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Get Your Portfolio on Track with Burlington Northern

Burlington Northern remains an Ultimate Stock-Picker top holding.


By Bradley Meeks | Stock Analyst

No one will argue with the notion that the fourth quarter of 2008 and the first couple of months this year were a disastrous time to be a long-term investor. Everywhere you looked, headlines pointed to the beginning of the end for the financial system. Commodities of all types precipitously declined. Credit markets resembled the highways in Chicago--gridlocked. Home values dropped and unemployment rose almost 1 full percentage point to 7.2% at the end of 2008.

Amid the market malaise, many firms with strong competitive advantages that rarely trade at attractive valuations did so, appearing on the radar of many of the top managers we have listed on our Investment Manager Roster. Some of these, such as  Burlington Northern Santa Fe Corporation (BNI), were actually among the top conviction holdings of the Ultimate Stock-Pickers managers. These are stocks that are not just widely held by the top managers we follow, but are held with some conviction--meaning that the managers that hold them have consciously made larger position bets on these names than they have on other securities in their own portfolio.

According to our latest holdings data, five of our Ultimate Stock-Pickers hold Burlington Northern in their portfolios, with  Berkshire Hathaway (BRK.A) (BRK.B) and  Alleghany (Y) both having major positions (in excess of 10% of their equity portfolios) in the name. Legendary investor Warren Buffett has been a big believer in Burlington Northern of late, first building a stake in the firm in April 2007 (purchasing roughly 10% of the railroad at that time) and then recently showing even more enthusiasm by purchasing additional shares in Burlington Northern during the first two months of this year. Meanwhile, Weston Hicks and the gang at Alleghany continue to have a lot of faith in Burlington Northern, with the railroad making up 36% of its stock portfolio at the end of last year--an issue we highlighted in a recent article on the 13-F filings of Alleghany and  Markel (MKL).

 Ultimate Stock-Pickers' Highest Conviction Holdings

Fair Value
Price ($)
Fair Value
No. of
Fund Owners
Berkshire Hathaway Inc. (BRK.B)MediumWide3,052.000.6614
Burlington Northern Santa Fe (BNI)MediumNarrow71.530.795
Wells Fargo Company (WFC)HighNarrow24.070.8312
Microsoft (MSFT)LowWide19.500.5613
Procter & Gamble (PG)LowWide51.340.6712
Johnson & Johnson (JNJ)LowWide54.890.6915
Coca-Cola Company (KO)LowWide42.800.787
Pfizer Inc. (PFE)MediumWide14.340.559
Wal-Mart Stores, Inc. (WMT)LowWide49.890.8312
ConocoPhillips (COP)MediumNarrow44.690.5411
Data as of 05-07-09. Fund ownership data as of funds' most recent filings.

Buffett Came to Railroads Much Later
While both managers have made big bets on Burlington Northern, it is interesting to note that this has been a fairly recent development for Berkshire (as opposed to Alleghany, which has a much longer, and much more storied, relationship with railroads, having originally been founded in 1929 as a holding company for the investments of railroad entrepreneurs Oris and Mantis Van Sweringen). Buffett, along with his main partner Charlie Munger, had verbally lambasted the industry over the years, only to change their minds more recently--something Munger highlighted during the course of his presentation at the Wesco annual meeting in 2007:

"Railroads--now that's an example of changing our minds. Warren and I have hated railroads our entire life. They're capital-intensive, heavily unionized..., heavily regulated, and long competed with a comparative disadvantage versus the trucking industry, which has a very efficient method of propulsion and uses free public roads. Railroads have long been a terrible business and have been lousy for investors. We did finally change our minds and invested. We threw out our paradigms, but did it too late. We should have done it two years ago, but we were too stupid to do it at the most ideal time. There's a German saying: Man is too soon old and too late smart. We were too late smart. We finally realized that railroads now have a huge competitive advantage, with double stacked railcars, guided by computers, moving more and more production from China, etcetera. They have a big advantage over truckers in huge classes of business. Bill Gates figured this out years before us--he invested in a Canadian railroad and made eight hundred percent. Maybe Gates should manage Berkshire's money. [Laughter] This is a good example of how hard it is to change one's mind and change entrenched thinking, but at last we did change. The world changed and, way too slowly, we recognized this."


Connecting Burlington Northern to the Tracks
So why do Warren Buffett and Alleghany like Burlington Northern so much? We believe it's for some of the same reasons Morningstar analyst Keith Schoonmaker likes this narrow-moat firm. Burlington Northern is one of the largest railroad operators in North America, generating more than $18 billion in annual sales and recently eking past  Union Pacific (UNP) to become the largest rail company in North America based on revenues. The company earns its keep by hauling intermodal containers, coal, industrial products, agriculture, and other freight over 32,000 miles of track. What provides Burlington Northern and several of its peers with their narrow moats is the fact that they own assets that are practically impossible to replicate--the tracks themselves. The challenge of obtaining rights-of-way and the cost of building tracks erect insurmountable barriers to entry for the industry.

But that hasn't always been enough to guarantee profitability for the railroad operators. After years of struggling against the rapid growth of truck and barge traffic during the 1950s and 1960s, the railroads were on the brink of collapse in the 1970s. Changes in the regulatory environment, though, which provided railroads with greater control over their operations, along with the gradual consolidation of the industry from nearly 40 Class I railroads in 1980 to just seven today, helped to not only pull these companies from the abyss but also improved their financial performance over time. By 2006, the railroads were hauling more freight than ever before, with many actually facing capacity constraints, and by then were starting to draw the attention of legendary investor Warren Buffett. While rail traffic did fall off somewhat last year, in response to the dramatic slowdown in the economy, demand for rail transportation is expected to continue to be strong longer term.

Demand for Rail Traffic Should be Strong Longer Term
Schoonmaker believes that secular growth trends favor rail as a desired transportation method, which he sees as a positive for Burlington Northern. The company's operations are located primarily in the Western parts of the United States, where it operates franchises in coal and agriculture--areas that are less subject to cyclical demand when compared with other freight commodities. With new coal-driven power plants coming on line domestically, the demand for cheap Western coal is unlikely to decrease for decades. The company hauls fertilizer and grain within the Midwest, as well as to the West Coast for export overseas, businesses that are likely to see growth pick up again once the world's economies recover. Burlington's Southern Transcon Line (that runs from Los Angeles to Chicago) is also well-positioned to respond to strong U.S. demand for imported goods from Asia that are shipped primarily in intermodal containers. Schoonmaker expects these secular growth trends to lead to an expanded use of the company's services for some time to come.

Selling High and Buying Low
Despite the long-term positives, Burlington Northern has not been immune to the slowdown in the economy. This could help explain why several managers, including Alleghany, were selling in the most recent period. When Burlington Northern first popped up on the Ultimate Stock-Pickers' Top Sales lists, our first thought was that the stock (like many other high-quality blue-chip firms) was being sold by our managers to meet redemption requests or free up cash that could be invested in more attractive opportunities--and issue we highlighted in a recent Ultimate Stock-Pickers' article. The reality, though, was a bit more nuanced. Upon digging into our top managers' holdings, purchases, and sales, we noticed that the largest seller, Alleghany, actually retained a very large position in Burlington Northern in its stock portfolio (equivalent to 36% of its equity holdings) even after reducing its position by 830,000 shares, or 22% of its position at the end of the third quarter.

While a sale of such a large stake would normally raise a red flag, we can't fault Alleghany for wanting to trim its exposure given how big its position in Burlington Northern had become by the end of the third quarter of 2008. And given that the stock was trading above $100 per share in September of last year (versus somewhere closer to $75 at the end of 2008), we have to take solace in the fact that Alleghany cashed out one fifth of its position at higher prices than it could have garnered had it waited until March of this year when the stock dropped down into the low $50s. Ironically enough, Berkshire had been fairly busy in January and February of this year adding to its own position in Burlington Northern, which when taken together with similar actions from three other Ultimate Stock-Pickers top managers-- Tweedy Browne Value  (TWEBX),  Amana Trust Income  (AMANX), and  Parnassus Equity Income  (PRBLX)--puts our long-term recommendation of the firm in some very good company.

Unfortunately, with the shares currently trading above our Consider Buying price, investors will need to leave this one in the train depot until it is once again ready to hit the tracks. In the meantime, we encourage investors to take a much deeper look at some of Burlington Northern's closest competitors (listed in the table below), several of which are currently trading at prices slightly below our Consider Buying price.

 Burlington Northern's Closest Competitors

Fair Value
Price ($)
Fair Value
Market Cap
($ Mil)
Union Pacific Corporation (UNP)MediumNarrow52.440.94$26,435
Burlington Northern Santa Fe (BNI)MediumNarrow73.090.81$24,818
Canadian National Railway (CNI)MediumNarrow43.431.03$20,794
Norfolk Southern Corp. (NSC)MediumNarrow38.060.67$13,947
CSX Corporation (CSX)MediumNarrow31.230.64$12,469
Canadian Pacific Railway (CP)MediumNarrow38.241.27$5,883
Kansas City Southern, Inc. (KSU)HighNone16.800.84$1,538
Genesee & Wyoming, Inc. (GWR)MediumNarrow31.001.03$1,117
Data as of 05-07-09.

Disclosure: Bradley Meeks doesn't own shares in any of the companies mentioned above.

The Morningstar Ultimate Stock-Pickers Team does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.