What does Buffett see in railways?

Richard Beales

What does the Sage of Omaha see in railways? Warren Buffett is paying a big premium to swallow Burlington Northern Santa Fe, a US railroad operator. The Berkshire Hathaway chairman seems to think rail transport could be building a bit of a head of steam.

On its face, the transaction – at a 31 percent premium to Burlington’s market price on Monday – makes other US railroad operators look relatively cheap. Stifel Nicolaus reckons there could be more than 30 percent upside in CSX’s stock price, for instance, if investors were to peg sector valuations off the Berkshire-Burlington deal – and that’s after the uplift rival stocks got after Buffett’s transaction was unveiled.

But it’s not that simple. Berkshire now has its railroad. Antitrust issues would most likely prevent it buying another, even if Buffett wanted one - and Burlington is anyway seen as one of the top names in the sector. Antitrust concerns would also be a barrier to consolidation within the sector.

Meanwhile, leveraged buyout investors are thin on the ground these days – as are activists like the Children’s Investment Fund, which retreated earlier this year after taking on CSX management for 18 months. So there’s no obvious reason to attach an M&A premium to Burlington’s rivals in the railroad business.

There is a general economic play. Railroad volumes and pricing have been soft through the recent recession. But they may at least have bottomed. Burlington’s adjusted third-quarter revenue of $3.6bn was down 27 percent on the previous year, but up eight percent on the prior quarter, according to BMO Capital Markets.

It’s tempting to raise other possibilities, too. Railways are more environment-friendly than trucks. Partly as a result, there’s a chance the Obama administration will encourage investment by the highly regulated railroad industry. On another view, any emphasis on American energy self-sufficiency could spur new coal-fired power plants, which in turn could boost coal transport volumes.

Yet the trucking industry, suffering from overcapacity, isn’t going to give up without a fight. And a recovery will take time to build, especially for the transport segments relating to consumer products. At best, Buffett’s fully-priced deal will only bear fruit over time. Short-term followers into the sector could be disappointed.

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