Wednesday, November 4, 2009

The Great Iron Horse Burlington Northern's New Engineer: Warren Buffett

Buffett gave us subtle hints almost 3 years ago when he stated he wanted to "bag an elephant", who new the elephant was a "Iron Horse" (a pseudonym for steam engine). Buffett has said in the past he was looking for a large deal, something that would move the needle- the needle being Berkshires enormous stock portfolio. Well Warren Buffett just bought Burlington Northern Santa Fe, that is the whole company. BNSF will now be under the Berkshire Hathaway umbrella with companies such as Geico, Dairy Queen, See's Candies, and Shaw Carpets (see the whole list here). This is by far the largest deal Buffett has ever done which totals a whopping 44 billion. Before this, Berkshire's biggest acquisition was the $16 billion stock purchase of reinsurance giant General Re, announced in 1998. Buffett, who has been building up his rail holdings for several years was in the headlines back in early 2007 when it was announced that he had taken positions in several of the major rail carriers. But why did he zero in on Burlington Northern. Here are some of the pieces to the puzzle:

1) it's a business (railroads) that easy to understand

2) it's has a high return on equity which is currently 15% for the trailing 12 months (last year it was 19%)

3) it's a business with a moat (has high barrier to entry) not just anyone can start a railroad company

4) it's had consistent earnings

5) it's very efficient way of moving goods

6) it's a play on coal and other commodities

7) it's throwing off lots of free cash flow

8) it has high-quality management (its track record speaks for itself)

Many people wondered why he had suddenly fallen in love with the sector. The simple answer is globalisation. With booming demand for commodities from the Far East and a hunger for cheap foreign goods in the West, the rail companies linking consumer and producer look appealing for the long haul. Buffett has said he realized a few years late that railroads were an appealing investment. As diesel prices rise, shipping by rail instead of truck becomes more attractive, and it would be extremely difficult for a competitor to build a new railroad. Continuing upward pressure of fuel costs make rail transport increasingly more competitive with the trucking fleet and shall prompt more wholesale purchasing within our own continent. The dominant trend is the demand for raw materials and machinery to fuel the construction booms in China and India. US rail firms transport grains and building and construction products for export; US exports to China. "I basically believe this country will prosper and more people will be moving more goods 10, 20, 30 years from now and the rails will benefit," Buffett told CNBC. It's also a bet on the future of another country -- China. China craves the coal and other raw materials that the U.S. produces. Those commodities fuel the great economic engine that is China, which is the factory to the world. U.S. coal and goods are shipped via rail to Pacific ports and then shipped to China. With his round-out purchase of Burlington Northern, Buffett thinks China will continue to be strong.

* Author is currently long BNI

Posted via email from stockmanmarc's posterous

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