There may well be room for more than one winner in the U.S. freight rail sector.
The leading freight line, Union Pacific (NYSE: UNP), has recently picked up market share from No. 2 Burlington Northern Santa Fe Railway (BNSF), a wholly owned subsidiary of Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B).
BNSF had a rough year, with delays and barely on-time deliveries. Buffett didn’t mince words last week in his annual letter to Berkshire shareholders, when he said that BNSF had disappointed many of its customers.
But what Buffett said about the past year may not be as important as what he said about the future: a plan to spend $6 billion on BNSF in 2015 on upgrades, including the purchase of hundreds of fuel-efficient locomotives.
“BNSF is by far Berkshire’s most important non-insurance subsidiary,” Buffett wrote. “That sum (being invested) is nearly 50 percent more than any other railroad has spent in a single year and is truly an extraordinary amount.”
To put things in perspective, BNSF’s 2014 results were not terrible. Its total revenues in the key freight sector rose 5%, to $22.4 billion. But that growth was dwarfed by a 9% increase in Union Pacific’s freight revenues, which surpassed BSNF and reached $22.6 billion for the year.
While the momentum may be with Union Pacific, BNSF has the resolve and commitment of Buffett, and a few things are striking about the way he discussed BNSF.
First, Buffett showed a hands-on approach and a deep understanding of all the factors – from weather to technology – that impact performance. He also revealed a confidence that the railroad could do better.
Buffett is not one to throw good money after bad. He’s likely to move quickly to sell assets that he no longer believes in. A vote of confidence from Buffett is about as strong a vote of confidence as an investor could get. And as a wholly-owned subsidiary of Berkshire Hathaway, investors interested in BNSF would be buying it as part of a diversified conglomerate.
But the competition between the nation’s two largest railroads doesn’t need to be a winner-take-all game.
Railroads are a quintessential American industry that are as important today as they were in the country’s early years. While the trucking sector can move materials over relatively short distances, there really is no good alternative to railroads for long haul transport. This is the reality Buffett recognized in 2010, when he led Berkshire Hathaway to acquire Burlington Northern Santa Fe.
Union Pacific is a venerable leader in this space. It has a 153-year history, a fleet of more than 8,000 locomotives and a strong track record with steady growth in both revenue and income in recent years. This is a business with an established base of customers that’s shown itself to be more than adept at running this massive and highly complex business.
BNSF is a similarly-sized force in the railroad sector. With the backing of Berkshire Hathaway, it will likely give Union Pacific a run for its money. But Union Pacific will prove itself a formidable rival.
The good news for both of these businesses is that demand for freight rail shipping is on the rise. They say a rising tide lifts all boats, and while the metaphor doesn’t quite work for ground-hugging railroads, there does seem to be a lot of good fortune in this industry to go around.
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