During his recent appearance on CNBC, Warren Buffett (Trades, Portfolio) (BRK.A, Financial)(BRK.B, Financial) was asked about the performance of Burlington Northern Santa Fe (BNSF) relative to its closest industry peer, Union Pacific (UNP, Financial). Specifically, Buffett was asked whether he agreed with the belief that BNSF has lagged UNP, and if so, how the gap could be closed.
First, let’s give a bit of background. Over the past five-plus years, most of the Class I railroads have made a concerted effort to materially improve their operating ratio (which is the inverse of a railroad’s operating margins). As shown below, UNP’s operating ratio has fallen by more than ten percentage points since 2011, compared to a roughly 800 basis point improvement for BNSF (I've selected 2011 as the starting point because BNSF was not acquired by Berkshire Hathaway until February 2010, with 2011 being the first full year of financial results).
That data point supports the conclusion that BNSF has not achieved operating improvements on par with its closest peer over the past 5-10 years. However, I doesn’t think that tells the whole story. As Buffett noted during the interview, BNSF has gained market share over time. That’s not something I’ve heard too often, so I decided to take a look at the data – and sure enough, he’s right. As shown below, from 2011 to 2019, BNSF took a few points of dollar share from UNP (based on relative revenues in both periods).
But this next chart is even more telling. When looking at volumes as opposed to revenues, the market has changed from a slight advantage for BNSF in 2011 to a ten-point share advantage in 2019. I think this reflects some combination of pricing actions and business mix, but I do not have a good idea of the split between those two factors.
Putting it all together, I think this shows the complete picture.
As you can see, BNSF’s revenues increased at a 2.3% compounded annual growth rate from 2011 to 2019 – a point higher than the result for UNP. In addition, operating income increased at a 5.8% compounded annual growth rate for BNSF over the same period compared to a 5.1% compounded annual growth rate for UNP. In terms of both metrics, I think the long-term results suggest that BNSF has more than held its own. For what it’s worth, BNSF began with a slightly higher mix of coal revenues, which have been a secular headwind to both rails over the past decade.
Conclusion
During the interview, Becky Quick asked Buffett for his thoughts on Precision Schedule Railroading (PSR). Does he believe it leads to an improved railroad? This was his response:
“We’ll see. We’ve watched it plenty. It makes the customer adapt to the railroad more than the railroad to the customers. And practically everybody has done it… It has improved margins dramatically… On the other hand, we’ve gained market share because the railroad customers apparently like us better. Over the long-term, we’ll see – it’s not like it's something we can’t do.”
I think that answer is telling. It suggests that, in Buffett's eyes, there’s more to see. There are some benefits associated with PSR, but there may be some costs as well. As always, Buffett is solely focused on the long-term health of the business. If the management team at BNSF ultimately decides that PSR is right for their business, then they will follow in the footsteps of their peers. The idea that BNSF may be a few years behind in doing so doesn’t seem to bother Buffett.
That perspective seems different to me than what I've heard from the most recent UNP conference calls. In my opinion, the analyst community has become obsessed with this idea of reaching a sub-60% (or even sub-55%) operating ratio as soon as possible. That makes sense if your objective is to construct a financial model that justifies higher price targets, but I’m not sure that should be the primary objective for the operator.
As Buffett said, we’ll see how this plays out. Personally, I have faith that the people running BNSF are continuing to make decisions that they believe are in the company's best interests for the long run. If that ultimately means implementing some version of PSR, then so be it.
I’ll let Buffett have the last word (quote from the 2019 shareholder meeting):
“We are not above copying anything that is successful. And I think that there’s been a good deal that’s been learned by watching these four railroads… if we think we can serve our customers well and get more efficient in the process, we will adopt whatever we observe. We don’t have to do it today or tomorrow, but we do have to find something that gets at least equal, and hopefully better, customer satisfaction and that makes our railroad more efficient. And from the actions of these other four railroads, there’s been growing evidence that we can learn something from what they do.”
Disclosure: Long Berkshire B shares.
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