Burlington Northern - Steven Wevodau

Burlington Northern: Then and Now

posted by Steven Wevodau

 

Blasphemy: Burlington Northern Shouldn’t Be Held

By: Paul Price April 21, 2008

Go ahead and attack the thought. Sell a Buffett stock? Am I nuts?

 

Read this and you decide.

Berkshire Hathaway (BRK.A) started reporting buys in Burlington Northern (BNI) a year ago in early April 2007 with 1.646 million shares for an average price of about $81.37/share. Buffett and Berkshire bought quite a few times after that by averaging down. Their last reported purchase was on January 22 at a price of $75.51 /share.

At Tuesday’s price of $99.77 these shares now trade at 16.8x estimated 2008 earnings of $5.90 - $6.00 and about 14.7x 2009 estimates of $6.75 - $6.80. The current yield on BNI shares is a historically meager 1.28%.

Value Line lists Burlington Northern’s 10-year median P/E as 14x and MSN MoneyCentral’s 10-year average P/E calculates to 14.13x. If BNI shares retreated to even 14.5 times this year’s consensus view of $5.95, the shares would drop back to $86.28.

If BNI shares regressed to a [still higher than typical] 1.5x projected 2008 sales, the shares would decline to $74.95. At a higher than normal 2.4x book value BNI shares would be $86.16 at year-end 2008.

The yield is now near the all-time low of just 1.2% even after the rise to $0.32 quarterly. For the current dividend to return to a more typical 1.5%, the shares would need to dip back to $85.33.

Is Burlington Northern a good company in a favored industry group? Yes. Are BNI shares likely to be higher at year end 2008 than yesterday? I doubt it.

Burlington Northern is riding the ‘Buffett effect’ and the tailwinds of the commodities frenzy right now. This seems to be more than fully reflected in its valuation.

I see much more risk of a share price decline back to $75 - $88 than a move up to $110 or better.

Go ahead and blast me, but I feel strongly that there are much better places for your investment dollars from now through December.

Now, with BNI shares closing yesterday at $66.86 I’m ready to take a position alongside that somewhat well known fellow Mr. Buffett. The shares actually made a new 2 ½ -year low intraday at $65.55 before bouncing back a bit with the overall market.

Berkshire Hathaway owned about 70.09 million shares or 20.47% of the entire company as of December 11, 2008 giving us some indication of his long-term belief in BNI’s prospects. Zack’s now carries estimates of $6.32 and $6.53 for 2008 and 2009 respectively. Both those numbers would represent all time high EPS.

Burlington Northern’s multiple has regressed to about 10.6x last year’s and < 10.3x forward estimates bringing the present valuation to a nice discount to its 10-year average P/E of 14x. The dividend was recently raised to $0.40 quarterly making the current yield 2.39%. That’s the highest rate on these shares in about 8 years.

Value Line calls BNI’s financial strength an ‘A’ while assigning them 85th percentile ratings for both ’stock price stability’ and ‘earnings predictability’ (with 100th being best).

A return to a more normal P/E of even 13 times 2009’s $6.53 estimate leads me to a $84.90 12-month target price. That’s almost 27% above yesterday’s close. Add in the 2.39% dividend and you could see almost 30% total return by year-end.

Is $84.90 achievable? BNI shares hit highs of $88, $95.50 and $114.60 in 2006-2007-2008 all on lower sales, earnings and book value than Tuesday’s comparables.

Want an even lower risk play on Burlington Northern? Consider this:

If BNI shares are $70 or higher [up at least 5% from Tuesday's close] on the January 15, 2010 expiration date:

  • You will have no further option obligations.
  • You will have $7,160 for your original $4,326 outlay.
  • Your $70 call will be exercised.
  • Your shares will be sold for $7,000.
  • Your $70 put will expire worthless (a good thing for you as a seller).
  • You will have collected $160 in dividends (at the current rate).
  • That’s a 65% cash-on-cash gain in this best case scenario.

If BNI shares are unchanged at $66.86 next January 15th:

  • Your $70 call will expire worthless.
  • Your $70 put will be exercised.
  • You will be forced to buy an additional 100 shares for $7,000 more cash.
  • You will now own 200 shares of BNI total.
  • You could sell those 200 shares for better than a $10/share immediate profit.

What’s the risk?

  • On the original 100 shares it’s your $66.86 purchase price less the $9.60 call premium.
  • That’s $57.26 /share.
  • On the put it’s the $70 strike price less the $14 put premium = $56 /share.
  • Your overall break-even is thus $56.63 /share.

While BNI certainly could be trading lower than that price next January, it has not changed hands that cheaply since the middle of 2005 (on trailing earnings at that time that were only about half of today’s). The dividend in 2005 was also less than 50% of the current level.

Disclosure: Author bought BNI shares and sold BNI puts Tuesday.

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