prevalou

Their purchase of Trane was ill-timed and it was a big acquisition. I prefer more careful managements.

high net income/revenues (or earning power/revenue or free cash flow/revenue) is a better protection against the risk of inflation. We agree on that. high revenues/assets is a better protection against the risk of inflation. Same reasoning than before: no margin of safety when you have heavy assets to produce revenue. When you have a high ROA, you have pretty good chance to have high free cash flow/revenues and high revenues/assets. It was the case with Coke. I recognize you can have high ROA companies with low free cash flows/revenues and very high velocity, where you can wonder if they are well protected against inflation. It would be another debate...

first point: already answered in my precedent post. . Anyway free cash flow takes into account capex and operational expenses. second point: from BNI 10 K: Capital Commitment Outlook for 2009 • The Company’s planned capital commitment program for 2009 is approximately $2.7 billion, or about $150 million lower than 2008. • BNSF expects to spend $1.9 billion to refresh track, signal systems, structures and freight cars and to upgrade technologies. • The Company anticipates acquiring approximately 350 locomotives at a cost of about $675 million. • Because of the significant volume declines associated with the economy, the expansion portion of the 2009 capital program is minimal and consists of ongoing work on projects already started.

I think it would be a positive if interest rates increase and their debt is fixed rate (the value of debt would decrease) . The deferred tax liability would be a positive too, because it's a zero rate financing.

thank you for your thoughful posts. I appreciate your rationality. Actually I realize we are in a "dialogue de sourds". First forget about the respective merits, brands, price of Coca Cola and BNI, I don't want to defend one or the other, I took the Coca Cola exemple as an illustration of a light business. You rightfully explain that if a good business can increase its price at the same level than its expenses (or capex), in line with inflation, free cash flow will not be affected in real terms. My point was and is about respective inflation risks for a light business and an heavy business. Maybe, it doesn't apply to BNI, but Graham stated that in an inflationary context, investors were surprised, because they thought businesses could compensate for their cost increase during the 1950/1970 period; they could not and worse, their ROA decreased. So, I prefer to be cautious, and i don't take as a given that BNI can raise its price as the same level than inflation. All things equal, a light business has an advantage. If you have a 7% free cash flow on revenues, and can increase your prices 10%, when your costs increase 20%, your free cash flow yield becomes negative. If you have a 20% free cash flow on revenue and the same apply, your free cash flow yield will be 12.7%. Not good but more protective. Now we can argue that with its stong brand, land, etc., BNI is protected and that 7% free cash flow yield on revenue is enough, but I prefer to look at the risks, before they happen. The Graham story is a reminder that logical accuracy can be denied by the facts.

and last try: BNI Roa is about 13% KO Roa is about 100% when there is inflation, businesses are reactive and there is generally a lag between the increases in expenses and the repercussion on prices. So, it is better to have a margin of safety. With a 100% ROA, the margin of safety is from my point of view better than with a 13% ROA.

a great reading on this subject is "the intelligent investor" from Benjamin Graham (chapter 2 the investor and inflation) Studying the 1950/1970 period, he found that with inflation, earnings on capital actually decreased (instead of increasing). Culprits: 1) a rise in wage rates exceeding the rate of productivity, and 2) the need for huge amounts of new capital, thus holding down the ratio of sales to capital employed. In an inflationary context, BNI would be sensitive to these two points, Coca Cola certainly a lot less.

ok, let's take an asset point of view. When you buy a business you buy a pice of assets. For Coca Cola, you buy an intangible asset, that will not depreciate in real terms, in an inflationary world. For BNI, you buy two assets: 1) land that will not depreciate in real terms (like Coca Cola intangibles) 2) properties (railcars, etc.), that will seriously depreciate in real terms. the sum of 1) and 2) will give depreciation in real terms. Maybe, you can suppose land will appreciate in real terms, why not. In this case, how much to match the depreciation on the other properties? What is the value of land versus railcars, etc.

this is the problem: the return on assets is the same (best case) in an inflationary world. So you have a fixed coupon of 10% with a 10% inflation. If you consider Coca Cola. Light business, the company can raise its price on the concentrate and increase its return on assets (no properties to replace)

Suppose BNI has 2 $billions net income for 30 billions properties. In an inflationnary world, BNI will maintien or slightly increase its net income. But, the properties replacement cost will jump. So, if inflation is 10%, replacement cost will jump 3 mrd$ a year versus net income will rise maybe 200 $millions.

I noticed BNI ahas a strong intermodal franchise. For instance, it carries nearly 80% of total asia pacific imports. It was a big advantage when the US consummed all what China produced. But we are maybe in a different world now, structurally more thrifty. So has BNI competitive advantage eroded?

anyway it doesn't matter. Buffett bought Coca Cola but Pepsico made the same performance long term, he bought Freddie Mac but Fannie Mae was a copycat too and at the end their competitive advantage were wiped out.

Actually I would prefer UP to BNI: better capitalized and less expensive (no Buffett premium) for the same job. the locomotives and railcars are older but it is not a bigt part of their properties. They have more land than BNI too

Another problem with railroads. If Buffett is right about future inflation (see his recent shareholders letter), businesses with large investments will be the most impacted. So why not invest in lighter businesses with higher ROA ?

thank you for the info. If I remember, cash flow in 1992 was about 5% of loans. Then even after 10% losses, shareholders equity would have been largely enough. Today, it depends if the buffer includes the 37B$ already written off. I prefer to be careful about it and consider the buffer to be 21B$, the 37 B$ written off being very very bad loans (not Wells Fargo standard), but maybe I am wrong. Another difference versus 1992 is that half the loans were not issued by Wells Fargo but by Wachovia. I am not so sure about their lending criterias.

In my calculations, I forgot the other assets. For instance Wells has 864 billion$loans and 1300 billion$ assets. But with 10% losses on loans i assume other assets will come clean.

WELLS FARGO M&T BANK US BANCORP TOTAL ASSETS 1 287 62 266 TOTAL LOANS 864 49 185 TOTL PROVISIONS 21 .788 3.5 Prov%loans 2.4% 1.6% 1.9% EQUITY 77 3.6 15 EQUITY% actifs 6% 5.8% 5.6% Equity%loans 8.9% 7.3% 8.1% CASH FLOW 25 1.1 7.1 Cash flows%loans 2.9% 2.2% 3.8% (prov+eq+cash flow)/loans 13.2% 11.1% 13.8% equity/loans 2010 after 10% loan losses 3.2% 1.1% 3.8% I made a rough spreadshit for Wells, M&T and US bancorp The stress test for me has to consider a hard depression possibility, even if it is remote. By the way, canadian banks don't pass the test

you are perfectly right. But who knows? Maybe someday, I will find one!

before buying a bank, I make a stress test: can the bank bear a 10% loss on its credit portfolio. I assume the bank can pay the loss with its provisions and one year cash flow. In 1992 (real estate crisis in California), Wells Fargo passed the test (5% provision/credit and 5% cash flow/credit). Today it is not the case.

moreover, GE is in a lot of cyclical businesses. In this case, tangible equity partly invested in cash is a cushion. Look at Intel, number one in their business but barely at break even, cash is a great plus for this company. A good portion of the goodwill was added in recent years, so maybe as the stock market, its value has diminished.

I noticed UNP has a lot more land than BNI (4,5 billions $ versus 1,7 billions$) on its book. Does someone know why there is such a difference between the two twin railroads?

the management of BNI (and UNP) is well paid, too.10.5 m$ for BNI in 2007: not bad for a business whose principal decision is :"how much do i increase the fares this year."

"Unlike the competition, BNIs maintenance cap ex is fully up to date (if not more)" I don't buy this argument. Except for the freight cars wich represent a small amount of properties (4%-5%)

could you explain the two important differences between UNP and BNI ?

"To kill an idea" is not obligatorily "to kill a company". For instance maybe BNI is just too expensive, even if it is a wonderful business, like Coca Cola in 1998.