(The following story by Karen Richardson and Daniel Machalaba appeared in the Wall Street Journal on April 10.)
NEW YORK — Warren Buffett is taking a ride on the rails.
Railroad operators have benefited in recent years from a boom in overseas demand for commodities, U.S. hunger for foreign goods and restrained competition from their big rival, trucking. And thanks to earlier waves of consolidation that left only a handful of public U.S. railroad companies, their earnings and their stocks have attracted investor attention.
So, the billionaire investor’s bet on Burlington Northern Santa Fe Corp. is the latest sign that the resurgence in railway stocks has some strength over the long haul.
The disclosure by Mr. Buffett’s Berkshire Hathaway Inc. of its 10.9% stake in BNSF boosted the share price yesterday of the nation’s largest railway operator, which has a market value of more than $29 billion. The price of BNSF’s stock, which trades on the New York Stock Exchange, rose by $5.36, or 6.5%, to end the session at $88.08. It is up 19.7% since the start of the year and 26.3% since the start of 2006. Berkshire, in its regulatory filing made late Friday, said it bought about 1.65 million shares on April 4 and 5 at prices ranging from about $81.18 to $81.80. It has accumulated a total of about 39 million shares.
Mr. Buffett declined to comment. Through his assistant, however, he confirmed that Berkshire also had acquired stakes in two other North American railroads, which weren’t identified.
Railroad stocks climbed on the news, with Union Pacific Corp., based in Mr. Buffett’s hometown of Omaha, Neb., climbing 3.8% to $107.15. CSX Corp., based in Jacksonville, Fla., rose 2.2% to $41.86 and Norfolk Southern Corp. of Norfolk, Va., advanced 3.8% to $52.89.
The Berkshire disclosure also lifted the Toronto-listed shares of Canadian Pacific Railway Ltd., based in Calgary, Alberta, and Canadian National Railway Co., of Montreal. CN is the top holding of Cascade Investment LLC, which manages the assets of Microsoft Corp. founder Bill Gates, according to FactSet Research. Mr. Gates, an avid train rider, also is a Berkshire director and a friend of Mr. Buffett’s. The two once traveled around China by rail.
Since railroad traffic has slowed with the economy since the third quarter, investors are waiting to see how the industry’s new-found pricing power will fare. The industry also continues to have high fixed expenses, which can eat into earnings if business slows.
Ken Hoexter, an analyst at Merrill Lynch, says that despite the near-term earnings risks, he remains bullish on the group. “Long term, the secular story of pricing and improved returns will drive improved share performance,” says Mr. Hoexter, who has a “buy” rating on BNSF’s stock and whose firm provides investment-banking services to BNSF and other railroads.
Railroad stocks slipped late last year as freight volumes declined, but rebounded this year on news of stock buybacks at BNSF, CSX, Norfolk Southern and Union Pacific. The share prices also rose on speculation that private-equity firms were taking an interest in the railroad group.
Burlington shares are trading at about 14.6 times estimated 2007 earnings, slightly cheaper than the 15.1 times of the railroad sector, according to Thomson Financial. Union Pacific is slightly richer at 15.3 times, while CSX trades at 16.3 times. Norfolk Southern appears cheapest at 13.2 times, while Canadian National trades at about 13.6 times.
“The business model is a good value at this price, with not much substitute product out there in terms of competition, and it has pricing power,” says David Carr, co-manager of the Oak Value Fund, part of Oak Value Capital Management, which has net assets of $148 million. Berkshire makes up 9% of the fund.
Unlike some of Mr. Buffett’s better-known purchases, such as carpet-manufacturer Shaw Industries Group Inc. and Benjamin Moore & Co. at the height of the dot-com boom in 2000, railway companies aren’t deeply out-of-favor contrarian investments in the current environment.
“The whole railroad industry is transitioning from cost-cutting to growth,” says Anthony Hatch, an independent railroad analyst and consultant in New York.
After falling on hard times in the 1970s, freight railroads took advantage of the industry’s partial deregulation in 1980 to streamline their tracks, labor forces and costs. In the past few years, a vastly consolidated rail industry has begun to reap the benefits of a surge in freight traffic, which has used up capacity on some of the railroads’ busiest routes and given the industry unprecedented power to raise rates.
Trucking companies, which had been drawing away freight from the rails, have run into rising fuel prices, which affect trucks more than trains. Their productivity also has been constrained because of a limited number of drivers.
In addition, globalization and longer supply chains are favoring railroads, which are moving large volumes of imported goods to consumer markets from U.S. ports.
“It’s clearly going to be a royalty-income stream on globalization,” says Thomas Russo, partner and portfolio manager at investment advisor Gardner Russo & Gardner, where he manages about $3 billion. Berkshire is his biggest position.
BNSF, whose rail system blankets two-thirds of the U.S, has spent aggressively to upgrade its Los Angeles-to-Chicago route and also encouraged development of large warehouse complexes next to its tracks while persuading trucking companies, steamship lines and parcel carriers to move their long-haul freight to its rails. When freight surged in 2003, BNSF was ready to handle the increased traffic, while others struggled.
For Berkshire shareholders, the investment was good news, helping to nudge the company’s Class A shares up $151 to $109,000 on the Big Board. Shareholders have been waiting for Mr. Buffett to invest more of the $40 billion in cash on Berkshire’s balance sheet, most of which has been collecting single-digit interest for the past couple of years.
“It’s just inspiring to see the appetite return,” Mr. Russo says about Mr. Buffett.