(BNI) Warren Buffett Takes the Train to Work – Why You Should Follow His Lead

November 11th, 2009

by Tony Daltorio, Investment U Research

We already knew that legendary investor Warren Buffett was bullish on the U.S. railroad industry through his holdings in Burlington Northern Santa Fe (NYSE: BNI) and others.

But his recent announcement that his Berkshire Hathaway (NYSE: (BRKA) or (BRKB) firm will pay $100 per share for the 75% of BNI that it didn’t already own, it proved that he’s not only bullish on the railroads, but on America as a whole.

He confirmed that by stating that it was a “bet on the country.”

Is the old fella a little crazy for paying $44 billion in a cash-and-shares deal – which included acquiring $10 billion of debt? Perhaps not.

While the railroad industry has struggled for a while now, that could all change in the years ahead, as highways grow more congested and environmental angst climbs.

Hit The Tracks and Go Green

Trains present a relatively easy alternative to those problems. They obviously don’t have to worry about traffic jams and according to Burlington Northern, when they carry 100 tons over 1,000 miles, they produce 45% less pollution than trucks.

And you can trace Warren Buffett’s thoughts on this all the way back to 2007: “As oil prices go up, higher diesel fuel raises costs for rails but it [also] raises costs for its competitors – trucker – roughly by a factor of four.”

That factor alone could easily drive freight shipments from the road to the rails, not to mention how moving containers over long distances by train saves on labor, too.

The Berkshire-Burlington Deal – Buffett Style

At first glance, the Berkshire-Burlington deal looks just like a typical Buffett agreement.

It highlights his affinity for profitable companies that don’t rely on high technology.
He’s a well-known fan of established companies that pay out dividends, which he can then reinvest.
With regard to Burlington, it has what Buffett calls a “moat” around it: a solid, defensible franchise that other companies can’t breach.

In Burlington Northern’s case, the “moat” is that nobody is going to try to build a new rail network across the United States anytime soon. That gives the firm a very tight grip on its business customers.

Burlington also has some of the most highly regarded managers in the U.S. railroad sector working for him. They proved it earlier this decade when they advised BNI to invest heavily in improving capacity. Despite criticism from Wall Street, that strategy paid off in 2004 when container traffic surged. Meanwhile, one of Burlington’s main competitors, Union Pacific (NYSE: UNI), suffered the consequences of inaction.

Even today, in spite of a weak economy, Burlington has still scored profits. Its third-quarter figures showed operating income down only 25.3% to $901 million, versus Q3 2008. And that was despite a 27% fall in freight revenue to $3.49 billion.

Burlington’s rate of converting profits into cash has fallen from a peak of over 80% to only 55% this year. But the company should still generate $870 million in free cash flow this year after capital expenditure of more than $2.5 billion.

And Buffett believes the industry’s total railcar volume – down about 18% this year – will reach and even surpass its pre-recession peak.

So what does this tell us?

Warren Buffett’s Investment Strategy – Value vs. Growth

Warren Buffett’s investment strategy is well known for value investments, which he tends to look for, over fast growth.

But he did buy a 10% stake in one Chinese technology company last year – battery and electric carmaker, BYD Company Ltd. (BYDDY.PK).

This tells us that despite his bullishness on America, he’s still practicing a key investment strategy: diversification.

In Buffett’s mind, he seems to believe that the United States is a safe, but somewhat dull market, featuring a strong legal framework and secure property rights for investors. But as solid as they are, it’s also got many aging, slower-growth companies.

His long-term value investment on something like railroads presents a sound way to gain cash dividends and broad exposure to companies that need coal and freight… but not so much by way of innovation.

That’s why he’s also turned to Chinese growth, as evidenced by his significant purchase into BYD.

To play the situation as safely and lucratively as possible, follow Buffett and look for better long-term growth prospects overseas.

Good investing,

Tony Daltorio

View original at: Investment U