Warren Buffett appears to be elephant hunting again. In April, the market became excited by the news that his Berkshire Hathaway
In his widely read letter to Berkshire shareholders this year, Buffett said, "We continue ... to need elephants in order for us to use Berkshire's flood of incoming cash." We now know that the other two pachyderms whose shares Buffett was buying were Union Pacific
We also know from reports that just since last Thursday, Berkshire has bought another 10.1 million shares of Burlington Northern. That's the third time this month Berkshire, or Buffett, or one of Berkshire's subsidiaries -- it's impossible to tell which -- has acquired Burlington shares. The investment company's holding in the railroad now comes to 52.1 million shares, or nearly 15% of the total. As of a May SEC filing, Berkshire had 10.5 million shares of Union Pacific and 6.4 million shares of Norfolk Southern.
Berkshire's holdings range widely and include companies it owns outright, such as MidAmerican Energy Holdings, manufactured-housing producer Clayton Homes, carpet manufacturer Shaw Industries, and the Buffalo News newspaper. In addition, it also owns big stakes in such public companies as American Express
But given the high profile of both Berkshire and Buffett, investors have been trying mightily since spring to see the precise allure of the rails for the billionaire investment guru. Sure, as public companies go, the three railroads that Berkshire's tied into are elephants, with market values that range from about $20 billion to slightly more than $28 billion. But Buffett didn't achieve his unparalleled investment success by just taking positions in big companies. There must be other things about the railroad business that Buffett and his colleagues find attractive.
Obviously, there are -- several billion dollars' worth of such characteristics so far. But to get a handle on them, it's necessary to have a little historical perspective. For instance, there's the interesting fact that, when the Dow Jones Index was born in 1884, all but two of its 11 included stocks were railroads. But through the years, an unhealthy combination of high regulation, low returns, and steadily increasing competition made the railroads and their shares yawners for growth-oriented investors.
In 1980, however, in a wave that removed governmental shackles from a number of industries, the railroad group was largely deregulated. The almost immediate results included increased consolidation, the pouring of more than $375 billion by the companies back into their operations over a quarter century, and -- in the past several years -- resumed attractiveness of the handful of remaining big rails in the eyes of investors. In fact, in just the past couple of years, shares of Burlington Northern Santa Fe and Union Pacific have each appreciated more than 50%, while Norfolk Southern is up nearly 45%.
More than just chugging along
But beyond all that, I have some other thoughts about the elements of railroading that might be tickling Warrant Buffett's fancy:
- Railroads are the type of industry that has long attracted the Omaha wizard. The Berkshire portfolio is notoriously heavy on basic industrial, financial, and consumer-goods companies and light on technology.
- If you believe the Association of American Railroads' contention that the rails require more than fivefold the capital spending of the average manufacturing company, new lines are unlikely to pop up in the U.S. anytime soon. In other words, barriers to entry for this industry are incredibly high, or they're not making any more railroads.
- In part because of that lack of new lines, along with consolidation, shortages of truck drivers, restrictions on the amount of time those drivers can sit behind the wheel, and increasing fuel costs, the railroads enjoy an increasing ability to meaningfully affect the prices they charge.
- The rails are relatively big cash generators. Over the past four quarters, for instance, Burlington Northern's free cash flow has totaled nearly $900 million.
- Our increasingly globalized economy, including more imports from places like China and India, results in the need to transport lots of goods from West Coast ports of entry to locations across the rest of the U.S.
Of course, that capex consideration can also be big for the industry. For instance, five years ago, Burlington Northern CEO Matthew Rose said that his company was spending $5.5 million each and every day for capital projects, including laying double and triple tracks along its 2,200-mile line from Los Angeles to Chicago.
But somewhat surprisingly, the rails, which for so many years were viewed as tired, uninspiring investments, actually have become somewhat of a growth group -- analysts expect double-digit EPS growth in the sector over the next five years. Looking even farther out, the U.S. Department of Transportation has said it expects 2002 freight transportation demand for the rails to expand by about 88% by 2035.
At the same time, owing to their price appreciations, the three rails in Berkshire's portfolio are not cheap historically. With forward 2008 P/Es in the general vicinity of 12 to 14 times, though, they trade at something of a discount to the broader market.
So there you have perhaps some indication of why Buffett and his minions are steadily increasing their ties to railroading. They don't need me to tell them that they seem to be on the right track.
For related Foolishness:
- Warren Buffett's Priceless Investment Advice
- Profit While the Dollar Sinks
- Norfolk Southern: Worth the Trip
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