Friday, March 2, 2012

Buffett on BNSF

From Warren Buffett's latest Berkshire Hathaway (BRKashareholder letter:

Measured by ton-miles, rail moves 42% of America’s inter-city freight, and BNSF moves more than any other railroad – about 37% of the industry total.

Buffett added that BNSF must maintain and improve 23,000 miles of track, 13,000 plus bridges/tunnels, nearly 6,900 locomotives, and 78,600 freight cars in all economic environments.

Obviously, operating a railroad requires no small amount of capital year after year just to remain competitive. Hopefully that capital can be put to use in a way that also generates acceptable returns for shareholders.

It's more than a decent business, at least it is these days, but far from ideal.

Buffett continued later by saying...

To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011. The three other major U.S. railroads are making similar outlays. Though many people decry our country’s inadequate infrastructure spending, that criticism cannot be levied against the railroad industry. It is pouring money – funds from the private sector – into the investment projects needed to provide better and more extensive service in the future. If railroads were not making these huge expenditures, our country’s publicly-financed highway system would face even greater congestion and maintenance problems than exist today.

Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, "Keep thy shop, and thy shop will keep thee."

The railroad business, at least in the U.S., is far better than it has been historically but that's not saying much. Changes in industry structure and the competitive landscape over time has made them more attractive.

In their current form, they're fine long-term investments but far from being among the best in my view.

BNSF did earn just under $ 3 billion after tax last year and that's likely to grow nicely. Profitability like that would be more attractive if it didn't require so much incremental capital each year. The inherent capital-intensiveness means BNSF is likely only capable of delivering solid but far from spectacular returns going forward.

BNSF certainly adds substantial societal value and is a solid investment but there are better businesses to own.

It would be nice if the things that add the most societal value were also the things that produced the highest returns for shareholders. Unfortunately, that's not the case.

Adam

Long position in BRKb established at lower prices
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