According to filings with the SEC on Friday April 6, 2007 Warren Buffet's Berkshire Hathaway is purchasing 39 Million shares of Burlington Santa Fe stock.
LC
Mere pocket change for Mr. Buffet. But...
Conventional Wall Street wisdom currently says that the historical highs now enjoyed by railroad stocks make them subject to downward corrections, or worse, if the current down trend in loadings persist.
So either:
1. Warren Buffet sees an interesting view in his crystal ball.
2. He is a rail fan.
3. He is ticked off at some of his neighbors in Omaha.
4. All, some or none of the above.
"We have met the enemy and he is us." Pogo Possum "We have met the anemone... and he is Russ." Bucky Katt "Prediction is very difficult, especially if it's about the future." Niels Bohr, Nobel laureate in physics
Berkshire typically holds an investment over a very long time frame, and I would expect that to be the case here. In this case, they bought 10.9% of BNSF for $3.2 billion. That makes them BNSF's largest stockholder.
....I say for us little investors, {me included}, not all eggs in one basket....Mutual Funds.
Quentin
Modelcar wrote: ....I say for us little investors, {me included}, not all eggs in one basket....Mutual Funds.
I'm diverified in stocks-a billion here, a billion there, a few more billion spread around. I know it is risky, but if I am in bad need of money for groceries and gas, I can always sell off one of the mansions.
Jjohnieray wrote:If i had some loose coin,this is where i would invest it.Mr. Buffet knows his stuff.
Too late, the stock is already WAY up on the news...
jeaton wrote: Mere pocket change for Mr. Buffet. But...Conventional Wall Street wisdom currently says that the historical highs now enjoyed by railroad stocks make them subject to downward corrections, or worse, if the current down trend in loadings persist.So either:1. Warren Buffet sees an interesting view in his crystal ball.
The conventional wisdom indeed suggests that the current business cycle should be entering a downturn relatively soon. Historically, business downturns always hit the transportation sector harder than other elements of the economy.
Historically, however, there has never been quite the network utilization for railroads as there is now. For whatever reasons, the industry has therefore never developed econometric models that correlate marginal costs with overall profitability as a function of congestion. The usual answer that you will get regarding marginal costs is that, with greater utilization of capacity, the marginal cost per unit of production will go down.
That is conventional manufacturing model theory. And historically, it was true for railroads.
However, at a certain point, the railroad cost curve diverges from the manufacturing model in key important details. To make a long and interesting story short, as utilization of capacity begins to recede, railroads should enjoy increasing profitability because the marginal costs of each unit of production will fall, rather than rise, with less business.
While that sounds counterintuitive, in fact it models out quite clearly using a standard capacity model with economic inputs. It is a natural result of efficiencies of operation that are gained in a network that is operated closer to its optimal, rather than physical, capacity.
And optimal capacity -- from the standpoint of profitability -- is a vastly different point than physical capacity.
Railroads have, wrongly I think, assumed that physical capacity meant economic efficiency, but the models show that it is far from it. If Buffett is looking at advanced econometric models, he would be seeing an ideal counterweight in the BNSF purchase to the normal effect on a stock portfolio of an economic downturn. The railroad industry is doing well, and BNSF is the best of the best in my book, and it will do much better when its network sheds some business and operates more closely to its economic optimum. That will happen either with 1) additional capacity, or 2) an economic downturn.
Investors pay close attention to business cycles. This cycle has had a long and strong run. But it is not typically the point in time to make large investments in general; rather the opposite -- take profits and get some cash. And notice that Berkshire Hathaway may be doing just that -- it has a very strong cash position at the moment. That fits with what an experienced investor would be doing at this point in the business cycle. The BNSF investment would be an anomoly -- unless Buffett thinks it makes sense because he sees something the industry itself does not see; that excess capacity, even a substantial amount of it, is a very good thing in a network and that the industry is just about to find out why.
A contrarian view no doubt, but the underlying model is so remarkably clear on the idea, the question may be better phrased as to why Buffett might be the first big investor to figure it out.
Oh, and I believe his son is a Wheat farmer ...
Warren Buffet bought stocks in other railroads too. Obviously, his percentage is low enough he doesn't have to disclose it.
Quote from CNN-money.
"Debbie Bosanek, assistant to billionaire Buffett, on Monday confirmed that Omaha, Nebraska-based Berkshire spent $700 million on one of the additional rail investments and slightly less on the other.
It was not immediately clear which other railroads Berkshire invested in. CNBC television earlier reported the investments, citing an interview with Buffett. He was not immediately available for another interview.
The Standard & Poor's 500 Railroads Index, which includes the four biggest U.S. railroads, rose as much as 7.2 percent to a record.
Buffett has made his name by investing in companies with strong management and businesses that he considers undervalued. It is common for shares of companies to rise when Berkshire discloses it has bought them."
If one wants to follow Buffets path, he can invest in Berkshire Hathaway or in certificates on the BH-stocks. With a little internet-search, one can find an opportunity.
Berkshire Hathaway is a very interesting company. That BH is now investing in railroads pretty much tells me they think the pricing power the railroads have had for the past few years is here to stay.
BTW...Howie Buffett was a corn farmer in Central Illinois, also owned a portion of GSI, a large manufacturer of grain bins...dont know if he is still doing both or not. Perhaps he does grow a little winter wheat, but generally that portion of Illinois is corn and soybeans, and with the corn prices at their levels this past winter, most of the acreage was targeted for corn. However...corn prices are falling.
Warren Buffett has traditionally only invested in companies with very strong economic moats, companies with strong economic franchises such as American Express, Coca Cola, Gillette (now Proctor/Gamble), etc. The past few years he has had difficulty finding satisfactory domestic opportunities and has turned overseas.
So, is this an investment in BNSF, or is this a play on the foreign manufacturing, primarily Asia?
As a sidenote...anyone here looking at the IPO for Blackstone Group? The private equity folks are sure making a lot of noise lately.
ed
He is already "giving" his money away, to things (Bill and Belinda Gates Foundation) he wants to be remembered by.
MP173 wrote: Berkshire Hathaway is a very interesting company. That BH is now investing in railroads pretty much tells me they think the pricing power the railroads have had for the past few years is here to stay.
"Pricing power" is, to me, an iffy investment tool. Businesses always look like they have pricing power at the top of a business cycle, and almost always seem to lose it in the downturns. This is typically more, rather than less, pronounced with capital intensive industries, even those with apparently impregnable captive markets.
I am skeptical of the assumption, partly because it is a term difficult to quantify. However, notwithstanding instances of contract negotiations at higher rates, I also note that more traffic is moving on railroads today (well, 2006) at lower R/VC rates than five years ago.
"Smithers, how is my New Haven stock performing?"
"Very well, Mr. Burns."
"And my Milwuakee Road, New York Central and New York Ontario and Western?"
"Outstanding, too, sir, If I may say so. And Rutland is soaring sir!"
"Yesss. Let those so called experts shoot their mouths off about Burlington or Union Pacific, I know where the bargains are. Oh, and up my stake in the Rock Island while you are at it."
TheS.P.caboose wrote:In talking about percentages, true Warren Buffet bought 10% of BNSF, also consider that Philip Anschutz, I believe, owns 51% of the Union Pacific.
Thanks to Chris / CopCarSS for my avatar.
That canny Scot, Andrew Carnegie, said put all of your eggs in one basket - and watch that basket carefully.
Dave
MichaelSol wrote:Historically, however, there has never been quite the network utilization for railroads as there is now. For whatever reasons, the industry has therefore never developed econometric models that correlate marginal costs with overall profitability as a function of congestion. The usual answer that you will get regarding marginal costs is that, with greater utilization of capacity, the marginal cost per unit of production will go down. That is conventional manufacturing model theory. And historically, it was true for railroads.However, at a certain point, the railroad cost curve diverges from the manufacturing model in key important details. To make a long and interesting story short, as utilization of capacity begins to recede, railroads should enjoy increasing profitability because the marginal costs of each unit of production will fall, rather than rise, with less business.While that sounds counterintuitive, in fact it models out quite clearly using a standard capacity model with economic inputs. It is a natural result of efficiencies of operation that are gained in a network that is operated closer to its optimal, rather than physical, capacity.And optimal capacity -- from the standpoint of profitability -- is a vastly different point than physical capacity.
Wow, Mr. Sol, you've thrown my limited understanding of economics for a real loop here.
The first two paragraphs quoted above I can well understand, but the third and fourth ones need further clarification.
Yes, for any segment of railroad there's a point of optimum utilization where a maximum amount of gross tonnage can be pushed through in each 24-hour period. On the double track CTC lines I'm familiar with, if the railroad runs trains with like characteristics [same maximum authorized speed and nearly the same horsepower per trailing ton ratio(HP/TT)] the trains will move in a fairly consistent and predictable manner.
Increasing the HP/TT of each train significantly will result in increased fuel and locomotive costs , but the productivity of the track segment in terms of ton-miles generated each day will increase as well. Under this scenario each train will be more costly to run, the revenue for each train won't increase, but if a few more trains can be handled across the entire railroad each day as a result, overall profitability should improve. Yes, the railroad is making less money per train; but with more trains moving, won't the total profit increase? I suppose we could call that the Wal-Mart way of doing business.
In mountain territory like the Union Pacific has across Wyoming and Utah and the BNSF has across New Mexico and Arizona, operating a mix of
is no way to run the railroad either.
If you have to be everything to everybody, smoothing out the HP/TT ratios for all trains strikes me as the most important step to really operating an economically efficient railroad.
I pointed this out one time during a one-on-one with an Executive V.P.O. and he responded with "Bob, we've already modeled what you've suggested in our computer and discovered that we could save $600,000,000/year in operating costs."
"So why aren't you doing it?" I responded.
"Because General Motors and United Parcel Service would never stand for their traffic being handled in 50-mph trains!" was his reply.
"But don't you see," I pointed out, "that you're having to run these 70-mph trains because they're constantly having to make up time due to being stuck - all too frequently and for far too long - behind a 40-mph bozo bow-wow pooch?"
This executive, who I admire greatly, smiled weakly with a knowing smile (he knew all too clearly what I was getting at), glanced at his watch, and politely retired to his business car.
- - - - - - - - - - - - - - - - - - - - -
Perhaps a little birdie landed on Mr. Buffett's shoulder and pointed out the explosion in capacity that's on the verge of happening once BNSF completes double tracking the remaining small segments of the Chicago - Los Angeles mainline. Freed of its greatest bottlenecks, the entire line is poised to benefit and the BNSF will be in an extraordinary position to complete for any business that moves two thirds or more of the way across the continent.
Union Pacific, on the other hand, won't begin to see such benefits for the markets it serves until
Both new capacity goals, alas, are years away.
jeaton wrote: Modelcar wrote: ....I say for us little investors, {me included}, not all eggs in one basket....Mutual Funds.I'm diverified in stocks-a billion here, a billion there, a few more billion spread around. I know it is risky, but if I am in bad need of money for groceries and gas, I can always sell off one of the mansions.
Here's another possibility based on some recent attempts at "investment influence".
Back in the 1990's, a certain tech billionaire (for the sake of anonymity we'll refer to him as "B. Gates". No wait, that's too obvious! Let's instead refer to him as "Bill G." ) bought a significant stake in a certain energy company. Shortly thereafter, the energy company brought in new management, changed it's name, became a diversified energy company with big bucks invested in high tech, and yadda yadda yadda a few years later nearly went belly-up from all this influence. FYI - the company is doing fine today, now that the 90's CEO was bought out.
Now, I'm not suggesting Mr. Buffet will try and do the same, but perhaps he sees an opportunity to make this company take advantage of profit maximization by excerting some control over it's business decisions.
We are all aware of the fact that a certain railroad is spending obscene amounts of money to add capacity to it's lower profit corridors while throwing nickel and dime expenditures at it's higher profit corridors. Perhaps Mr. Buffet is able to do what some of us wish we could do to/for this particular railroad!
Either that, or Mr. Buffet is also a disciple of Chairman Mao!
Dave:Buffett leaves the companies alone. He buys the management as much as the companies. Now, that is not to say he wont step in if necessary, as he did to clean up Solomon Bros in the early 90's, but generally his mission is to deploy the massive amount of cash the BH insurance companies generate in float.
BH's annual reports are on line and I would highly recommend reading of them. Be prepared as they are quite lengthy, but oh so entertaining and very educational.
One of BH's big errors was investing in USAir back in the 80's or 90's. Buffett learned from that experience that airlines have very little command over their capacity and hence their pricing. Is he making the same mistake with railroads? His overall track record has been outstanding. As a disciple of Graham he seeks out value. Time will tell.
MP173 is right, Buffet is basically a passive investor, and usually for the long term. And of all the major industry in the US, I think outside interference with the management of a Class 1 Railroad would likely be a disaster for all concerned.
Northtowne
Bob-Fryml wrote: ..... but if a few more trains can be handled across the entire railroad each day as a result, overall profitability should improve.
No.
Yes, the railroad is making less money per train; but with more trains moving, won't the total profit increase?
Yes.
Profitability is the measure of efficiency in use of resources. An operation earning $50 on $500 of revenue earns 10% profit. An operation earning $75 on $1000 of revenue earns 7.5% profit.
The first is more profitable, but earns less profit. The second earns more total profit, but is less profitable.
More profit requires consuming in that instance twice the resources to achieve lower profitability. The sensitivity to cost changes increases significantly. An 8% change in an input cost reduces the profitability in the first instance to 2%. In the second instance, the profitability is destroyed entirely and a loss is incurred, even though it had more profit initially.
The Beta, or risk factor, is significantly higher for the railroad earning more profit, when it does so at the sacrifice of profitability.
This is why profitability is a key financial ratio, whereas profit is just a number.
Bob-Fryml wrote: Perhaps a little birdie landed on Mr. Buffett's shoulder and pointed out the explosion in capacity that's on the verge of happening once BNSF completes double tracking the remaining small segments of the Chicago - Los Angeles mainline. Freed of its greatest bottlenecks, the entire line is poised to benefit and the BNSF will be in an extraordinary position to complete for any business that moves two thirds or more of the way across the continent.
Well, the old argument used to be that capacity caused prices to fall, and constrained capacity caused prices to rise. Now, with a hugely expensive capacity expansion, coming fully available at just about the time as traffic should begin to decline as a result of the normally expected business cycle, doesn't this particular scenario suggest that something different would happen? The idea of "an extraordinary position to compete" is suggestive to me .... even as costs of operation and paying off the new investment will necessarily be higher ... compelling the need to get the business ... compelling the usual cost-cutting to fill the lanes ....
This angle just doesn't fit too well, if the premise is that Buffett is taking into account the downside of a business cycle, which judging by the BH cash position, suggests that he is ....
While profitablity is important, in the case you provided it really has very little meaning. More important is the return on equity or the return on invested capital, or possibly even return on assets. Each provides a snapshot, as does the profitability margin, when all are combined along with a number of other ratios, one can truly get an understanding of a business.
Return on Equity (ROE) is in my opinion considerably more important than profitability margin. That truly measures the ability of a company to utilized invested equity and retained earnings.
ROE utilizes net margins, asset turnover, and financial leverage to determine the number. It allows an analyst to compare companies of various sizes for efficiency of investment.
BNSF's ROE was around 18% last year...not bad for an asset intensive company.
MP173 wrote: While profitablity is important, in the case you provided it really has very little meaning. More important is the return on equity or the return on invested capital, or possibly even return on assets. Each provides a snapshot, as does the profitability margin, when all are combined along with a number of other ratios, one can truly get an understanding of a business.
If you don't give any credence to the risk function; then true, it has little meaning with regard to ROE. However, the higher risk is a risk directly to ROE. Profitability is a surrogate measure of that risk.
And while I tend to agree about the importance of ROE, that is a different discussion. In the case of declining marginal costs with reduced traffic, ROE is preserved in a fashion if that happens -- and the profitability is the most direct way of measuring that, because the marginal cost improvement is, well, a cost function, not an equity function.
BNSF's historic cost elasticity is typically around .57 to .62. Both profitability and ROE go to hell in a handbasket prettty quickly in a business cycle downturn with those numbers. I think that elasticity is considerably higher these days, which means it will shed costs more quickly in a downturn than it would have been able to in the past -- which is good, but which is also the direct result of higher marginal costs of operation of a congested system.
What does that do to ROE? Depends. ROE can be a complete phantom -- enough debt can reduce the equity to the point that just about any positive rate of return makes the ROE look great -- at the sacrifice of a sustainable debt to equity ratio.
Want a good ROE? Borrow money. Good policy? Only if it improves the rate of return -- the profitability -- because the debt is used to increase the efficiency of the operation by appropriate investment. How would you measure the effectiveness of that debt investment? Profitability! Using debt to artificially increase the ROE by buying back shares and reducing the actual equity -- substituting debt -- is another discussion altogether, but is a reminder that not all high ROE is good for the company.
ROE is never, ever a substitute for a profitability or return on sales measure, because ROE is, or can be, a creature of debt, and more debt can make ROE look terrific.
For a while.
Profitability remains the measure of choice for management performance and company strengths, not the least in part because it measures risk better than ROE, which doesn't measure it at all -- indeed, it can be an inverse measure of risk.
Again, this is in the context of why is Buffett doing this now? As opposed to when the stock was half the price, and the capacity expansion was already underway, with all of its presumed advantages?
My thought is that it is because he sees improving profitability in a business downturn, and is willing to buy -- as Jay points out above -- at a point when the typical sophisticated investor sees the stock at a natural peak subject to a correction.
And ordinarily, for railroads, a business downturn is always an unhappy "correction" unless someone like Buffett sees something very different at this particular point in time, providing a sufficient enough reason to take the historical risk that a railroad stock would historically present at this point in the business cycle.
Michael:Several points here.
1. Explain your comments on risk and profitability. I have read them several times and rather than comment on it, I ask for clarification.
2. I dont agree with you on the premise of increased profitability in a downturn. I dont disagree, I just dont agree...yet. Perhaps we will have to see what happens when we do have a downturn. Dont know if BNSF is in that downturn, I think the rails are, as are most of the transports. 1Q reports will be out later this month.
3. I agree with your comments regarding debt and ROE. No doubt part of the big movement by Private Equity firms now is to transfer equity to debt. Will the loadup on debt yield high returns for the PE firms? Time will tell. I would not want to be holding previously issued corporate debt for firms that just went private and loaded up on debt. Their Moody's ratings are already being affected.
4. We have discussed previously the BNSF's purchase of stock while issuing more debt to fund the capacity issues. I dont necessarily agree with that move, but perhaps the MBA laptop nation knows better.
5. I do not think Buffett purchased BNSF and others due to the increased profit margins during the downturn. I think he purchased it solely on the belief that it will be a wise investment. Many books have been written on Buffett's methodology and I have read several. Basically Buffett's investing philosophy boils down to this. Determine the value of a business and then buy only when that business is selling at a significant discount to it's value (The Warren Buffett Way, Robert G. Hagstrom, pp 122). Buffett has made a determination that BNSF was under valued and made a significant purchase. He also believes that BNSF is a better investment at the time he purchased it than other companies he owns (either outright or in major stock holdings). Based on his tenet of buying and holding for the long run, he believes BNSF is a value. I would believe that is because of future earnings rather than a downturn in business. After all, the downturn in business will at some point turn around.
Our community is FREE to join. To participate you must either login or register for an account.