Why I Don’t Like the Choo-Choo Train Business

“Profit Confidential” Column, by Michael Lombardi, CFP, MBA

I think Warren Buffett has been playing too much bridge with Bill Gates. First Gates buys just under 10% of Canadian National Railway and now Buffet takes a $26.0-billion gamble on railway company Burlington Northern Sante Fe Corp.

In all due respect, while Buffett was quoted somewhere as saying this is “an all-out wager on the economic future of the United States,” my question is: what future is he talking about?

Sure, because of the falling value of the U.S. dollar, Americans will not be traveling that much outside the U.S. this coming year. And, yes, because of rising oil prices, cheap airline fares will not last long. But transporting passengers is only a small part of Burlington Northern’s operation.

The company is really in the transport business. Burlington Northern ships autos, lumber, coal and other containers full of goods. Aside from coal, we would have to see the auto and home building sectors really pick-up for Burlington Northern’s revenue and profits to jump.

Buffett is buying further in to an old industrial business with big capital expenditures and poor returns on capital. Buffett’s deal values Burlington Northern at about 2.5 times the company’s peak sales. I don’t see that as a bargain.

The home building sector will not be coming back anytime soon. Hence, lumber shipments will not increase. Do you see a boom in auto sales coming? Again, it could take years for auto sales to get back to their 2006-2007 levels. Burlington Northern’s carloads fell 18% in the first nine months of 2009 compared to 2008. Now, just imagine how bad 2008 was compared to 2007.

As for me, I’m not a big fan of the choo-choo business right now. Sure, it is a great play if the economy is rebounding, but we may be far away from an economic rebound. If Buffett had waited, I believe he could have picked up Burlington Northern for a lot less money two years from now than he did yesterday. (Sometimes that is the problem with having too much money in your bank account. You feel pressured to do something for your shareholders.)

Michael’s Personal Notes:

Have you been following the Jim Rogers and Nouriel Roubini debate? Roubini is one of the fellows who called the real estate bubble. Now Roubini is saying that investors are creating an asset bubble that could burst. Specifically, on CNBC yesterday, when asked about gold bullion hitting $2,000 an ounce, Roubini said it is “Utter nonsense.”

Roubini’s comments did not sit well with well-known commodity investor Jim Rogers. Rogers basically said Roubini doesn’t know what he is talking about. I’m sorry, Nouriel, but I have to agree with Jim Rogers on this one. Gold bullion is long way from “bubble” territory. Bubbles don’t happen when 95% or more of investors are not participating in the bubble. From the stats I see on our financial advisory subscription sales, I would say that 95% of retail investors are not invested in gold.

Where the Market Stands:

“Round and round she goes, where she stops, nobody knows.” That old phrase about the roulette table can cutely describe the stock market today. Up one day, down the next. The longer the Dow Jones Industrial Average sits just under the 10,000 level, the more bearish the reports I read and follow on the market (which is good for stocks). But, any way you look at it, 2009 has been a truly wonderful year for the stock market. The Dow Jones Industrial Average sits this morning 11.7% higher than where it started the year. You can’t call this bear market rally dead yet.

What He Said:

“In 2008, I believe investors will fare better invested in T-Bills as opposed to the stock market. I’m bearish on the general stock market for three main reasons: Borrowing money in 2008 will be more difficult for consumers. Consumer spending in the U.S. is drying up, which will push down corporate profits.” Michael Lombardi, PROFIT CONFIDENTIAL, January 10, 2008. The year 2008 ended up being one of the worst years for the stock market since the 1930s, with most stock indices down 30%-40% for the year.