During the worst of the downturn, I remember pulling my Wall Street journal out of its yellow rain protection bag thing only to see Warren’s billionaire grin on page A1.
The headline read of Buffett’s acquisition of Burlington Northern Sante Fe, which Buffett happily declared to be an “all-in wager on the economic future of the United States.”
He was lying.
In very simple terms, railroads are the classic case for value investing; they’re difficult to build, impossibly efficient, and extremely resilient to economic downturn.
A Perfect “Moat”
Buffett compares his investments to castles. When he invests in something, he says he wants a really big castle, but most importantly, he wants a really big, deep, and wide moat around it. So what does he see in BNSF?
A blog post at FT says the following about railroads: (summarized)
- Trains can move a ton of freight 470 miles on a single gallon of diesel whereas tractor-trailers manage only 130.
- Trains can carry the same amount of freight as 280 trucks. Impressive, sure, but especially impressive when you consider that every truck needs a driver, and only a few people work on a modern locomotive.
- No new railroads are being constructed, and 40% of all railways in existence in the 1980s are no longer used.
The points about efficiency speak for themselves; railroads have a very clear competitive advantage. Tack on the decline in usable railway and the rise of the American consumption economy and we have a very clear winner!
Transportation this, transportation that
Everyone is telling me that I need to have more exposure to transportation in my portfolio. In most of these articles, I’m being sold on the idea that I should buy into dry bulk shipping companies, as they are sure to see rising profits as the world economy rebounds. I think that view is foolish, to say the least.
To show the failure in such a simple view, I’ve enlisted the help of the Department of Transportation. They maintain a website that shows “marine highways” or the waterways that move through and around the United States that are most conducive to the transport of goods.
Here’s one of their graphics:
If you look at the above picture, you’ll see a map of marine highways—I call them rivers—that run through the United States. But if you pay more attention to the map, you’ll realize that there’s far more to it than just the rivers. Look all around the United States—that’s what we like to call the ocean!
The reality is that dry bulk and container shippers have zero structural advantages in shipping goods over water. (Read more about structural advantage in a post about Monopoly.) Following the 2000’s boom, shipping companies ordered ships in record amounts because they could. You can fit unlimited ships on the ocean surface, but you can’t fit unlimited trains on railway tracks.
In further exploring the DOT website, I found the agency’s map of railways:
Notice how few railroads there are, and how limited the possibilities are for future expansion. Consider the following:
- The difficulty in building a new railway knowing how many homeowners, business owners, and farmers live between points A and B. (Pick your own points A and B).
- How much time and money it would take to force an eminent domain through court to start construction of new railways.
- The capital investment railroads require.
Those four difficulties are the best moat you’ve ever found in a business in your whole life. You’ll truly never find one like it.
How Buffett Lied
The reality is that the American economy did not need to experience a revival for railroads to make sense. Buffett doubled down on railroads because they make way too much sense. To purchase railroad securities is to say to the markets, “Hey, I bet you that Americans either import stuff from other countries or export stuff to other countries in the future.” That’s a pretty sure bet.
But Buffett doesn’t just buy any railroad. He’s not just some ETF guy who wants the whole industry at any cost; no, Buffett’s going to pick the right industry, and also the right company in that industry.
Examine this map of BNSF’s active railways:
This map, compiled and released into the public domain by Wikipedia’s nerd army, shows how much of a stranglehold BNSF has on railway shipping. The red lines are railway in which BNSF has trackage rights, rights which entitle it to ownership of the railway. The pink lines are those on which it can ship its goods through another railway company, using the other company’s trains.
I’m going to bring back the old chart, which shows all American railway in service:
In comparing the two, it becomes obvious that BNSF owns every piece of worthwhile railway in the United States. It has exposure to every single western port, every entry into Canada excluding only New England, and virtually every port in the Gulf of Mexico.
Whether or not the US economy recovered after the global financial crisis was really a moot point. Not only was BNSF perfectly positioned to profit on any minute uptick in low-cost shipping, but it’s also protected even if the US economy stagnates. If we were to revert to an entirely agriculture and manufacturing economy, BNSF would still have just as much stuff to ship. This time, though, the trains would be heading out from the American Midwest, rather than in from the sea ports.
Buffett Knew It
I think many passive and active investors alike get the wrong idea about Buffett. Yeah, the guy is good, I’m not going to say he isn’t, but he’s also very good at speaking so simply that he almost sounds like an idiot.
Imagine that tomorrow one of your friends came up to you and said, “Hey, I’m killing the broad market; I’ve generated annual returns of 34% for the past 10 years.”
You’d probably ask, “How?”
And he or she would reply, “I just buy good companies for really cheap.” Or even worse, “I just try to never lose.” Oh boy…
In essence, that is Buffett’s philosophy, and those words easily summarize his investing thesis. But when you really look at why Buffett is buying company X, his purchase is rarely fixated on the balance sheet, or even the company’s plainly obvious discount to its peers. Instead, it has to do with all the other information that you and I could find quite easily, but would never pay attention to.
- Coca-Cola – A major Berkshire Hathaway holding, Buffett saw what everyone else could have: Americans actually prefer the taste of Pepsi, but Coke outsells them nearly 2:1. Pepsi is sweeter, but Coke’s brand pulls on their heartstrings.
- GEICO – Insurance is a commodity. To compete with a commodity, you have to sell on price. Nobody does this better than GEICO, which is branded as the low-cost auto insurance provider. If the economy tanks, there are fewer people seeking cars, but more people seeking low cost auto insurance. If the economy roars, the low-income demographic starts buying cars, and GEICO’s low cost insurance.
- BNSF – Shipping is a commodity. If you need to ship from one end of the country to another inexpensively, then you have to use BNSF railways. If you need to move product from Mexico to Canada, you use BNSF. If the US economy stops importing stuff, then we start exporting stuff. If the US economy tanks, then we revert to manufacturing and agriculture, two industries that rely heavily on railway shipping. If the US economy roars from high-paying service employment, then we start importing stuff from Asia, which invariably lands on Pacific seaports connected to BNSF railway.
I won’t hesitate to say that it was BNSF’s railway, not their balance sheet (okay, maybe a little of the balance sheet) that sold Buffett on buying the rest of the company at a discount. He can call it a bet on the economy all he wants, but it was really just a bet on normalcy—and 99.9% of the time, things are pretty darn normal.
Photo by: ELETOH