In my previous article, I put together Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio)'s investment rationale for Apple (AAPL, Financial) and airlines citing their own words. Somebody came up with the happy idea of compiling original Buffett and original Munger for railroads. In today’s article, I’ll share what I found – the comments they made about the railroads when they first made the purchase a couple of years ago.
Buffett on the railroads during an interview with Charlie Rose: (Link)
Charlie Rose: Why did you do it (pulling the elephant trigger on BNSF)?
Buffett: Well, I felt it was an opportunity to buy a business that is going to be around for 100 or 200 years, that’s interwoven with the American economy in a way that if the American economy prospers, the business will prosper. It is the most efficient way of moving goods in the country. It is the most environmentally friendly way of moving goods, and both those things are going to be very important.
But the biggest thing is the U.S. is going to do well. I mean, we can’t move the railroad to China or India. They haven’t figured out how to do that. So you know, it’s sort of like if you remember that song about New York, we have to make it here or we can’t make it anywhere.
Charlie Rose: Frank Sinatra.
Buffett: But it does move 400 – it moves a ton of goods 470 miles on one gallon of diesel. It replaces – a train replaces 280 trucks on the road. It emits far less into the atmosphere that’s damaging than trucking, and it moves – I’m talking about the whole rail industry – it moves 40% of the goods.
Charlie Rose: And you have new ports of entry like Houston that are bringing a lot of goods –”‹”‹
Buffett: Oh, sure.
Charlie Rose: through the Panama Canal.
Buffett: And we’re going to have more people in this country, and they’re going to be using more goods over time. And sure, there’s a bad year from time to time. In the next 100 years, there will probably be 15 bad years, and I don’t know what order they’ll appear, but I also know the railroads will be essential to the country.
Charlie Rose: But I mean, (Charlie Munger) also pointed out, it is said, that, you know, there was – this was a regulated industry.
Buffett: Sure.
Charlie Rose: This was an industry that was capital-intensive.
Buffett: Very capital-intensive.
Charlie Rose: This was an industry –”‹”‹
Buffett: You spend money.
Charlie Rose: that was unionized.
Buffett: It was unionized. You spend money in this business of money to repair track, add capital-intensive, and it is regularly every day. You’re spending a lot rolling stock, whatever it may be. So it’s regulated, and it will continue to be regulated, and it will continue to be capital-intensive.
I think that the service provided by railroads is so important in many ways. I mean, it’s the right way to move goods around the country to the extent that you can do it. And it’s far, far more attractive in terms of global warming than using trucks, for example. So it will be here, and if we get a reasonable return on the added capital investment – because it will take added capital investment – we’ll do OK.
Charlie Rose: Reasonable return is good enough?
Buffett: Reasonable return is good enough, Charlie. I mean, 50 years ago, I was looking for spectacular returns, but I can’t – I can’t get them. We have – we have $8 billion or $10 billion to invest every year.
And we’re in the utility business, and it’s the same thing there. When we build electric generation or something of the sort, we shouldn’t expect a spectacular return. We’re building things that are essential to society, and people need our services. They really don’t have any choice in the case of the electric utilities, for example, and sometimes in case of rail. And we should get a decent return on that. Enough to encourage us to keep putting money into the business, but we’re not entitled to spectacular returns.
Charlie Rose: You carry coal?
Buffett: Well, that’s a big one in terms of tonnage, yes.
Charlie Rose: And if, in fact, we wean ourselves off coal, is that a big problem?
Buffett: Well, we will wean ourselves off coal over time. We can’t change 40% of electric generation that goes – that comes from coal. We can’t change that next week or next month or next year, but we will reduce it over time, and we should reduce it over time.
Charlie Rose: And you can add other things to carry and changes will be –”‹”‹
Buffett: There will be more grain to move, and there will be more all kinds – chemicals – or whatever it may be. There will be more things moving around this country 10 or 20 or 30 years from now.
Charlie Rose: Knowing your idea about moats –Â is that no one is likely to get into the railroad business?
Buffett: If they wanted to reproduce the Santa Fe, it might take $100 billion or so.
Charlie Rose: And 100 billion years.
Buffett: They’d have to be a real sport.
Charlie Rose: And they are also modernized today, are they not?
Buffett: Enormously. Enormously. The railroads – take a railroad like BNSF. They’re moving far more ton miles of product with less in the way of people, less in the way of fuel. Railroads have become far more efficient over the years. There were a million and a half people employed in the rail industry after World War II. Now there are about – less than 200,000 in the U.S., and they’re moving far more goods. So it’s really become efficient. You watch those 130-unit trains double stacked.
Charlie Rose: You had other railroad companies in your portfolio.
Buffett: Right.
Charlie Rose: You’re selling them?
Buffett: I’ve already sold them. Yes. I’ve done that just to facilitate the transaction. I think they’re good investments, but I would have held them if this hadn’t happened.
Explanations from Buffett on the BNSF purchase in 2010 Berkshire Annual Report
Both of us are enthusiastic about BNSF’s future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel efficient than trucking is, which means our railroad owns an important advantage in operating costs. Concurrently, our country gains because of reduced greenhouse emissions and a much smaller need for imported oil. When traffic travels by rail, society benefits. Over time, the movement of goods in the U.S. will increase, and BNSF should get its full share of the gain. The railroad will need to invest massively to bring about this growth, but no one is better situated than Berkshire (BRK.A, Financial)(BRK.B, Financial) to supply the funds required. However slow the economy or chaotic the markets, our checks will clear.
We have two very large businesses, BNSF and MidAmerican Energy, with important common characteristics that distinguish them from our many others. Consequently, we give them their own sector in this letter and split out their financial statistics in our GAAP balance sheet and income statement. A key characteristic of both companies is the huge investment they have in very long-lived, regulated assets, with these funded by large amounts of long-term debt that is not guaranteed by Berkshire. Our credit is not needed: Both businesses have earning power that, even under very adverse business conditions, amply covers their interest requirements. For example, in recessionary 2010 with BNSF’s car loadings far off peak levels, the company’s interest coverage was 6:1.
Both companies are heavily regulated, and both will have a never-ending need to make major investments in plant and equipment. Both also need to provide efficient, customer-satisfying service to earn the respect of their communities and regulators. In return, both need to be assured that they will be allowed to earn reasonable earnings on future capital investments. Earlier I explained just how important railroads are to our country’s future.
Rail moves 42% of America’s intercity freight, measured by ton-miles, and BNSF moves more than any other railroad – about 28% of the industry total. A little math will tell you that more than 11% of all intercity ton-miles of freight in the U.S. is transported by BNSF. Given the shift of population to the West, our share may well inch higher. All of this adds up to a huge responsibility. We are a major and essential part of the American economy’s circulatory system, obliged to constantly maintain and improve our 23,000 miles of track along with its ancillary bridges, tunnels, engines and cars. In carrying out this job, we must anticipate society’s needs, not merely react to them. Fulfilling our societal obligation, we will regularly spend far more than our depreciation, with this excess amounting to $2 billion in 2011. I’m confident we will earn appropriate returns on our huge incremental investments. Wise regulation and wise investment are two sides of the same coin.
Munger on the railroads during the 2007 Wesco meeting
“Now (railroads) is an example of changing our minds. Warren and I have hated railroads our entire life. They're capital-intensive, heavily unionized, with some make-work rules, heavily regulated and long competed with a comparative disadvantage vs. the trucking industry, which has a very efficient method of propulsion (diesel engines) 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, etc. They have a big advantage over truckers in huge classes of business.”
Munger during the 2017 DJCO meeting
“We said railroads were no damn good. There were too many of them, they had truck competition. And we were right; it was a terrible business for about 80 years. Finally they get down to four big railroads, and it was a better business.”
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