The Burlington Northern Santa Fe Cash Machine

Not long after announcing the buyout of Burlington Northern Santa Fe railroad for $26.5 billion, Buffett swore that he paid a massive price to purchase a business that would provide large benefits to his company over the long haul.

“You don’t get bargains on things like that,” he said in a Charlie Rose interview that aired on PBS in November 2009. “It’s not cheap.”

In as little as five years later, that seems like a very hollow assessment. BNSF has already become a major cash machine for Berkshire Hathaway, buoyed by the boom in onshore oil. Through Sept. 30 2014, the railroad already sent $15 billion in dividends to Berkshire and Buffett, based on information in the regulatory filings released recently. Even more surprising… The company is poised to give Buffett back all of the money he spent by taking the business private by the end of this year.

The railroad’s annual revenue has gone up by 57%. Earnings have more than doubled to $3.8 billion since Buffett took over. Even with the railroad facing scrutiny by the public because of safety issues and delays of service, sales have still continued to climb.

“He stole it,” said a Berkshire shareholder and author of books about the company named Jeff Matthews. “He’s got to feel really good that he bought it when he did, because it’s a wonderful asset, and it’s done nothing but get more valuable in the time that he’s owned it.”

The profit at the railroad has continued to climb during the third quarter. Agriculture and industrial revenue grew, as well as oil shipping. BNSF makes up more than 20% of Berkshire Hathaway’s total business during this time period, according to a regulatory filing made on November 7.

Oil Glut

The third-quarter profit of Berkshire Hathaway slipped by 8.6% and dropped to $4.62 billion on investment results, and this included impairment by the holding of Tesco PLC, a UK retailer. Berkshire Hathaway stock rose by 0.7% to $216,525 in trading after operating earnings beat the expectation of analyst estimates on gains because of units like the railroad.

The tracks of Burlington Northern Santa Fe sit atop the Bakken formation in North Dakota, where producers of energy are extracting oil using fracking and other methods to get crude oil from the ground in large quantities. Because of the limited pipeline capacity, oil companies are looking to Burlington Northern Santa Fe in order to ship the products that they gather to the refineries.

The additional freight has exacerbated train tie-ups that are weather-related, and the railroad has spent many months trying to resolve these issues. During June, the US Surface Transportation Board mandated that Canadian Pacific Railway and Burlington Northern Santa Fe create and report the plans that they have in place to fix these delays.

Below Standards

At a September hearing in North Dakota, officials of the state urged BNSF to improve their service. The company said that it is adding additional workers and more railcars in order to improve operations. During last week’s filing, Berkshire Hathaway mentioned that the service at the railroad is still “well below” its high standards.

By expanding crude shipments, there is also a further risk for this industry. Tank car derailments in Canada and the United States have led to oil spills, fires and even bankruptcies of a smaller carrier called Montréal, Maine & Atlantic Railway LTD, which a derailment in Québec last year had killed 47 people.

Burlington Northern Santa Fe has worked hard to figure out the concerns about oil shipments. They have also agreed to purchase 5000 safer tank cars. In addition, they are going to charge a surcharge on older generation of cars involved in some of the worst accidents.

Since Berkshire Hathaway took over, investments like this have been quite common. The railroad itself budgeted a record $5 billion this year in order to upgrade its network, buy equipment and expand its facilities. That’s over $1 billion more than it had previously spent in 2013.

Stock, Cash

Even with the bigger outlays, the earnings at Burlington Northern Santa Fe have climbed and helped to make the amount that Buffett paid look rather tiny. Berkshire Hathaway was already the largest shareholder of the railroad when Buffett chose to buy out the remaining 77.5% of the business. The price included the existing Berkshire Hathaway stock plus $15.9 billion in cash. Since 2011 started, Burlington Northern has paid distributions to Berkshire Hathaway of at least $750 million per quarter.

The man competitor of Burlington Northern Santa Fe, Union Pacific Corp., is currently trading at 12.6 times annual pretax, pre-interest income, according to data that Bloomberg has compiled. If Buffett’s railroad was capable of getting that kind of a price now, the 77.5% would currently be worth about $66.5 billion – which is more than twice than what Berkshire Hathaway has paid.

Part of the success that Warren Buffett has seen with Burlington Northern Santa Fe has come right down to luck, according to James Armstrong, who oversees the shares of Berkshire Hathaway as the president of Henry H. Armstrong Associates. When Buffett bought the company, they were hardly shipping any crude oil. Nobody knew that BNSF would have such a big role in transporting this oil from the place that it was produced.

Putting luck aside, there is not much upside for Buffett to brag about this investment, says Armstrong. Berkshire Hathaway always wants to purchase more businesses and it needs to have a strong reputation for paying higher prices.

“It’s never in Buffett’s interest to indicate that he got a bargain, even though that’s what he’s shooting for,” said Armstrong. “He has to manage other people’s perception of him.”

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