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Economic recovery must be coming. Warren Buffett says so. At least that's the assumption behind his decision to acquire 100 percent of the shares of Burlington Northern Santa Fe Corp. (www.bnsf.com), the nation's largest Class I railroad. The Sage of Omaha, who has a reputation for basing his decisions on solid business fundamentals, is putting his confidence behind a return to consumer spending, the consequent prospects of the rail industry in general, and the viability of BNSF in particular.
Actually, as Buffett made clear, it's more of a $44bn gamble. The chairman of Berkshire Hathaway Inc. (www.berkshirehathaway.com), the holding company that aims to acquire the 77.4 percent of BNSF shares that it doesn't already own, called his bid "an all-in wager on the economic future of the United States." And added, with characteristic frankness: "I love these bets."
It's no surprise that Warren Buffett loves railroads. In addition to its existing 22.6-percent interest in BNSF, Berkshire holds shares in Union Pacific Corp. and Norfolk Southern Corp., though it plans to dispose of those positions "well in advance of the closing of the transaction," BSNF said in a statement. Berkshire is offering $100 per share for BNSF, which was trading at around $97.20 as of midday last Friday.
Wall Street analysts like the move. Lee A. Klaskow of Longbow Research (www.longbowresearch.com) says railroads in general have fared relatively well in the recession. "There have been a lot of headwinds facing the rail industry. They have been showing that, despite being extremely asset intensive, they're able to change their cost structures and flex with demand." By overhauling operations, parking some equipment, furloughing employees and benefiting from a drop in fuel prices, the rails "have netted better results than expected," Klaskow says. The industry, he concludes, is an "extremely attractive long-term investment."
Longbow is neutral on BNSF's stock, although Klaskow thinks the company's shareholders "are getting a very good deal." He describes the railroad as "more or less the gold standard west of the Mississippi. It's done a good job of building out a robust network for intermodal and coal."
Longtime transportation analyst Anthony B. Hatch, now heading up ABH Consulting (www.abhrailconsulting.com), agrees that industry margins are holding up well in the face of recession. He expects the rails to continue to win market share from trucks, in addition to partnering with them on intermodal services. (Witness last week's announcement of a new, multi-year agreement between truckload carrier J.B. Hunt Transport Services and Norfolk Southern Corp., for intermodal operations in the eastern rail corridor.) The environmental advantages of rail over truck are yet another reason why trains should prosper in years to come, he says.
BNSF further stands to benefit from growth in international purchases of grain, one of the railroad's biggest-earning commodities, Hatch says.
Jon A. Langenfeld of Robert W. Baird & Co. Inc. (www.rwbaird.com) issued a report on the heels of the announcement saying he was "incrementally positive" about BNSF and the rail industry as whole. Berkshire's bid "supports our bullish long-term thesis on BNI [BNSF's stock ticker symbol] and on the rails given what we believe will be continued pricing power and improving returns that will substantiate higher full-cycle valuations," Langenfeld writes. "We recognize BNI as a best-in-class rail carrier based on consistency of service and financial performance over the past decade."
Boosting the railroad's prospects are recent investments in new technology, equipment and double-tracking of high-volume intermodal lanes, Langenfeld notes. The resulting efficiency improvements will "produce a lasting impact on the long-term margin profile."
With some 32,000 miles of track, BNSF is the nation's largest intermodal rail carrier, and has shown the highest rate of growth in that sector, Langenfeld says. But the company's heavy involvement in containers and trailers also raises some questions. Five years ago, western railroads were suffering from severe congestion on their routes and in transfer yards, thanks to a flood of imports from China. With business down in all sectors, that's not much of a concern today. But some experts worry that a resurgence in economic activity could mean a return to those days of bottlenecks and delayed shipments.
Not a problem, says Hatch. Investments made by BNSF in its system since 2004 should alleviate the impact of higher volumes. "I think there will be some degradation in service and speed, but a mild one," he says. Rail operations are much more efficient than before. Whatever happens, "this will be the real test of whether all that money, brainpower and technology really works. There are very solid signs out there to suggest it will be a lot different this time."
Also open to question is the degree to which trans-Pacific shipping lines need U.S. West Coast ports to move their containers inland. Another byproduct of congestion was the rerouting of many ships through the Panama Canal, to East and Gulf Coast gateways. With the opening of a third set of locks at the Canal in 2014, that trend will likely accelerate. The change tends to result in shorter inland hauls, making the economics of double-stack trains versus long-haul truck less attractive. The two major western railroads - BNSF and UP - would stand to lose the most from such a development.
Klaskow believes Southern California ports will continue to play a major role in the movement of goods to and from Asia, and that congestion won't be a big factor. "At the end of the day, there's plenty of capacity at [the ports of] Los Angeles and Long Beach," he says. "No one needs to not ship there because of capacity problems." Keep an eye, though, on fuel prices, he adds. The higher they go, the greater chance that trans-Pacific carriers will bypass the West Coast.
Maybe it all comes down to the continuing ability of Warren Buffett to make the right picks. For all of his wisdom in buying and holding sensible companies over the years, he's not infallible, having speculated in currencies and dabbled in those dreaded derivatives. Assuming the deal goes through, BNSF will be Berkshire's second-biggest operating company in terms of sales, so any slump in the rail industry could have a serious impact on the parent's fortunes. For now, Berkshire has tons of cash and needs a place to park it - so what better location than a sector that shows huge promise on its fundamentals, and stands to benefit from the inevitable global recovery?
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