Buffett's Biggest Oil Play Ever

If you follow Warren Buffett closely, you may be scratching your head on this one.

After all, Buffett's last famous big oil deal was one of his few large investing missteps. In 2008, Buffett ramped up his stake in ConocoPhillips at exactly the wrong time. In his own words:  

I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year [2008].

And you probably haven't heard much about Buffett and oil since (except for him slowly reducing his stake in ConocoPhillips).

That's because Buffett's move was a stealth oil play. But it's a stealth play that's so big it can render any subpar returns he may generate on ConocoPhillips immaterial.

Let me explain the massive move he made and then explain how we can still follow his coattails today.

The play
A year and a half ago, he claimed the $44 billion acquisition of railroad Burlington Northern Santa Fe was "an all-in wager on the economic future of the United States."

That makes a lot of sense. Since railroads get paid to schlep raw and finished goods, they are a big part of the circulatory system of a healthy economy. Healthier consumer demand leads to fatter top and bottom lines.

Still, on the surface, Buffett was still paying a 30% premium for a 19th century business during uncertain economic times. Underneath the surface, though, Buffett masterfully locked in a huge play on rising oil prices when prices were around $70 a barrel.

He explained the advantage clearly in his recent shareholder letter:

Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That's three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs.

When he explains it like that, it doesn't take a Buffett-sized brain to see how that 3:1 relative fuel efficiency advantage of railroads over trucking is powerful as oil prices rise.   

How you can play this advantage
Now, obviously we can't buy Burlington Northern directly anymore. We can buy it through shares of Buffett's sprawling holding company, Berkshire Hathaway (NYSE: BRK-B  ) , but if a pure railroad play is what you're after, there are still some choices that are selling for lower multiples than what Buffett paid for Burlington Northern.

Buffett paid almost three times tangible book value for Burlington Northern. Here's a list of the sizable railroads we can buy on major U.S. exchanges. I've sorted them from cheapest to most expensive.

 Company

Market Capitalization
(in millions)

Price/Tangible Book Value

Guangshen Railway (NYSE: GSH  ) $3,544 0.78
Norfolk Southern (NYSE: NSC  ) $23,407 2.18
Kansas City Southern (NYSE: KSU  ) $5,551 2.29
Canadian Pacific Railway $11,110 2.38
Union Pacific Corporation (NYSE: UNP  ) $46,910 2.69
Canadian National Railway (NYSE: CNI  ) $33,848 3.08
CSX (NYSE: CSX  ) $28,037 3.25
Genesee & Wyoming $2,257 5.38

Source: Capital IQ, a division of Standard & Poor's.

You'll notice that five of the railroads sell for price-to-tangible book values below three, including one in China -- Motley Fool Global Gains pick Guangshen Railway.

All of the other railroads on the list are based in either the U.S. or Canada and offer the potential to be our very own Burlington Northern.

Meanwhile, Guangshen is a way to participate in China's focus on building up its infrastructure. As Buffett's trusted Burlington Northern CEO Matthew Rose puts it:

You read a lot about China in terms of the investments they are making in airports, railroads and highways. They are rebuilding and expanding every mode of transportation over there ... so that they can be more efficient, which means that their foreign exports to places like the United States, Europe and the rest of the world will be better positioned to remain competitive as their labor costs rise over time.

The takeaway
I'm not one to take advice from Buffett lightly. In this case, he's done very well on his investment in Burlington Northern, and he's given us a clue to the possible fuel-efficiency advantage of railroads over trucking.

I'm adding these companies to my watchlist so that I can see if there's a good opportunity here (besides the Berkshire Hathaway shares I already own). If you'd like to start a free watchlist of your own, we'll keep you updated on your favorite companies and give you immediate access to a new special report, "Six Stocks to Watch from David and Tom Gardner." Click here to get started.

Anand Chokkavelu owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value selection. Berkshire Hathaway and Canadian National Railway are Motley Fool Stock Advisor recommendations. Guangshen Railway is a Motley Fool Global Gains pick. Genesee & Wyoming is a Motley Fool Hidden Gems selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (60)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 04, 2011, at 3:49 PM, midnightmoney wrote:

    I inherited --stand back -- 8 shares of csx in 1993. Ignored them til 2005 when it dawned on me to at least reinvest the dividends. I've got 40 now and am thinking about dropping some real money into the company for the same reasons mentioned in the article. Wished I'd done so years back. CSX has been a very solid performer relative to the sp over the past decade.

  • Report this Comment On March 04, 2011, at 6:09 PM, LSLOANPDX wrote:

    WHAT IS THE REASON NO STICKER ON ARTICLE FOR CP AND GWR.

    THIS TO GO WITH NO YIELDS.

    WHO IS THE PROOF READER WHO CARES ABOUT THE PAYING SUBSCRIBERS.

  • Report this Comment On March 04, 2011, at 11:01 PM, DonkeyJunk wrote:

    @LSLOANPDX

    You paid for this free article? You need more help than MF can provide. Also, your shift key appears to be stuck. Today must have been a totally downhill day.

  • Report this Comment On March 04, 2011, at 11:12 PM, ddaydetroit wrote:

    I also have CSX stock I'm waiting to see what will happen when the panama canal widening project is done and the largest cargo ship can go from China to the eastern seaboard. CSX has pretty much the all the eastern shipping ports covered

  • Report this Comment On March 05, 2011, at 3:53 AM, HouseOfSpears wrote:

    Used to work for UNP so I used to follow the rails carefully, but did't Buffet buy CSX at $90 - $100. I believe UNP has consistently outperformed CSX? I have been trying to decide if UNP has topped out. I have to stay with UNP because they have access to the powder river basin coal locked up, and thay are stating to do shale oil extraction in the "oil beds" where UNP has Wyoming and vicinity all locked up, except for maybe a few short lines.

  • Report this Comment On March 05, 2011, at 6:31 PM, plcoyne wrote:

    wasn't Genesee&Wyoming a Hidden Gems pick a while ago? so why no ticker symbol?

  • Report this Comment On March 06, 2011, at 9:08 AM, TMFBomb wrote:

    @plcoyne,

    Genesee & Wyoming's ticker is NYSE: GWR and is Candaian Pacific Railway's is NYSE: CP.

    -Anand

  • Report this Comment On March 06, 2011, at 9:44 AM, wax wrote:

    Interesting article if you own Berkshire.

    Wish you would have explained how the freight Buffet moves on his train is going to get to where it needs to go though. I guess folks can drive through his rail yard and toss in the trunk of their cars.

    CSX has been touting this very same thing for months and months in a radio spot. Is it impressive? Not really.

    You make it seem as if trucking companies can't hold a candle when it comes to rail and that Buffett is so smart for buying a train company.

    So what happened to McLane trucking? I think Buffett still owns that company?

    In the end, Buffett is a smart guy, way smarter than me. But the genius he possess is possible because of all the pictures of George in his wallet, not because he locked in diesel prices.

    Wax

  • Report this Comment On March 06, 2011, at 11:47 PM, 11x wrote:

    wax, do you drive up to the Swift Transport terminal or Wal Mart distribution center to get your product? Come on man, if you're going to ship truckloads of freight from California to New York, you can put it on a semi truck that gets 6 MPG and ship it to a warehouse or you can put it on a freight train that can haul much more cargo for the same amount of fuel or less. Thus if you are going for long distance freight it's more cost effective to load the train up. This means long-haul trucking companies are more in competition with train companies than short distance, or LTL (less than truckload) carriers. LTL and short haul will still take it from the train terminals to the local warehouses as they always since the beginning of the train terminal/depot have and do now. FYI my grandpa has in his driveway a 1918 Ford Model T "Depot Hack" made for this purpose so it's not a new concept.

    I looked at McLane's site and they are not in the long-haul trucking business. A company like Swift, Covenant Transport, or Werner is more likely to see loss of business due to high costs of fuel. That business is more likely to move to train. What we saw last time oil went this high was a bit of moving production and manufacturing back over to USA because transport costs were too high to bring it over from China. Mexico also becomes more competitive. From this, I could see KSU (Kansas City Southern) being a potential good pick as they focus mostly on North/South transportation deep into Mexico.

  • Report this Comment On March 07, 2011, at 2:55 PM, plange01 wrote:

    buffetts biggest oil play was petro china.

  • Report this Comment On March 08, 2011, at 4:10 PM, MaxPower13 wrote:

    wax, you have your cause and effect reversed. Buffett doesn't possess his genius because of the "pictures of George in his wallet." he has his "pictures of George in his wallet" because of his genius and and single-minded focus.

  • Report this Comment On March 11, 2011, at 4:40 PM, StructuralDefect wrote:

    I'd like to see someone calculate the statistical probability of Burlington Northern being nationalized during an extreme economic crisis versus the probability of the same for Guangshen Railway.

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