3 Reasons Why Railroads Are One of Warren Buffett’s Best Investments

Source: Thinkstock

Source: Thinkstock

In 2009 Warren Buffett’s Berkshire Hathaway (NYSE:BRK.B) bought out on of the largest rail transport companies in the world—Burlington Northern Santa Fe. The buyout was the company’s acquisition to date. This in itself would indicate that Warren Buffett likes the rail transport business. However, I should note that in order to satisfy regulators he had to divest his positions in shares he owned of other rail transport companies including Burlington Northern’s regional competitor Union Pacific (NYSE:UNP) and Norfolk Southern (NYSE:NSC). We can see that not only did Buffett dish out billions to buy Burlington Northern but he had been accumulating shares of railroads for quite some time.

Since then the shares of each of the major rail transport companies have risen dramatically, which suggests that there is something to Warren Buffett’s insight.

Why, then, does Buffett like rail transport companies? There are three primary reasons.

The first is that rail transport companies are highly profitable. While the economy more generally is cyclical, and while a rail transport company’s volume is cyclical, by extension these companies have very low operating costs, and as a result they don’t need to generate an enormous amount of business in order to generate a profit. This makes rail transport companies especially attractive in times of economic weakness because their competitors in the trucking and water transport industries tend to lose a lot of money in recessions.

This profitability is in large part due to the second reason, which is that rail transport companies have very little competition. There are literally seven companies in North America that control extensive track networks: Burlington Northern, Union Pacific, Norfolk Southern, CSX (NYSE:CSX), Canadian National (NYSE:CNI), Canadian Pacific (NYSE:CP), and Kansas City Southern (NYSE:KSU). Furthermore these companies don’t all compete for the same business. For instance in the eastern part of the United States there are only two companies—Norfolk Southern and CSX. There are, in fact, some regions in the western part of the United States and in the northwestern part of Canada that are controlled by just one company, meaning that if a business wishes to transport something by rail they are effectively dealing with a monopoly.