Written by Mary Buffett
As I reflected on the recent purchase of Heinz Foods by Berkshire Hathaway, I thought about some of Warren Buffett’s other purchases that met some initial skepticism. In 2005, Berkshire purchased a 22 percent position in BNSF (originally called Burlington Northern Santa Fe Railways) and four years later acquired the remaining shares at nearly $100 a share. There were some felt that Buffett’s long love of trains — including a well-detailed model train set he once owned — had something to do with the purchase.
People forget that Warren Buffett always looks for the that diamond in the rough, that company that would be a great long-term investment or purchase outright for a discount. However, there is a greater story when it comes to the transformation of the freight rail industry in the last generation. Today BNSF has more than 32,000 miles of rail throughout the Midwest and along the West Coast. It competes against Union Pacific and while they are the nation’s second largest freight rail network, they are the major player hauling corn and coal.
In order to better understand why it is a good bet, you have to travel back and see where freight rail nearly went off the tracks.
In the 1970s, the rail industry had a near-death experience. When people think of trains, they still conjure memories of the heyday of passenger rail travel where families back east would enter urban cathedrals like Grand Central before they entered trains with names like “The San Francisco Chief” or “The Rocky Mountain Rocket.” We all know what happened. Jet travel was faster and cheaper; within a decade, passenger rail was on a one way trip to insolvency. On the freight side, trucks were far more nimble than trains and they were eating into their share. Overregulation of the railroads was onerous.
The once-powerful New York Central and Pennsylvania Railroads lost ground, merged together, and failed so spectacularly that it’s demise is still taught in business school today. The money-losing passenger rail lines became AMTRAK, the Northeast corridor freight lines became Conrail, a government-owned entity. Companies like Union Pacific, the Atchison, Topeka and Santa Fe Railways, or others who owned smaller fragmented lines were merged together. The rest of the industry limped through the 1970s and 1980s until deregulation helped them rebuild their financials. When you look at the current BNSF rail network, it represents the sum total of countless mergers and consolidations. How did rail rebound? Freight rail began a turnaround in 1980 when the Staggers Act deregulated the industry. Freight rail rates dropped considerably and companies got the breathing room they needed to rebuild and reinvest. Billions were spent to purchase better fuel efficient engines, improve rail lines, and maximize the efficiencies. Since 1980, freight rail’s marketshare has risen from roughly 30 percent to 43 percent.
More importantly, freight rail had to learn to adapt to a new world of transportation. They had to work with their competitors by participating what’s known as “intermodal transportation.” When you purchase a wrench sold at Home Depot, but made in China, its travel to the United States is a supply chain ballet. Containers of wrenches and other tools are placed in large containers when they leave from Chinese ports.
Then they sail the Pacific and arrives in Los Angeles or the Port of Oakland. When they arrive in America, they are loaded by crane on to specially designed piggyback flatcars that carry twice as much weight than a generation ago. At some point, they are off-loaded on semi-trailer trucks that arrive at distribution centers before they end up in your local store. When rates are compared, rail has become the most efficient way to move product.
While freight engines look the same as they did in the 1970s, there has been a total transformation under the hood. Smarter trains with flexible fueling allow companies to better hold down fuel costs. Now a generation of hybrid locomotives is starting to come on line and freight rail has become a far more efficient method of getting goods to their final destination. BNSF is exploring natural gas as an alternative for normal propulsion and if that works, they will use a domestic and inexpensive fuel that may further revolutionize the cost equation for freight rail.
Today CSX and its competitors can move a ton of freight at roughly 500 mpg/ton. Meanwhile average family sedan, which is roughly two tons, gets an average of 25 mpg or 12 mpg/ton. Now that US domestic energy production is increasing, only trains can get crude oil to market. Coal and other raw materials cannot travel by truck or plane. The tonnage for delivered crushed stone, gravel, sand have also increased year over year.
So let’s get back to Warren Buffett for a moment. Completing the BNSF acquisition in 2010 as the stock market was slowly finding its way out of the 2008 collapse was classic Buffett. He purchased a critical American brand on the cheap, even though Berkshire paid a premium for their stock. For Buffett, freight trains offer a durable competitive advantage within the delivery chain that planes or truck cannot match because you cannot get lumber to market in a converted DC-10. Now that the complexion of American business is changing in freight rail’s favor, Warren Buffett will get the last laugh for a purchase some labeled as foolhardy. Freight rail companies, when run well, will be profitable for the long haul.