Warren Buffett sees strong rail system as key to U.S. growth
Then on Feb. 12, he answered a call from Warren Buffett, the legendary investor who looks for long-term return and whose Berkshire Hathaway holding company had just closed on its $26 billion purchase of the 77% of BNSF shares it didn’t already own.
“Warren called me and said, ‘I’m looking forward to our first century together,’ ” Rose says. “I’d never heard an investor use the word ‘century’ before.”
When the deal — the largest purchase in Berkshire’s history — was announced in November, there was plenty of second-guessing. Was age finally catching up with the “Oracle of Omaha?” Railroads, after all, generally are viewed as 19th-century technology, and they’ve suffered big drops in shipping and revenue in the recession. And the 79-year-old Buffett is talking about an investment that pays off throughout the 21st century?
Buffett chuckles at the suggestion that buying the nation’s second-biggest railroad is a sign of senility. He argues that railroads represent the future. They’re best-positioned to haul the raw material and finished goods for a nation and economy that he insists are bound to grow. Unlike trucks, trains don’t have to compete on congested highways. Nor do railroads depend on strapped governments to maintain infrastructure.
“They don’t need the government to build them new highways and airports,” he says in an interview with USA TODAY. “They’ve already invested heavily in their infrastructure and technology, and they plan to invest more to keep up with the growing demand.
“They’re the only mode of freight transportation that can handle growth. What’s not to like about that?”
Buffett also laughs that his big bet on the future — taking what for him was the radical step of splitting Berkshire class B shares (BRKB) 50-to-1 to make the BNSF acquisition acceptable to the railroad’s shareholders — is a second sign he’s slipping.
“We didn’t split the A stock!” Buffett says in a half-joking defense of his competency. Berkshire’s iconic class A shares (BRKA) currently are priced at a jaw-dropping $122,090 each.
Nor would he have split Berkshire’s class B shares, priced at more than $3,000 a share before the BNSF deal, if he didn’t think his wager was worth it. When the class B shares were created in 1996 as a way for smaller investors to buy a piece of Berkshire, Buffett says the plan always was to execute a stock split if it became necessary to close an important purchase.
But he also intended to be pretty picky about what would be worth that step. A railroad is that purchase.
Buffett grew up in the 1930s and 1940s when folks in Omaha, the hometown he shares with Union Pacific, thought eating Sunday lunch at the Union Pacific station downtown was a sign of social sophistication.
And he confesses to a life-long love of railroads.
He has an elaborate model railroad layout on the third floor of his home for his children and grandchildren, though “it gets little action,” he says, because they don’t share his fascination and he has little time for it.
But buying BNSF (for Burlington Northern Santa Fe) is no nostalgia play. Buffett foresees a dynamic and profitable future not just for BNSF but for the nation’s rail industry; so much so that he chastises himself for coming to that view, he says, two years late.
“There are just four big railroads in the U.S.,” Buffett says. “I know the people who run three of the four, and they’re all good people. They will all have similar destinies. They will all do very well, especially Union Pacific and BNSF.”
Counting the $8 billion in BNSF shares Berkshire already owned, the $26 billion in cash it paid for the remaining BNSF shares, and the assumption of $10 billion of debt, Buffett has invested $44 billion in the railroad.
Rail also is a capital-intensive industry. Buffett says, “If anything, we’ll be investing more” in BNSF in the near term “as we build it for the future.”
His move has been good for the industry. When the BNSF buyout was announced, BNSF’s stock, which had been bumping along at around $77 a share, immediately shot to near Berkshire’s $100-a-share offer price. BNSF shareholders weren’t the only beneficiaries. Most of its rail competitors’ shares jumped, too, and, for the most part, have remained strong.
Several analysts suggest that as much as $18 billion has poured into the industry as investors bought other so-called class I rail stocks: Union Pacific, CSX, Norfolk Southern, Kansas City Southern, Canadian Pacific and Canadian National.
“Some of those who took money out of the BNSF deal wanted or needed to still be in rails,” says Morgan Stanley transportation analyst William Greene. “But, of course, there’s more to it than that. Some of that share (price) improvement in those other (railroads) is related to investors buying those names because they think the rail fundamentals are improving.”
Drawing lots of attention
However it’s attributed, the long-term value investment thesis for which Buffett is famous has become evident to other investors.
“Buffett is looking at (railroads) in terms of the long-term population and GDP growth in this country,” Greene says. Assuming a modest long-term economic growth rate of 2.5% and average annual population growth of 1.5%, “that translates into a lot of new goods being made and transported to a lot more people in this country over the next few decades,” he says.
“Then take into consideration that we’re not building new highways and ports in this country,” Greene adds. “That means there’s only one way to move all the extra stuff we’re going to have to move as our population and economy grow.”
No one argues that railroads are now good investments simply because Buffett has deemed them worthy. But his ability to spot a long-term value opportunity, and his willingness to move ahead of the pack, makes him one of America’s most closely followed investors.
“No doubt, Warren Buffett created a lot of positive press for the rails,” says analyst John Mims, who follows the industry for BB&T in Richmond, Va. “But the institutional investors out there aren’t going to be swayed as much by that as retail investors,” he adds, noting that only a sliver of rail shares are owned by individuals.
Yet, institutional investment managers sometimes miss trends. Even when they don’t, they can be reluctant to jump in until a prominent investor makes a bold leap.
“What Buffett did was highlight for everyone that this is just a real positive time for the rails right now,” Mims says. “(Shipping) volumes are getting better. Pricing is getting better. By announcing that Berkshire was investing $44 billion in a railroad, Buffett, with his track record of success, was endorsing the viability of the rails.”
Impact of ups and downs
But what if, as some economists continue to predict, a second half of a double-dip recession is headed this way later this year or next? What if, as some bears suggest, the U.S. economy goes into a prolonged period of stagnation and weakness, creating a Japanese-like lost decade or two?
“As long as it isn’t a lost century, I’m OK,” Buffett says.
“We used to call these things ‘panics,’ ” Buffett says of the recent recession. “In the 19th century, we had seven or eight of them. We had the Great Depression. We’ve had flu epidemics. We had the Civil War. But the person who bets on this country and its economy going backward is the guy who has to explain himself, not me.
“Since 1790, this (the USA and its economy) is the wonder of the world,” Buffett says. “The ingredients of that have not disappeared from this world; 9/11 and all sorts of things have come and gone, but the United States’ success story isn’t over.” That’s why he was comfortable in November calling Berkshire’s BNSF buyout an “all-in wager on the economic future of the United States.”
“Our country’s prosperity depends on its having an efficient and well-maintained rail system,” he said. At the same time, he said, “America must grow and prosper for railroads to do well.”
BNSF’s Rose says the industry, and BNSF in particular, is well-positioned to help the nation prosper. It’s already made huge investments in new technology, infrastructure and markets, he says.
After the industry was deregulated in 1980, Rose says, “The railroads spent the next two decades going on a productivity binge, wringing out excess costs, getting rid of inefficient lines, finding wage rates that we all could live within, both for employees and our companies. We think we are a very productive institution at this time.”
U.S. railroads were 144% more efficient in 2008 than in 1980, according to the Association of American Railroads, the industry’s trade group. In 2008, they carried, on average, a ton of freight 457 miles on one gallon of diesel fuel, up 5% from 436 miles just a year earlier. And the association claims that if just 10% of the freight that now moves by truck were moved to the rails, the USA would burn 1 billion fewer gallons of fuel a year.
And that’s what they want to do: move more freight from the highways to the railways. The fuel savings would be an economic benefit to the rails and shippers, and a general benefit to society and the environment, Rose says.
“While there’s been a tremendous couple of decades of productivity with the trucks, they’ve hit that peak, and now they’re headed down,” he says.
And the railroads are ready. The AAR’s member railroads have poured more than $440 billion, better than 40% of their combined revenues, between deregulation in 1980 and 2008 into new locomotives and technologies to improve hauling capabilities and lower costs. They’ve laid double, triple, quadruple tracks in heavily traveled rail corridors to relieve costly shipping bottlenecks. They’ve opened new and enlarged existing rail yards and intermodal shipping sites, where ocean shipping containers and de-coupled highway truck trailers can be stacked on flat cars for long-haul shipping, to make lines more accessible.
Meanwhile, inflation-adjusted average shipping rates, excluding fuel and other surcharges, fell 49% over that same 28-year period, according to AAR data. And the same economics of scale that help make rails the lowest-cost option for transporting heavy loads long distances also happen to make them relatively “green” in an era when that increasingly matters. Rose and other rail boosters claim long-haul trains are three to four times more fuel-efficient than trucks in terms of freight tons miles per gallon of fuel.
“This has an enormous beneficial effect on society,” Buffett says.