Warren Buffett targets companies with moats, but these days the easiest moat to identify for Burlington Northern Santa Fe (NYSE: BNI) is that which lies between stabilization and recovery.
Burlington Northern rattled the railroad sector by posting a 30% decline in earnings amid a 27% fall-off in freight revenue. Although the railroads presented a consensus view that business conditions had bottomed out during the second quarter, and marginally improved sequential freight volumes confirm that they have for now, Burlington Northern's revenue decline still outpaced the 26% decline noted last quarter.
I suspect that the substantial barrier separating demand stabilization from sustainable demand recovery is not quite the moat that Berkshire Hathaway (NYSE: BRK-A) investors had in mind. Burlington's freight volumes declined 17% year-over-year, which is in the ballpark with the 15% drop observed by competitor CSX (NYSE: CSX).These volumes are much improved from the 22% declines reported by CSX and Union Pacific (NYSE: UNP) after the second quarter, but recent glimpses of fourth-quarter expectations from industrial bellwethers such as Peabody Energy (NYSE: BTU) and steelmaker Nucor make it difficult to anticipate continued improvement in volumes hauled. Reflecting the persistent weakness in construction-related demand confirmed by dismal results from USG (NYSE: USG) last week, Burlington Northern watched revenues from industrial products slide by 34% in the third quarter. Revenue from consumer-driven segments such as automobiles and containers, which account for some 31% of Burlington's traffic, dropped by an astounding 36%.
Union Pacific CEO Jim Young extended his cautious outlook into 2010: "I think next year we're going to be hard-pressed to see much of a volume increase." To date, railroads have exhibited a laudable capacity to increase operational efficiency to absorb revenue declines, but without a true recovery in demand, that ability can take the sector only so far.
I would like nothing more than to endorse Warren Buffett's choice in the railroad sector as best in class, but the operator's combined debt and deferred income taxes have climbed to more that $19 billion. That's some heavy cargo! While the company's operating ratio of 74.2% is respectable, it nonetheless stands some 1,150 basis points above that reported by my preferred operator: Canadian National Railway (NYSE: CNI).
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