tons over 1,000 miles produces 45% less pollution than a long-haul truck does, according to Burlington.

In addition to being more fuel-efficient, Rose makes the argument that trains are simply more efficient – period.

While it takes just two train employees to drive a 9,000-foot, 300-car train, it would take 300 truck drivers to move the same amount of freight.  That is, in part, because of new regulations enacted in the trucking industry that cap the total number of hours a driver can spend behind the wheel.

And unlike trucks, trains don’t get stuck in traffic – accounting for the third and final leg of Rose’s “three-legged stool” – traffic congestion.

“Congestion costs the industry $8 billion a year,” said Ray Kuntz, president of the American Trucking Association. “And it’s growing at 8% to 10% per year.”

No doubt, Burlington Northern is exceptionally well positioned.

The company controls approximately 32,000 miles of railway track throughout the United States and Canada. Burlington’s rails cover two thirds of the continental United States and its abundance of West Coast rail terminals and make it a vital artery in America’s Asian trade network. 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 five years, U.S.-China trade has increased by 114%, reaching $386.7 billion.

Burlington has expanded its operations in lockstep. Rose spent $2.6 billion, or 16% of the company’s $15.8 billion in 2007 sales, to expand and improve the company’s rail network, BusinessWeek reported.

“Railroads – now, that’s an example of changing our minds,” Berkshire’s Munger said. “We threw out our paradigms, but did it too late. We should have done it two years ago, but we were too stupid to do it at the most ideal time.”

Berkshire may have been a little late, but the train still hasn’t left the station. Shares of Burlington Northern closed at $89.06 Friday, up $2.47 – or 2.85%  – each.

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