Buffett’s Railroad Aims to Sustain Its Profit Streak as Rivals Grow Wary

(Bloomberg) -- Warren Buffett’s purchase of BNSF Railway Co. was an “all-in” wager on the U.S. economy that has reaped rewards for his Berkshire Hathaway Inc. Now, it’s the economy that is tempering expectations for the business.

Slowing growth, trade battles and chatter from rivals about a “puzzling” economic backdrop are spurring questions about the rail industry. Berkshire’s second-quarter results expected on Saturday will reveal if Buffett’s BNSF extended a four-quarter streak of profit topping $1.2 billion, a level it had never reached before last year.

“We’re going into this earnings season with some concerns over the rail activity,” Cathy Seifert, an analyst at CFRA Research, said in a phone interview. She sees the possibility of “some downward pressure” on BNSF from weather-related disruptions, the trade wars and mixed energy pricing.

Rival railroads are warning of pain to come. CSX Corp. plunged the most in more than a decade after it reported a weakened sales forecast amid an economic backdrop that Chief Executive Officer Jim Foote called one of the most “puzzling” he’s seen. Union Pacific Corp., whose second-quarter results beat analysts’ estimates, has said it expects second-half volume to decline.

BNSF carloads probably fell by 4% in the second quarter from a year earlier, according to Bloomberg Intelligence data. UBS Group AG analysts led by Brian Meredith cut their second-quarter revenue-growth estimate for the railroad to 1% from 9%.

Even as the U.S. expansion chugs on as the longest on record, railroads are seeing pockets of weakness stemming from Midwestern floods, trade battles and competition from trucking. UBS analysts see declines in volumes across the industry, “though it remains difficult to determine whether this is due to trade tensions versus broad cyclical weakness,” they said Tuesday in a note.

BNSF joined Buffett’s company almost a decade ago, and has contributed as Berkshire’s profits rose to records. Buffett, Berkshire’s chairman and chief executive officer, in 2016 called the railroad one of the company’s “powerhouse” businesses. BNSF accounted for about 10% of Berkshire revenue last year.

Buffett, 88, has used his investing acumen over more than 50 years to build Berkshire into a behemoth that houses retailers, utilities and heavy manufacturers as well as insurers and the railroad. Omaha, Nebraska-based Berkshire tends to avoid giving guidance, making it harder to gauge outlook for any of its many, varied businesses.

The railroad has run into bumps before. Its profit sank in 2016 as shipping demand slipped on low oil prices and a shift away from coal. In 2014, harsh winter weather and surging crude shipments clogged rail lines and delayed shipments.

Some other topics that might come up Saturday:

Insurance Weakness?

Barclays Plc analysts expect earnings from Berkshire’s collection of insurers to decline year-over-year. Berkshire has exposure to the commercial market, which has been in a state of flux as insurers push for rate increases because of worsening claims trends, Meyer Shields, an analyst at Keefe Bruyette & Woods, said in a phone interview.

And the outlook for auto insurance is ominous for Geico, according to Seifert.

“We’re seeing from some of their competitors a deceleration in growth combined with a slight deterioration in claim trends,” Seifert said. “My expectation is that Geico is not going to be immune to those pressures.”

Buffett has called insurance the “engine propelling Berkshire’s growth” because the business generates funds that can be invested for years.

Kraft Heinz

Berkshire’s recent earnings reports have all been tinged with some Kraft Heinz Co. news -- none of it good. The packaged-food giant has announced a $15.4 billion writedown, investigated itself over procurement and accounting issues, faced a regulatory probe and ousted a CEO.

The drama led to a $2.7 billion hit against earnings for Buffett’s company in the fourth quarter. Kraft Heinz has yet to report its first-quarter earnings, scheduling an announcement for next week.

Berkshire helped create the food company and is its biggest shareholder, with a stake that exceeds $10 billion. Kraft Heinz shares lost about half their value in the year ended June 30.

Buffett has made it clear he has no plans to sell the stake. Still, he was forced to admit that Berkshire and 3G Capital overpaid for Kraft, and that its household-name products such as macaroni & cheese, Kool-Aid and Jell-O have lost some of their allure.

“People will always need to buy food so I’m not worried about it being a disaster,” KBW’s Shields said. “But if there’s been this underlying assumption of the value of prominent American brands, maybe that doesn’t look as well going forward.”

Crazy Swings

Morgan Stanley analysts expect a $9.7 billion gain before taxes in Berkshire’s equity portfolio, based largely on stock-price surges by American Express Co., Apple Inc. and Coca-Cola Co. Such dramatic swings have become a part of life for Buffett’s conglomerate.

Berkshire’s net income varies widely from quarter to quarter because of an accounting rule that took effect in 2018 and requires the company to account for fluctuations in its more-than $190 billion stock portfolio.

Of Berkshire’s 10 biggest holdings, eight rose in the second quarter. Leading the way were American Express with a 13% gain and JPMorgan Chase & Co. at 10%. The only decliners were Kraft Heinz and Wells Fargo & Co., which spent the quarter looking for a new CEO.

Swelling Pile

Investors will be looking for any hints that Buffett has found new ways to deploy the growing cash pile at Berkshire, which was $114 billion as the first quarter ended. Buffett said he’s been stymied by “sky-high” prices for potential acquisition targets.

“Things are expensive,” Shields said. “One of the things that’s worked really well for Berkshire is not overpaying.”

Still, Buffett has found a couple avenues to pursue in recent months. He agreed in April to invest $10 billion in Occidental Petroleum Corp. for a preferred stake and warrants as the oil producer worked to clinch the deal for Anadarko Petroleum Corp.

Berkshire also loosened its share-buyback policy last year. That’s allowed Berkshire to snap up $3 billion in stock since the change, a small amount compared with the billions that banks repurchase every year. Berkshire generally tucks buyback announcements into its quarterly filing.

“I’m not overly optimistic that there’s going to be a large buyback,” CFRA’s Seifert said.

Trade Spats

Berkshire’s businesses cut across a swath of the American economy, giving a sense of the broader health of the U.S. Heated trade battles have, so far, left Berkshire’s operating earnings generally unscathed.

Still, quarterly reports can give investors a sense of how the tariff impact is leaking into different industries. The Marmon unit, which owns railcars and makes industrial parts, has said that margins were pressured by tariffs. Precision Castparts attributed lower sales of pipe products to the trade issues. In 2018, Forest River, which makes recreational vehicles and cargo trailers, saw a slowdown because of tariffs on steel products.

To contact the reporter on this story: Katherine Chiglinsky in New York at kchiglinsky@bloomberg.net

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Dan Reichl, Steve Dickson

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