(The following appeared at SeekingAlpha.com on February 29.)
Burlington Northern Santa Fe (NYSE: BNI) ($89.05) is the second-largest railroad firm in the U.S., with a track network stretching some 32,000 miles through 28 U.S. states and two Canadian provinces. The company’s network is particularly strong in the western part of the U.S.
Warren Buffett’s Berkshire Hathaway holds about a 20% stake in BNI (more than 63 million shares). Buffett has made no secret of his desire to purchase more of the stock.
Buffett has said that the poor performance of the railroad industry in years past prejudiced him, and he was slow to realize the value to be found in the industry. But he appears to have changed his opinion quickly, buying up significant stakes in railroads — with Burlington by far the largest position.
When it comes to the U.S. railroad industry, barriers to entry are high. Securing right of way and laying track is a very expensive endeavor, as is finding workers and maintaining tracks. As a result, there are really only four major long-haul American railroad companies, and the danger of new entrants is minimal.
The key to discerning competitive advantages between the major railroad firms lies in the strategic location of their networks. Specifically, BNI has the largest network of track in a region of the western U.S. known as the Powder River Basin. The Powder River Basin is found in states like Colorado and Wyoming, and it is home to America’s largest reserves of coal. Further strengthening BNI’s advantage is that the vast majority of this coal is low in sulfur. With U.S. sulfur emissions standards getting ever more stringent, many utilities are switching to Powder River Basin coal to generate electricity.
Burlington Northern Santa Fe has picked up the lion’s share of the coal shipping market for the Powder River Basin. It would be next-to-impossible for competitors to build an equivalent network in the region. In short, BNI’s economic moat is wide.
Another driver for BNI is that not only is it seeing rising volumes, but also rising prices. BNI is in the process of gradually renegotiating contracts with companies that ship across its lines. Due to high demand for shipping commodities and tight U.S. railway capacity, BNI has been successful in securing massive rate hikes. In addition, most new contracts include clauses that allow BNI to recover much of its rising diesel fuel expenses via fuel surcharges.
BNI still has a hefty debt burden, with a D/E ratio of more than 70%, but that burden is dropping as BNI uses some of its tremendous free cash flow to pay down debt. And BNI looks reasonably valued with a price-to-earnings-to-growth [PEG] ratio of around 1.1 — the stock trades at 13 times 2009 earnings estimates with a long-term growth rate of +14%.
Investors often avoid the rails during economic downturns, but BNI’s exposure to less cyclical business lines such as the transport of coal and agricultural products is sheltering it from the slowdown in the U.S. economy. All in all, investors may wish to follow in the footsteps of the world’s most famous investor and scoop up some shares of BNI.