After Warren Buffet decided to add the majority remainder of Burlington Northern Santa Fe (NYSE: BNI) to his Berkshire Hathaway (NYSE: BRK.A) fund about a month ago, some criticisms and negative fallout didn't take long to materialize. Lead-ins like "Berkshire May Lose AAA Rating On Burlington Buy", "Burlington Bet Could Derail Berkshire", and my favorite, "Has Buffet Lost His Mind?" made a pretty clear statement that some investors (albeit a minority) thought Buffett was losing his touch - or at least his discipline.

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I understand the criticisms. I really do. When the guy calling the shots says the acquisition was "not a bargain", and when a principal commodity the railway hauls - coal - is apparently on its way out, you have to wonder if he's just trapped in the 20th century.

After the November 13 interview with Charlie Rose, though, and after some due diligence on the industry, I think Omaha's oracle is still as savvy as ever.

A Tale Of Two Industries
The chief concern regarding Burlington - and for all rail companies - is coal. It's dirty and politically unpopular. Lawmakers are mulling legislation that could limit the amount of coal that can be burned to produce energy (part of the cap and trade argument).

How bad would it hurt? Coal accounts for 40% of rail volume and 20% of rail revenue nationwide. Needless to say, that's a big chunk of money for the rail industry. The number, however, doesn't explain a key transition going on within the industry's customers right now.

There are two basic branches of rail transportation - intermodal and carload. Carloads are generally used to transport commodities in a boxcar, strapped to a flatbed, or dumped into a rolling bin that hauls the materials for later use as part of a manufacturing process. Coal is an example - consumers don't buy it, but factories need it to manufacture things consumers do buy.

"Intermodal" describes the transportation of finished goods. Trailers full of goods that can rest on a flatbed and also be hauled on the road by a truck are, in essence, intermodal transportation.

Intermodal Rebound
That's an important distinction to make, as it sets up a couple of key data points about rail shipping activity in the United States:

  • Commodity carload counts are up about 10% since May, but they were sequentially down in September and October.
  • Intermodal container counts are up 13% since May and were up every month since July.

That's the strongest May-October intermodal rebound we've seen since at least 2006, and it points to a very encouraging trend, particularly for intermodal plays. And, some analysts feel that it was indeed the recovery move.

Now, care to guess which railroad's been building its intermodal business like crazy? Burlington Northern Santa Fe.

As it stands right now, intermodal/consumer product shipping makes up about 35% of Burlington's total revenue, whereas coal makes up about 22% of the company's revenue (but make no mistake - access to coal and cheap shipping helps Buffett's utility holdings).

Weaning Off Coal
In the Charlie Rose interview, Buffett specifically acknowledged the country was going to wean itself off coal. He also realizes it's not going to happen overnight, or over a decade for that matter - 40% of the country's power is made by coal. Even as coal approaches obsoleteness, though, the lack of need for coal transportation will have a minimal impact on BNI's business since it doesn't rely heavily on coal revenue. Indeed, the growing need to ship finished goods - cheaply - will only grow in time, which is right up Burlington's intermodal alley.

Perhaps Mr. Buffett is more in touch with the shape of things to come than any of us gave him credit for. More importantly:

Best Of The Best
While the Burlington background is fascinating, it's also irrelevant - you can't buy BNI now and expect to make any money. Burlington's not the point, though. Similar opportunities exist with several outstanding rail names that are effectively following in Burlington's intermodal footsteps.

  • Canadian National Railway (NYSE: CNI) - Intermodal is the biggest single piece of the revenue pie at 20%, while coal makes up only 6%.
  • Union Pacific (NYSE: UNP) - The intermodal/coal mix is about 18%/24% of total revenue. It's probably the most troubling of the three stocks in that regard, but it's a very well-managed company that is in the habit of topping EPS estimates.
  • Canadian Pacific (NYSE: CP) - Grain shipping (another railway hot spot) and intermodal are tied at 27% of total revenue; coal makes up 11% of total revenue.

Bottom Line
A strong intermodal business and lack of coal liability may not prove tremendously beneficial in the very foreseeable future, but I trust the Oracle's insight about the rail industry's long-term growth - whether or not coal goes away. (To learn more, see Warren Buffet: How He Does It.)

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