By Tony Hatch Exclusive to RailPrime
Shhh — it’s quiet — TOO quiet! BNSF — formerly and to many still the Burlington Northern Santa Fe Railway — remember them? When one looks at railroads from the investment perspective, it seems that they, like Genesee & Wyoming (and soon Kansas City Southern, before it becomes part of the Canadian Pacific Kansas City, or CPKC) have disappeared. Investors and analysts focus on the publicly traded stocks and tend to see BNSF only through the eyes of its major competitor, the Union Pacific … often via comments on their rival (free from analyst concerns — and pricing). The only finance types who seem to care about BNSF are Berkshire Hathaway superfans who flock each year, pre-Pandemic anyway, to Omaha (irony!) for “Buffettpalooza”/the Berkshire Hathaway annual meeting.
But how can you ignore the largest railroad on the continent, and the one with the largest — and best — intermodal franchise on the planet? You simply cannot, even with the relative paucity of information available out there.
BNSF has played a part in the railroad industry’s public re-opening, with CEO Katie Farmer prominent at the North American Rail Shippers annual meeting in Chicago last month, and the only Class I with a public presence at the Intermodal Association of North America’s Intermodal Expo in Long Beach, also last month. (By the way: BNSF — and the UP — have so far mostly held their cards close to the vest on CPKC. Both do a lot of interchange business with the KCS into Mexico, so we will see what, if anything, publicly comes out about concessions requested and granted in Texas and south.)
Succession Issues? Nope. BNSF is one of only two Class Is not to have what I have been hailing as a succession issue, by which I mean clear stakeholder understanding of who — and what — comes next (the other being the CPKC, naturally). Farmer is an experienced and popular leader with a wide-open window in front of her.
CEO Katie Farmer is an experienced and popular leader with a wide-open window in front of her, writes Hatch. But Berkshire Hathaway itself has issues. Yes, they inadvertently revealed that Greg Abel, who runs the BH industrial portfolio (including BNSF) would succeed Buffett. But that leads to two questions. First, when? Many business publications called for a definite date (The Economist even stated that “Time’s Up!”). Buffett’s golden touch may have become more mortal of late, and there is some restlessness even in his fan base. There was significant questioning of his $6.5 billion (pocket-change) investment across the board in the Big Five Japanese trading/industrial concerns. One thing to remember is those companies, particularly Sumitomo and Mitsui, have historic and global rail interests and aspirations.
Buffett’s remaining tenure may have rail implications because of the second question: What’s next? Although Buffett’s longtime collaborator Charlie Munger has said Abel would “keep the culture,” with the Buffett magic on the bench, there’s some discussion of two things that make me pause: (1) a move to be more “hands-on” with the portfolio including the railway; and (2) the potential of a breakup of the conglomerate, an investing format that is as out of fashion as corsets everywhere but, still, though perhaps waning, in Buffettland (the BH assets no longer trade at a premium to the net asset value).
One other note: The fears of a more hands-on approach to BNSF is real, given some public statements by BH on BNSF performance relative to, say, the UP (see below) that have caused me some concern, though of late there’s been a bit more cheerleading (“Katie’s doing an incredible job”).
ESG — is anything hotter in investing? Certainly not. And here, with environmental, social and governance, we also get a BNSF/BH split. BNSF is all in, starting with their CEO, the first woman to lead a Class I. They were early on a more “kindler/gentler” approach to labor relations. They were perhaps first to announce experimenting with a hybrid-powered locomotive with Wabtec. As an aside, BNSF was always seen as a tech leader and will likely be a leader in post-PTC AV railroading. Back to ESG: Buffett/BH have come out against “stakeholder capitalism” and efforts to pass environmental disclosure (etc.) proxy proposals, and they’ve been engaged in public debate with the likes of BlackRock and CalPERS on the issue.
Financial performance. BNSF doesn’t make it easy on us; they report — late and on a Saturday (perhaps the inspiration for the weekend surprises in the KSU Odyssey?), so we are forced, at this writing, to use somewhat dated, by Street standards, numbers. BNSF reported strong Q2/21 numbers —– their third-quarter numbers, assembled within Berkshire Hathaway’s results, won’t be reported until perhaps Nov. 6, two weeks after the rest of the Class Is report. Revenues were up 26% on a slight (albeit perplexing, as you shall see) mix hit, and volumes increased almost 25%. OpEx matched the volume, so the OR “only” improved by 70bps to 60.4% (over 500bps higher than that of UP). But intermodal was stellar. In a period of extreme stress, BNSF produced revenue growth of 32.6% on a volume surge of 27.4% (so something was moving in Q2!). Ag’s split was +19%/+13%, industrial products +17%/+18%, and coal … well, don’t think we have a trend here, but revenues were up 42%. BNSF also got a credit rating increase from S&P over the summer (that plays well to calm STB concerns). In Q3/21 BNSF — with what Farmer calls their “Bias for Growth” (so much better than using “begets”) — is leading the pack, with volumes up 3.9%, one of three (of seven) Class Is to show increases at all. The industry was flat (+0.2%) and UP was down a percent.
BNSF has what is generally considered the premium intermodal franchise, not just in the West but in the world, Hatch notes. Ian Dewar Photography / Shutterstock.comBNSF, Supply chains and the STB. Like their peers, BNSF is caught up in the supply-chain mess at present, but they seem to be getting a handle on things (to paraphrase the competition). Farmer was one of several CEOs, including UP’s Lance Fritz, to emphatically defend rail activity and the disruption caused by the pandemic and the aftermath in terms of ocean, ports, warehouses and terminals (customer pick-up). By not publicly embracing PSR (see below), they have avoided the STB’s direct wrath; and at the North East Association of Rail Shippers’ fall conference, STB Vice Chairman Robert Primus, in a rather strident attack on private equity/financial influence on the rail sector (missing the example of Genesee & Wyoming entirely), called the Buffett/BNSF history a positive one.
Farmer, former BNSF CEO Carl Ice and longtime Chief Marketing Officer Steve Bobb have been quoted as saying they would not “trade off” volumes for margin (sweet music to the STB). Of course, the STB is fighting the last war — with the possible exception, strangely, of CN, the rail industry has moved past PSR (or PSR 1.0) to a growth/ESG/Tech focus. You could say BNSF was already there.
To PSR, or to not PSR – is there really a difference? That OR “gap” to the UP has been a point of discussion by Buffett (and others) in the past, and although BNSF has, in general, narrowed the gap, there are three broad reasons for it: (1) the high percentage of one-way unit train business (ag/coal/consumer products); (2) the mix effect; and (3) that BNSF is the only Class I not to “publicly embrace Precision Scheduled Railroading … although Hunter Harrison famously worked out the origins, the tablets from on high, while working at what’s now the BNSF. But BNSF wasn’t going with the crowd. In fact, dating back to Farmer’s predecessor Carl Ice, they have stated they would pick and choose which PSR (er, techniques) they would use on their railway. Of course, BNSF quietly has been dipping their toes into PSR waters since 2009 everything they do is rather quiet, at least to this stakeholder group). And recently, they seem to be embracing it more. But they are running super-long trains (reportedly up to some 15,000 feet, and — shudder — blended trains involving intermodal and carload (which, as Hunter once said, could lead to service level increases for manifest business-like lumber). But they aren’t going all in (they are still No. 6 of 7 Class Is in average train length, and run about one-third shorter than UP), and they aren’t talking about it much.
The BNSF-UP mix comparison. Comparing BNSF with UP is easy, superficially, the two giants of the West, although methods (not just timing) of reporting makes the classic “apples-to-apples” comparison difficult. Surprising to casual rail observers, by H1/21, BNSF was the bigger of the two railways (by ~6% in terms of revenues, although they are accounted differently and that gap could be viewed as larger). In terms of 2020 operating income, the UP was slightly larger. Let the arguments begin:
- But BNSF is much larger in intermodal, which is, as we know, lower margin (higher OR) but not necessarily lower returns (ROIC). We don’t get BNSF’s except via the slow, somewhat controversial STB version, which put UP’s ROIC at 14.4% and BNSF’s at 11.6%, both above the weighted average cost of capital of 7.89%.
- Looking at six months volumes, UP’s Premium and BNSF’s Consumer Products business units were both the biggest in their respective concerns (both combine intermodal and automotive), and – we know UP’s auto franchise is much larger. In terms of six month’s volumes, BNSF’s Consumer Products Business Unit (CBPU) was 56% of the total, UP’s Premium Business Unit (PBU) was 50% (and they break it out — intermodal volumes were 42% of the total). Revenues were closer: 35% (BNSF’s CPBU) vs. 32% (UP’s PBU), but UP’s intermodal alone was 23%.
- BNSF also has, to borrow a phrase from their rival, what is generally considered the “premium” intermodal franchise, not just in the West but in the world. Think of the customer base, starting with J.B. Hunt moving to UPS, Schneider, Maersk, Amazon.
- BNSF’s Coal Business Unit is roughly double that of the UP — also a double-edged sword, most likely (but not for the next 12 months or so, thanks to the NatGas price pop: it’s up ~20% quarter to date!). But while BNSF has two-thirds of the western market, their yield (revenue/car) as opposed to price is a rebuke to the whisper that they “bought the market” — it’s $2,010/car compared to UP’s $2,051. If that’s buying the market, then the market sells itself cheaply!
- BNSF’s ag revenue base (H1/21) is ~7% bigger than UP’s on a similar gap in carloads. It’s harder to get a yield comparison, given that UP’s grain/ferts yields of $3,500-$3,800/car is well below BNSF’s ag products yields of $4,089, but the former’s large food & refrigerated sub-unit has a healthy $5,230/car yield. My suspicion is that BNSF, the founder of the big grain shuttle franchise, has a better ROIC here. It will be interesting to see how long-haul CP-originated grain to KCS plays out, although BNSF has a multi-destination marketing plans, and both have good access to the Pacific Northwest.
- UP is a merchandise powerhouse, the industrial products carrier in North America — here, they own 58% of the market (H1/21 revenues), but a quarter of their total is high-margin plastics (no public revenue comparisons are available). Here, too, it will be interesting to see how the CPKC plays out in terms of CBR for both railways.
BNSF represents the future for North American railroads. This is not to say the future isn’t at Prince Rupert and Montreal, Texas and Omaha, Florida and Jacksonville, Atlanta and the Crescent Corridor, or Calgary and Monterrey (or the 600+ short lines). But the rail growth is coming out of intermodal, and changing and dynamic retail/industrial supply chains (and players) — powered by technology, innovation and change. Although we don’t hear from them as much as we would like, we can see it is certainly happening at BNSF.
Tony Hatch is an independent transportation analyst and consultant, and program consultant for Progressive Railroading’s RailTrends® conference. Email him at abh18@mindspring.com.
