Early April we learned that Warren Buffett’s Berkshire Hathaway spent $3 billion for an 11% ownership position in Burlington Northern Santa Fe (BNI), one of the country’s major railroads. The stock jumped 6.5% on the announcement reflecting the perception that if Buffett owns this stock, it must be a good investment.
While we should look to a great investor, such as Buffett, for ideas, we should never invest blindly without knowing what we are buying. Moreover, he purchased the stock at lower prices, and his investment objective and tolerance for risk may not be the same as ours.
Not knowing anything about Burlington Northern, except that it is a railroad, I used the Company Stock Risk Profile™ research tool to find out for myself. The stock’s rating was Medium Risk, having failed 20 out of 50 categories (the range for Medium Risk is failing 18-33 categories). Here are the key points.
POSTIVE:
Burlington Northern has a leading market position in its industry with 32,000 route miles in 28 states and two Canadian Provinces. The company ships a diversified range of products in the industrial, agricultural, consumer and energy sectors. Corn, ethanol, petroleum products and coal caught my attention. Most of the coal comes from the Powder River Basin of Wyoming where the coal is low in sulfur and in high demand.
The company has been generating a lot of cash. Consistently growing since 2002, cash from operations amounted to $3.1billion in 2006, up from $2.6 billion in 2005. Subtracting capital expenditures from cash from operations, free cash flow totaled $1.1 billion last year. The company started 2007 on a strong note with cash from operations at $1.1 billion and free cash flow at $ 611 million in the first quarter.
Burlington’s shares still represent good value. The Company Stock Risk Profile™ uses six valuation methods encompassing 12 catergories giving a comprehensive result. Burlington failed 4 of the 12 catergories.
NOT SO POSITIVE:
The balance sheet was not as strong as I expected. Long-term debt as a percentage of total capital ended this year’s first quarter at 39.8%. While certainly not onerous, long-term debt is not at a level that I would consider low risk. The current and quick ratios are at .56 and .41, respectively, well below the 2.0 and 1.0 that I like to see.
Earnings performance has been somewhat of a mixed bag. Relative growth in earnings per share has been unremarkable as Burlington’s growth rate for the last five years has been only about on par with the railroad industry and the S&P 500. Return on equity, the bottom line measure of a company’s profitability, has been higher than the industry, but below the S&P 500. While reported earnings have not disappointed the Street, the consensus earnings estimate has been declining for this year and next.
Management has been consistently selling stock for the last 12 months. It would appear that management may have a less positive view about Burlington’s prospects than Buffett.
To gauge potential buying power for a stock I look at Street coverage and institutional ownership. I like to see less than half the analysts following a stock recommending purchase and less than 50% of the outstanding shares owned by institutions. Of the 19 analysts covering Burlington, 8 are recommending purchase. But institutional investors hold 74% of the outstanding shares.
Why did Buffett buy such a large position in Burlington Northern now, and not, for instance, in 2004 at less than half the current price? What could be changing perception? One idea I would propose is that railroads are a more energy efficient way to transport goods. Taking this theme a step further, rising demand for rail transportation would make the industry less cyclical leading to higher valuations for the stocks.
Based on this investment theme Burlington’s fundamentals and investor perception should move in a favorable direction. Valuation measures are positive and there’s room for ratings upgrades. I’m going to carefully consider Burlington Northern’s shares for inclusion in my portfolio.
