As a counterpoint to Joe Weisenthal’s belief that Burlington Northern (BNI) is only a good value to Mr. Buffett based on the prospect of liberal politics delivering stimulus and benefits for railroads, we’d like to highlight the following.
The entire modernization and renaissance of the U.S. freight railroad system came as a result of massive deregulation back in 1980, oddly under President Jimmy Carter. Since then, the U.S. freight railroad system actually became one of the most efficient and innovative in the world.
While Warren Buffett and BNI shareholders may enjoy the benefits of some government stimulus dished out by a liberal government, this is unlikely to be the Oracle’s reason for buying. In fact, BNI shareholders should fear ‘liberals’.
Despite some valuation metrics that some railroad bears may present, they forget the compelling long-term story for U.S. rail — Basically, railroads enjoy massive barriers to entry since nobody will be able to recreate their rail networks. It would be nearly impossible for a company to get the vast inter-connected land ownership such a feat would require today.
Thus railroads have extremely high barriers to competition. They only need to contend with existing rail players, and alternative forms of transport. On this, they’re doing just fine. Value Line expects BNI to earn over $10 a share in cash flow per share in 2010, which puts Buffett’s purchase at just 10x this number. Not bad for a business with massive barriers to entry and a long future ahead of it.
In addition, one must remember that railroads have the substantial ability to cost effectively scale up once in place. For example, you can simply add a track alongside and existing one and double capacity. Or you can de-bottleneck certain bridges and overpasses to allow for double-stacking of containers, again basically doubling capacity. Such scaleability means that U.S. railroads have enormous economies of scale against trucks, and vast economic moats defending their businesses.
As the American economy grows well into the future, the established railroad networks will thus be able to capture growth in economic activity as some of the most cost competitive ‘veins’ of the country. As more blood flows, they will naturally have more traffic. As long as they can be competitive with trucks of course, which is highly likely to be the case due to strained U.S. road infrastructure and the common sense nature of rail travel for longer-distance delivery. (Trucks will always be there to then split up loads and spread out from distribution nodes)
Thus the main threat to railroads doesn’t come from a free market, but actually from a return to the harsh regulations which strangled America’s rail competitiveness in the past. This would likely come as a result of liberal outrage towards what appear to be rail ‘monopolies’. Any BNI shareholder should actually hope that liberals don’t become too powerful, since then they might start clamping down of railroads ability to make business decisions, raise rates, and cut costs.
The author owns shares of BNI.