Warren Buffett Couldn't Have Imagined the Success of This Purchase

When Berkshire Hathaway bought Burlington Northern Santa Fe, there's no way he foresaw the boom in rail.

Aug 10, 2014 at 12:55PM

Warren Buffett

Warren Buffett is good at seeing the long-term future of a business, but there's no way he imagined railroads would be this successful.

We all know that Warren Buffett is good at investing. Just about every financial media company out there (including The Motley Fool) writes countless articles on his business acumen and his uncanny ability to identify great deals in the market. Still, I highly doubt that even Buffett could have imagined the success of one of his most daring purchases: Burlington Northern Santa Fe. The major change that Buffett probably did not see coming since the 2009 acquisition? Crude oil via rail. Let's look at how this seemingly insignificant part of the railroad business is completely transforming the likes of Burlington Northern.

Burlington Northern Rail

Image source: NE2 via commons.wikimedia.org.

An energy play, but not the energy play Berkshire anticipated
Back during what may be considered the bottom of the economic recession, many people thought Buffett's Berkshire Hathaway went out on a limb in November 2009 when it bought railroad company Burlington Northern Santa Fe for $34 billion. Even respected Wall Street names such as Bruce Greenwald said the business was nothing special and just a simple energy play because rising diesel costs meant moving goods via rail was less expensive than by truck. At the price Berkshire paid, Greenwald called the deal close to insane.

Rail did become an energy play, but not in the way Greenwald described. 

At about the time Berkshire bought Burlington Northern, another trend was emerging: Tight oil production from places like North Dakota and Texas was becoming commercially viable, and the boom was about to take off. Within a couple years, many of these regions' pipeline capacity was maxed out. So a couple daring oil producers tried moving oil via rail as a temporary relief until the more permanent solution -- pipelines -- could be installed.

Somewhere along the way, companies realized that rail could serve refiners on the East and West coasts, areas that pipelines simply weren't reaching. Shipping oil via rail to coastal refineries enabled the industry to displace the expensive imported crude from places such as West Africa and Saudi Arabia with a cheaper domestic source. The use of rail also gave producers the options to transition to markets in need much quicker than possible with long-term volume commitments in a pipeline. 

All of these elements have translated into a massive boom in oil transport via rail. Between 2008 and today, this has gone from a marginal 10,000 carloads per week to close to 450,000 carloads, most of which are moving oil from either the Bakken formation in North Dakota or oil sands in Canada. There is enough investment in Canadian crude by rail capacity that by 2015 shipment levels should reach 1 million barrels per day, considerably more than what would be shipped by the Keystone XL pipeline.

Landing on just the right company
This development has been huge for the entire rail industry, and Burlington Northern has one of the most extensive rail networks to service the boom in oil via rail.


Source: Commons.wikimedia.org.

With a majority of its tracks located in the North Dakota region, and control of a majority of the lines that connect the U.S. and Canada, Burlington Northern has seen its oil shipments increase more than 11-fold since 2009, to over 600,000 barrels per day. It is on track (pun intended) to increase total oil shipments to over 1 million barrels per day with an investment in over 10,000 new tank cars for that very purpose. Thanks in large part to this boom in oil transportation, revenue at Burlington Northern has increased by 60% and net income is up 88% since it was brought by Berkshire Hathaway nearly five years ago.

Since Burlington Northern is now private, we don't have a completely accurate number as to how much it is worth.  If we were to infer a valuation for the company based on the average total enterprise value-to-EBITDA ratio for the rail industry today -- about 11.3 times -- Burlington should be worth about $100 billion. That's almost triple what Buffett paid. Pretty impressive for a company that was allegedly nothing special and overpriced.

What a Fool believes
I'm certain that Buffett and Berkshire Vice Chairman Charlie Munger looked at Burlington Northern and saw an opportunity that many others didn't. However, it seems far-fetched that they foresaw the boom in oil production, the need for rail to fill the gap in transporting the material, the overall benefit that rail would provide in moving oil to underserved markets, and the exact rail company that would be at the center of that movement, years before these trends even developed. I'm guessing that Buffett and the shareholders of Berkshire Hathaway aren't complaining about the success, though, because it has made for quite an impressive return on investment.

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven’t heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America’s greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, “The IRS Is Daring You to Make This Investment Now!,” and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Tyler Crowe owns shares of Berkshire Hathaway. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

The Motley Fool recommends Berkshire Hathaway. The Motley 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information