Buffett may lure more investors in railroads

Warren Buffett’s $26 billion purchase of Burlington Northern Santa Fe, the largest U.S. railroad, may attract more investors to an industry undergoing a “once-in-a-lifetime comeback.”

“Railroads have just gotten the biggest endorsement they possibly could,” said John Mims, an analyst at BB&T Capital Markets. “This will get people off the sidelines in an industry they’ve been wary to invest in. We will probably be saying in 10 or 15 years that a new rail renaissance began with this acquisition.”

Berkshire’s largest purchase spotlighted an industry struggling with dwindling freight demand. Buffett described his move was “an all-in wager on the economic future of the United States,” because shipments and railroads’ pricing power would rise in a recovery.

The billionaire investor is extending his bet on the industry after more than two decades of deregulation helped railroads cut labor costs, sell or abandon unprofitable routes and invest in more fuel-efficient locomotives. The 1980 Staggers Act legalized contracts between shippers and carriers and swept away a federal rulemaking structure dating to the 19th century.

Buffett cited railroads’ fuel-cost advantages over trucks in 2007 after his initial stake in Fort Worth, Texas-based Burlington Northern was disclosed. Tuesday’s $100-a-share offer is a 31 percent premium to Monday’s $76.07 closing price.

Rare comeback:

Buying the rest of the carrier shows “this is an industry that has gone through a very rare, once-in-a-lifetime comeback,” said Anthony Hatch, an independent railroad analyst based in New York.

Railroads remain one of the lowest-cost ways to move goods over long distances, with a double-stacked train handling the equivalent of 320 semi-tractor trailer loads over highways, said Mims. Diesel fuel at U.S. pumps has risen 17 percent this year.

Besides attracting other investors to railroads, Buffett’s purchase may damp political pressure in Washington to reregulate shipping rates, said B. Craig Hutson, a debt analyst for Gimme Credit Publications.

“Having someone of Buffett’s stature owning one of the four major railways makes it less palatable for D.C. to do something the railroads would find onerous,” Hutson said. “Buffett is well liked and respected in D.C.”

Burlington Northern and Union Pacific compete west of the Mississippi River. Burlington Northern focused on coal and agricultural shipments to close the gap with Union Pacific, which bought Southern Pacific Railroad in 1996.

Largest by sales:

Burlington Northern overtook Union Pacific as the largest in the U.S. by sales last year with $18.02 billion in revenue, topping Union Pacific’s $17.97 billion. CSX and Norfolk Southern operate primarily east of the Mississippi River.

Taking Burlington Northern private will remove Wall Street pressure to meet quarterly earnings estimates and may give the railroad more access to Berkshire’s capital for research and innovation, BB&T’s Mims said.

“This will sharpen up the railroad industry quite dramatically as they learn how to cope with growth again” after the recession, said Aaron Gellman, a professor at Northwestern

University’s Transportation Center in Evanston, Illinois. “Everyone will be taking cues from Burlington Northern.”

Shippers are not sure of the implications of having the biggest U.S. railroad in private hands, said Bob Szabo, executive director of Consumers United for Rail Equity, a coalition of freight customers that advocates for more pricing competition.

CURE is concerned that Buffett’s premium for the rest of Burlington Northern may “artificially inflate the asset base” next time railroads seek a rate increase, he said.

BB&T’s Mims said Burlington Northern may get a little more “aggressive” on pricing for its intermodal service, which already accounts for about a third of its business. Intermodal refers to containers that move by a combination of rail, road and sea.

Freight carloads on major U.S. railroads fell 18 percent this year through the week ended Oct. 24 compared with a year earlier, according to the Association of American Railroads.

Volume will start to improve in the coming months, making Burlington’s valuation “very attractive” for Buffett, said Art Hatfield, an analyst at Morgan Keegan & Co. in Memphis, Tennessee. “He just sees this as a solid, well-run company going through a stage of economic retraction,” Hatfield said. “He doesn’t like fixer-uppers. It’s just Buffett buying a business he likes and understands.”