In recent years Wall Street has recognized the need for railroads to transport coal and, to a lesser extent, ethanol amid a growing U.S. emphasis on domestic sources of energy. Sometimes dismissed as old-fashioned, stocks in the sector have soared. According to the American Association of Railroads, rail freight volume was 1.74 trillion ton miles in 2006, up nearly a fifth since 2000.

Burlington has been sharing in the bounty. In 2006 the company posted revenues of $15 billion, up from $13 billion the previous year. Revenues from shipping coal climbed almost $500 million, to $2.9 billion.

Better Than Treasuries?
Buffett's Burlington stake is "not the sort of move where you'll see huge rates of return," says Mark Hirschey, a professor at the University of Kansas School of Business. (Berkshire also confirmed an Apr. 9 Associated Press report that it had bought stakes in two other unspecified railroads.) Instead, he says it's a smart long-term bet on a "storehouse of value." Hirschey says the $3 billion-plus stake also fits Berkshire's need to put huge sums to work.

With all that cash sloshing around, "the big question is: 'Is it better than Treasury-bill [interest] rates?' And it probably is," says Morningstar (MORN) analyst Matt Nellans. He also points out that Buffett has a deep understanding of the transportation industry from his ownership of trucking outfit McLane. This knowledge of a competitor might provide some insight that outsiders lack, he suggests. Additionally, he points to Buffett's long record of finding "at least reasonable bargains."

The deal, Nellans says, comes after several other unexpected bets from the renowned investor. Last May, Buffett took a majority stake in Israeli manufacturer Iscar. Another surprise deal came last fall when Berkshire agreed to take on the liabilities of British reinsurer Equitas while gaining the power to invest its almost $9 billion in capital reserves. Both of these deals came out of the blue, Nellans says. "I would love to know his pricing metrics," he adds.

Airline Investment Angst
Not all of Buffett's forays into transport have been successful. In 1989, Berkshire took a stake in carrier US Air (now US Airways) that caused Buffett a great deal of agita. However, airlines are widely regarded as more volatile businesses than railroads.

Still, Buffett's move flies in the face of analysts who tend to be lukewarm on railroad stocks after their long bull run. Following the news of Berkshire's stake, Standard & Poor's downgraded Burlington to sell from hold, maintaining its $80 price target, below the Apr. 9 close of $88.08. "The stock already factors in continued near-perfect operating conditions," an S&P note says.

Even so, analyst Kevin Kirkeby says Buffett "has a much longer time horizon" than his own 12-month price target. (S&P, like BusinessWeek, is owned by the McGraw-Hill Cos. (MHP).) After a strong run by the railroads, S&P has no buy or strong buy ratings on stocks in the sector.

High Costs to Entry
David Winters, CEO of money management firm Wintergreen Advisers and a train afficionado, was more enthusiastic. Railroads, he says are "unduplicable franchises" protected by huge costs of entry. "The economics of railroads have improved more than people's perception of them," says Winters. (Wintergreen holds Berkshire Hathaway stock.)

Just as Berkshire Hathaway acquired MidAmerican Energy, Hirschey of the University of Kansas says he wouldn't be surprised to see Berkshire move on other companies that, like Burlington, stand to gain from an increasing focus on politically safe stores of fossil fuels.

Companies he suggests could be of interest to Buffett include energy outfits Apache (APA), Anadarko Petroleum (APC), and Canadian Natural Resources (CNQ). Hirschey characterized Buffett taking a stake in Microsoft (MSFT) as less likely than an investment in the energy companies like Apache but not out of the question. Microsoft Chairman Bill Gates serves on the Berkshire board.

With Berkshire's move into railroads, Burlington competitors CSX (CSX), Canadian National Railway (CNI), and Union Pacific (UNP) also saw healthy bumps in their stock prices on Apr. 9 as the S&P Railroad index chugged higher by 4.4%, with some component stocks finishing the session at or near all-time highs.

They're "long-term, steady, knowable businesses," Winters says. "Classic Berkshire, [it's] trains of profit as far as the eye can see."

(Articles taken from Businessweek)