Monthly Archives: February 2014

Norfolk Southern Capex

NorfolkLogoI spent some time today with Norfolk Southern’s recently filed 2013 10-k.  With a $28 billion market cap and 6.7% trailing after-tax earnings yield, it bears a striking resemblance to that former target of Mr. Buffett’s “elephant gun“.

Now suitably reloaded, it doesn’t require much imagination to see how elegantly the Norfolk lines would fit with Burlington’s.

Norfolktrack

Of course, one should not let the imagination linger too long, for regulators have effectively preempted such a union, noting in 2001, that any future merger between Class 1 railroads would “bear a heavier burden to show that a major rail combination is consistent with the public interest.” (546)   Most simply, the STB merger policy “disfavors mergers that reduce competitive options for shippers absent substantial overriding public benefits.” (550)

So let us assume then that Mr. Buffett’s elephant gun is safely stowed.  The question remains–should we take aim, particularly since Mr. Buffett might be similarly inclined, but cannot?  After all, imitating or “cloning” has served many investors well.

Norfolk’s financial performance over the last three years has been strikingly consistent–revenue ton miles between $186 and $194 billion, freight train miles between 74.8 and 76.3 million, and revenue per ton mile between $0.0581 and $0.0595. (K5)  Those loads were good enough to produce $3.1-3.2 billion in net cash from operating activities in each of the last three years. (K46)

And where did the money go?  2011 saw $2.16 billion in capex, $576 million in dividends, and $2.05 billion spent repurchasing stock (extra debt was raised that year to fund the excess).  2012 saw $2.24B in capex, $624MM in dividends, and $1.29B spent on stock (again, extra debt was raised).  2013 saw $1.97 billion in capex, $637MM in dividends, and $627MM spent on stock.

So I guess that you can see the theme.  Norfolk’s business gushes cash at a remarkably consistent rate, but every year, nearly two-thirds of that cash is just as consistently reinvested in capex (i.e., track, railroad ties, locomotives, freight cars, etc.).  In itself, that fact is not necessarily bad, for reinvested cash may create opportunities for growth and productivity improvements in the future.  However, in the case of railroads (or at least, Norfolk), it just seems that desired future never arrives.

To be fair, cash flow from operations has grown at Norfolk over the last decade.  In 2004, cash flow from operations tallied $1.66 billion.  Recall that 2013 saw cash flow from operations of $3.08 billion.  So growth of $1.4B.  But to get there, Norfolk had to invest $13.32 billion over the last nine years, or roughly $1.5B every year.  So there was a return on all that capex, and not an indecent one.  After all, everyone knows that railroads are capital-intensive businesses, and a regulated “utility” of sorts.

Yet, it is a bit surprising to see free cash flow at Norfolk in 2005 at $1.08 billion, and to see it at $1.11B in 2013.  After all, it almost sounds like a boast when I see Mr. Buffett write: “We are not, however, resting on our laurels: [Burlington Northern] will spend about $4 billion on the railroad in 2013, roughly double its depreciation charge and more than any railroad has spent in a single year.” (2012 Letter to Shareholders)

Perhaps tomorrow will shine brighter on the railroads than today.  Then at last, the seeds of yesterday’s capex will fully blossom.  Until then, count me as too impatient or unimaginative, or worse.

Disclosure: I own shares of Berkshire Hathaway.

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Alaska Airlines and Rewards

Alaska Air Group filed their 2013 10-k yesterday, and even that fickle Mr. Market seems impressed.

2013 saw Alaska Airlines expanding rapidly into new markets, acquiring nine new aircraft (“new 737-900ER’s with the Boeing Sky Interior”), buying back $159 million in stock, increasing their social engagement (“We saw healthy increases in both of our primary social communities with Facebook growing by 45.9% and Twitter by 43.2%”), and enhancing their culinary flair [ok, that last one is a project for 2014].

From my seat, I was struck by the huge growth in per-share GAAP earnings (from $4.40 per diluted share in 2012, to $7.16 per share), as well as the large proportion of those gains attributable to a “one-time, non-cash Special mileage plan revenue item.”  As they advise:

“Our consolidated net income for 2013 was $508 million, or $7.16 per diluted share, compared to net income of $316 million, or $4.40 per diluted share, in 2012. Significant items impacting the comparability between the periods are as follows:

• Both periods include adjustments to reflect the timing of net unrealized mark-to-market gains or losses related to our fuel hedge positions… 

• In 2013, we recognized a one-time, non-cash Special mileage plan revenue item of $192 million ($120 million after tax, or $1.70 per diluted share) that resulted from the application of new accounting rules associated with the modified Bank of America Affinity Card Agreement, and the effect of an increase in the estimate of the number of frequent flier miles expected to expire unused.” (p. 29)

Of course, I mean not to suggest anything nefarious here, and their disclosures are quite consistent and explicit.

However, the gears of the mind begin to turn, for it reveals that the most impactful thing an enterprising airline executive could do in 2014 to boost GAAP earnings would be to modify their reward program.  In fact, if one were clever, such modifications–suitably tempered–could be a consistent, recurring, valuable treasure trove.  You could take $192m today, though would it not be more useful to take 40m each year over the next 5?

Disclosure: No position.

MFC Industrial and IAT Reinsurance Settle

In the Friday evening news dump, there were some interesting tidbits, including, and with no particular relation to one another, a mine safety disclosure from Berkshire Hathaway, and a settlement agreement between MFC Industrial and IAT Reinsurance.

Peter Kellogg of IAT (who controls 33% of MFC’s shares) was ultimately elected to MFC’s Board after an interesting proxy fight this past December.  Friday’s settlement indicates that the MFC Board size will now increase from five to seven:

“On or prior to the date hereof, the Board has passed a resolution fixing the number of directors of the Company at seven (7), subject to the filing of the Notices of Dismissal of All Claims With Prejudice pursuant to Sections 8(a) and 8(b) hereof. The Company covenants that during the Term, the number of directors of the Company shall not be increased from seven directors unless such increase is approved by at least 6 of the 7 directors of the Company. The vacancy on the Board resulting from the increase in the number of directors of the Company to seven shall be filled within one hundred and twenty (120) days from the date hereof by a person who is qualified to act as a director of the Company and who is selected and approved by mutual written agreement of the Company and IAT.”

Mutual agreement on two names?  Mark me intrigued.

Disclosure: I own shares of Berkshire Hathaway and MFC Industrial.

eBay’s Bill Me Later

eBay’s 2013 10-k came out on Fridaylogoebay_x451, and much there is worthy of comment.

For the last few years, I have followed the growth of Bill Me Later within the eBay portfolio, and over that time, my skepticism has increased commensurately (though perhaps ‘exponentially’ would be more accurate).

eBay acquired Bill Me Later in those interesting times of October 2008 for roughly $1 billion USD.

Basically, Bill Me Later offers promotional credit for eBay purchases.  From the 10-k:

“We also provide credit products through our Bill Me Later service. Currently, when a consumer funds a purchase using Bill Me Later, a chartered financial institution extends credit to the consumer, funds the extension of credit at the point of sale and advances funds to the merchant… Although the chartered financial institution continues to own each of the customer accounts, we subsequently purchase and retain most of the consumer receivables related to the consumer loans made by the chartered financial institution and are also responsible for servicing functions related to the customer account…  U.S. consumers may be offered an opportunity to defer payments under some promotional arrangements offered on select merchant sites. Interest on such purchases can be deferred for up to 18 months.”

In 2008, the receivables for Bill Me Later were more or less immaterial to eBay’s balance sheet.  In 2013, eBay purchased $794 million of consumer loan receivables, up modestly from the $727 million purchased in 2012.

In aggregate we find: “as of December 31, 2013, the total outstanding balance of [Bill Me Later’s] pool of consumer loans was $2.9 billion, of which the chartered financial institution owns a participation interest of $65 million, or 2.25% of the total outstanding balance of consumer receivables at that date.”

And apparently, I am not the only observer to have an eye on Bill Me Later, for:

“On August 7, 2013 and January 13, 2014, we received Civil Investigative Demands (CIDs) from the Consumer Financial Protection Bureau (CFPB) requesting that we provide testimony, produce documents and provide information relating primarily to the acquisition, management, and operation of the Bill Me Later business, including online credit products and services, advertising, loan origination, customer acquisition, servicing, debt collection, and complaints handling practices.  We are cooperating with the CFPB in connection with the CIDs.”

Disclosure: No Position