Burlington Northern Santa Fe (BNI)

Although the outlook for the North American railroad industry has improved significantly since the 1980s, much of this is priced in. For nearly the entire decade of the 80s, the large railroads had 6x-9x P/E multiples. These P/Es have roughly doubled over the last 20 years to 13x-17x. Further multiple expansion for the sector is unlikely. Nimble investors could well get a much better entry point in rail stocks, as recent signs point to a railroad industry feeling the effects of a slowing U.S. economy (year-to-date rail volumes are down 2.7%). Here is something else to think about: during the California gold rush, the ones who made the most money were those who sold the picks and shovels. Instead of buying BNI at 90% of X, a number of smaller companies that supply the resurgent railroad industry’s cap ex needs may prove to be the best bargains if you share the increasingly rosy outlook on the major rails with investors like Warren Buffett.

Although the outlook for the North American railroad industry has improved significantly since the 1980s, much of this is priced in. For nearly the entire decade of the 80s, the large railroads had 6x-9x P/E multiples. These P/Es have roughly doubled over the last 20 years to 13x-17x. Further multiple expansion for the sector is unlikely. Nimble investors could well get a much better entry point in rail stocks, as recent signs point to a railroad industry feeling the effects of a slowing U.S. economy (year-to-date rail volumes are down 2.7%). Here is something else to think about: during the California gold rush, the ones who made the most money were those who sold the picks and shovels. Instead of buying BNI at 90% of X, a number of smaller companies that supply the resurgent railroad industry’s cap ex needs may prove to be the best bargains if you share the increasingly rosy outlook on the major rails with investors like Warren Buffett.

One must note that Burlington faces north of $1.1 billion in accrued liabilities on its balance sheet due to asbestos, environmental, other personal injury, and employee termination costs over the years. This is in addition to increasing pension and healthcare liabilities ($630 million in underfunding at year-end) and a fair amount ($640 million/per annum) of operating leases that add to the fixed nature of its cost structure. BNI’s debt maturities are well-structured and all of these additional liabilities in their present form can be handled by BNI’s cash flow. However, settling these liabilities over time will require a great deal of cash that might otherwise have been returned to shareholders.