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Author: gocanucks Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 20350  
Subject: playing defense? Date: 11/3/2009 11:58 PM
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BRK board is filled with praises for the BNI deal -- play on this, secret asset that. It is pretty clear most of those people don't know much about BNI.

I covered the transportation industry for a brief stint and I was always puzzled by WEB's interest in BNI. Among the big 6, BNI is not the best run (CNI), does not have the highest op margin (CNI & NSC), does not have the best route network (UNP), does not have the most legacy contract to be repriced (UNP), yet is always trading at a premium. In fact, I'd argue it has the worst business mix given 40% of volume is intermodal, which by definition is subject to more trucking competition. In the long term, the key LA-Chicago long-haul route will also see more competition from Prince Rupert port by CNI and a Mexican port by KSU. Some people are excited by export coal, but they don't realize PRB coal is low BTU, and China is not interested in those coal. I think export coal is less than 0.1% of volume, and Matt Rose always acknowledges it will never be a big part of the business, unless export coal to Europe creates demand for PRB coal as a substitute for eastern utilities. (in that case, NSC is a better "play"). Export grain is the crown jewel of the network, but that is about 10% of volume (higher in revenue), and '07/'08 were peak crop years, and i doubt we will see much higher volume.

I don't believe WEB invests in themes or plays. i realize he has lowered the bar to 10% return, but at the price he is paying (20x forward, 16x peak EPS), he is barely getting 5% returns -- the business itself is doing sub 10% ROIC (depending on how you classify deferred tax liabilities) and spends 18% of sales on maintenance capex. This is about as opposite as possible to a See's Candy type of business.

As far as growth goes, don't kid yourself that BNI will grow faster than GDP. Look at its volume mix, by definition it will be a GDP type grower. Maybe it will take some share from trucking, but coal is at risk of environmental regulations. With respect to pricing, nobody has pointed out that BNI's mgmt mentioned on the latest call that pricing will come down to 2-3% from 6% in recent years (which drove the EPS growth).

The only explanation is that WEB is playing defense. Rails are as defensive as it gets in the cyclicals space. He is essentially buying a $40B bond yielding 5% with minimal risk of default, with the coupon growing mid single digits in real terms. But what I am puzzled about is while revenue/pricing will be inflation hedged, so will be capex/operating costs. So BRK will never see much owner earnings and all the incremental capex will be at about 10% ROIC. Again, this is the anti-thesis of what WEB has been preaching all these years.

For all the hype of elephant all these years, this is kinda anti-climatic in my book. I don't see why a small nimble investor wants to invest in BRK any more. Any stroke of genius of Buffett in public equity market is not going to matter too much in the grand scheme of things given the new mix.
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