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fundamental thinking

In this photo provided by Burlington Northern Santa Fe Railroad, a freight train travels through New Mexico.

Investing legend Warren Buffett has stated that he would be happy if he and his partner, Charlie Munger, could come up with one good investment idea every year. That one good idea currently appears to be Burlington Northern Santa Fe Corp. , a Fort Worth, Texas-based railway company that hauls freight.

Of the investments disclosed in recent 13F filings with the U.S. Securities and Exchange Commission by Berkshire Hathaway Inc. , it's by far the biggest purchase.* Accumulation began in April, 2007 and has been steady since. The latest buying, in January, increased Mr. Buffett's stake to 75-million shares, or 21.75 per cent of the company. It's now one of Berkshire Hathaway's largest holdings.

The prices paid for Burlington Northern stock range mostly between $75 and $80 (U.S). With the price currently trading several dollars below that range, followers of Mr. Buffett can buy even cheaper than the master himself.

In the past, Mr. Buffett has said the railroads were not his kind of investment. He described them as capital intensive, heavily unionized, extensively regulated, and operating at a comparative disadvantage against the trucking industry.

However, railways now appear to have a competitive edge in long-haul transportation thanks to years of upgrading infrastructure and equipment in response to deregulation in the 1980s. For example, locomotives today get 75 per cent more mileage from a gallon of diesel than they did in 1980, observes IHS Global Insight consultant Kenneth Kremar.

The upgrading continues. Of note, Burlington Northern is keen on technology that will allow it to run trains closer together, increasing productivity even more.

Energy and environmental trends have also conspired to bestow an edge. As Burlington Northern's chief executive officer, Matthew Rose, recently told Business Week magazine:

  • the further the price of crude oil rises above $25 (U.S.) a barrel, the more trains enjoy a cost advantage (they use just a quarter of the fuel trucks use).
  • highways have problems with traffic congestion.
  • trains are more environmentally friendly - a locomotive transporting 100 tons over 1,000 miles (1,600 kilometres) produces 45 per cent less pollution than long-haul trucks.

The U.S. industry is presently dominated by five rail companies. The division of the U.S. rail system into five railroads means more control over pricing. Railways might be capital intensive but with fatter margins, they can more easily cover capital costs.

Of the big five, the two largest are Burlington Northern and Union Pacific Corp. But Burlington Northern has "a record of more consistent management than Union Pacific does," writes Money Magazine editor Michael Sivy.

Burlington Northern controls nearly 50,000 kilometres (over 30,000 miles) of track throughout the United States and Canada, including a line that runs through Mr. Buffett's home town of Omaha, Nebraska. When it comes to railway networks, size matters. For one thing, a large network can provide seamless shipping to a greater number of destinations.

Burlington Northern's network spans two-thirds of the continental United States and is concentrated in the Midwest and West. The terrain and dispersed populations of these regions play to the strength of rail in long-haul freight transportation. Rail companies operating in the more densely populated Eastern region face relatively greater competition from trucks due to shorter hauling distances between destinations.

The location of Burlington Northern's geographic footprint also yields a natural advantage over other railway companies (except Union Pacific) when it comes to shipping imported Chinese goods across the U.S. due to easy access to terminals along the West Coast. Lastly, the company's lines running north and south down the middle of the U.S. give it the lead position for shipping imports and exports generated by free-trade agreements with Canada and Mexico.



Footnote: *The large investments last fall in the preferred shares of Goldman Sachs, General Electric and other privately arranged transactions weren't purchases of common shares or opportunities available to ordinary investors. So, for purposes of this article, they weren't considered as candidates for Mr. Buffett's one best investment.

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