Hope you had a great time with your family this Thanksgiving. For me, Thanksgiving was an excuse to maximize my time with my family before they left for India this coming Sunday on a three month long vacation.
Anyway, coming to the topic of this blog, today I watched this amazing show on CNBC called Warren Buffett and Bill Gates - Keeping America Great, where the two greatest legends of the current times took questions from Columbia B-School students on various topics ranging from the economy to philanthropy.
One question raised by Lisa Williams, a first year MBA student, caught my attention. Her question was directed towards Warren Buffett on his recent acquisition of Burlington Northern Railways.
To give a little background, on Nov 3, 2009, Warren Buffett’s Berkshire Hathaway Inc. announced its intention to increase its exposure to Burlington Northern Santa Fe (BNSF), a railroad company, from its current stake of 22.55% to 100% for a whopping 26 Billion USD, making it his largest ever investment till date. Burlington Northern is in the business of operating railroad network in North America. It operates in about 32,000 route miles covering 28 US states and two Canadian provinces. The BNSF railway transports a wide range of products and commodities including the transportation of consumer products, industrial products, coal, metals, minerals, automobiles and automobile parts and agricultural products derived from manufacturing and natural resource industries.
Coming back to the question, Lisa’s question was, ’There has been a lot of discussion around the true drivers of the deal with Burlington Northern. I was wondering if you could share with us the key motivation for wanting to increase your exposure to railroad sector at this time’. In reply, the humorous Mr. Buffett quipped, ‘you know, when I was 6, I wanted a railroad set, my dad didn’t get me one..’, sending the audience into splits. Then he went on to explain his real rationale, which can be summed up in 5 key points
One. Burlington Northern last year moved a ton of goods 470 miles on one gallon of diesel which is far more efficient than what takes place over the highways
Two. Railroads put a far fewer pollutants into the atmosphere than trucks will
Three. One train can replace 280 trucks on the highway.
Four. Railroads are here to stay- you can’t move them to India or China.
Five. There will be more people in this country in future, that will be moving more and more goods and railroads would be the most environmentally friendly and the cost efficient way of doing that.
In short, the railroads are tied to the future prosperity of this country. He called it ‘basically, a bet on America’.
Before you rush to invest all your life savings in BNSF, I suggest you read further my two reasons for taking Mr. Buffett’s stated reasoning with a pinch of salt.
Firstly, coal accounted for almost half the tonnage moved by BNSF in the first nine months of 2009 and a quarter of the company’s revenues. The coal that BNSF hauls is high quality and is responsible for more than 10 percent of the electricity produced in the U.S. Think about it, Mr. Buffett also owns MidAmerican, an energy company that owns coal fired plants in the states through which BNSF’s tracks run across. Sounds logical? BNSF may be an acquisition with a vision to secure shipping vehicle for Berkshire’s growing array of power plants, than a bet on America’s future powered by railroads.
Secondly, according to the US Department of Commerce Census Bureau 2006, the U.S. transportation system moved an average of 53 million tons of freight worth $36 billion per day in 2002. Trucks hauled close to 60 percent of the weight and two-thirds of the value of shipments. Trucking provided a better option than railroads to the manufacturers because it allowed them the flexibility to deliver smaller, more frequent and more reliable shipments that aligned closely with their production schedule and hence leading to lower inventories. However, in the recent times, there has been steep increase in the transportation costs due to increase in diesel fuel prices coupled with highway congestion problems, lower fuel efficiencies of trucks and regulations that put a cap on miles driven per driver. Companies have responded to these problems by investing in IT solutions that result in full trucks that never stop. They should instead be talking about using more of railroads, if Mr. Buffett’s vision has to come true.
Both these thoughts lead me to think that it is not railroads that Mr. Buffett had in mind when he bought BNSF. Another interesting thing to note is that the top 15 of Mr. Buffett’s biggest investments include CPG companies (P&G and Kraft Foods), retail (Wal-Mart) and a railroad company within logistics (BNSF) and not a trucking company like J.B. Hunt. Would he use his powers to influence the CPGs/retailers to look at railroads for their transportation needs thereby increasing the profitability of his entire portfolio?
It would be interesting to see who goes laughing all the way to the bank. Either way, Mr. Buffett wins, because he also owns a couple of banks in his portfolio!