I 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.
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.