BNSF and MidAmerican

[jay21]

Kiltacular, yes, agreed.  You can look at the difference between the GAAP tax expense and the taxes paid for cash disclosure to see how big of difference this can make.

 

My initial analysis did not include a breakout of the deferred taxes (BRK reports one deferred tax line item as opposed to by operating segment).

 

When looking at MidAmerican's filing: http://www.midamerican.com/include/pdf/sec/20121231_99_mehc_annual.pdf

 

We get a much better understanding of the ROE:  15,910 equity and 5,120 of goodwill. Much better than the ROE I was showing before.

 

The deferred taxes of BNSF equals 16,319 and Mid-American is 7,903 so that should help us better understand the capital that we should allocate to the Regulated Business segment of BRK.

 

Thanks for doing this, I've been very curious.  As I'm being lazy today, what did the return on newly invested capital (or return on tangible equity) get to on MidAmerican with the adjustments you just mention?

 

It's in the 10% to 15% range, which seems like the target return Buffet would want to see for this type of business.  I plan on reading the filings for BNSF and Mid American in the near future and may give a more detailed answer later if I find something interesting.

[racemize]

It's in the 10% to 15% range, which seems like the target return Buffet would want to see for this type of business.  I plan on reading the filings for BNSF and Mid American in the near future and may give a more detailed answer later if I find something interesting.

 

Please do!

[jay21]

It's in the 10% to 15% range, which seems like the target return Buffet would want to see for this type of business.  I plan on reading the filings for BNSF and Mid American in the near future and may give a more detailed answer later if I find something interesting.

 

Please do!

 

I'm reading MidAmerican's annual report and it will take me awhile to get through.  A few interesting things so far.  Should I post them as I come across them or should I wait until I get through the whole thing?

[jay21]

I went through Mid-American primarily to look at what the ROE of the business is.  Most people are probably already aware that utilities' profits are regulated as either cost plus or on the ROE.  Here are the mentions of ROE I found in the report:

 

Pursuant to ratemaking principles approved by the UB, all of MidAmerican Energy's wind-powered generating facilities in service at December 31, 2012 are authorized to earn a fixed rate of return on equity over their useful lives ranging from 11.7% to 12.2% in any future Iowa rate proceeding.

 

The Company indirectly owns a 50% interest in ETT, along with subsidiaries of American Electric Power Company, Inc. ("AEP"). ETT owns and operates electric transmission assets in the ERCOT and, as of December 31, 2012, had total assets of $2.0 billion. ETT is regulated by the Public Utility Commission of Texas, which has approved rates based on a 9.96% after tax rate of return on equity and a debt to equity capital structure of 60:40.

 

Electric Transmission America, LLC ("ETA") is a company owned equally with subsidiaries of AEP to pursue transmission opportunities outside of ERCOT. ETA has a 50:50 joint venture with Westar Energy, Inc. to build transmission assets in Kansas. Construction began in 2012 and has received the necessary approvals from the FERC, including a return on equity, inclusive of incentives, of 12.8%. The project is expected to cost approximately $180 million and be in service on or before December 31, 2014

 

As of December 31, 2012, $3.7 billion, or 43%, of MidAmerican Energy's property, plant and equipment, net, was subject to these ratemaking principles at a weighted average return on equity of 12.0%.

 

 

So it looks like the ROE should fall between 10% and 12%.  Also, it should be worth noting that MidAmerican is a holding company and there is some debt at the HoldCo level.  I am trying to get some clarity on the HoldCo balance sheet, but can't seem to find much.  We know there is ~4.6b of debt there.  My point is the ROE is not solely based on the OpCos but also the amount and cost of debt at the HoldCo level.

[xo 1]

Thanks, Jay21.  Interesting notes.  Can you explain in more detail what you meant in your last paragraph with respect to needing to understand the HoldCo debt to understand the ROE, please?  Again, many thanks for sharing your good work.

[jay21]

Thanks, Jay21.  Interesting notes.  Can you explain in more detail what you meant in your last paragraph with respect to needing to understand the HoldCo debt to understand the ROE, please?  Again, many thanks for sharing your good work.

 

Sure can.

 

Note that the HoldCo owns stakes in all those companies were I was pointing out the ROE.  The ROE is based upon the entity's/investee company's balance sheet.  So that ETA project has a specified debt to equity ratio with an ROE of 9.96%.  The HoldCo accounts for the equity as an investment on their balance sheet, which may look something like this.

 

Assets:  20b of equity investments in the investee utilities.

Liabilities: 4b of debt

Equity: 16b

 

In the example, the 20b equity investments have a regulated ROE of 10% to 12%.  Using 10% as a base, the assets earn $2b.  The HoldCo gets the $2b and pays $200m in interest (based on a hypo after tax borrowing of 5%).  That leaves the HoldCo with $1.8b of earnings on $16b of equity for an ROE of 11.25%.  Even though the regulated business earned 10% ROE, the HoldCo could lever that return into a higher ROE.

[xo 1]

Thanks.  That was very clear and helpful.

[racemize]

Thanks.  That was very clear and helpful.

 

Yes, this thread essentially answered my question to Buffett from the other thread.  Very helpful!

[jay21]

Other things I thought were interesting were the cash vs. GAAP taxes.  Here are the last 3 years expenses:  148, 294, and 198

Here are the effective tax rates:  9%, 18%, 14%.  However,  the supplemental disclosure shows the company is actually receiving income taxes every year:  1,341, 575, and 305.

 

Also, MidAmerican owns ~600m stake in BYD.  So even if the company can't dividend up money to BRK, they can still purchase securities and the money doesn't have to constantly be reinvested in utilities.

[MVP444300]

http://online.wsj.com/article/SB10001424127887324034804578348214242291132.html

 

Welcome to the revival of the Railroad Age. North America's major freight railroads are in the midst of a building boom unlike anything since the industry's Gilded Age heyday in the 19th century—this year pouring $14 billion into rail yards, refueling stations, additional track. With enhanced speed and efficiency, rail is fast becoming a dominant player in the nation's commercial transport system and a vital cog in its economic recovery.

 

 

This time around, though, the expansion isn't so much geographic—it is about a race to make existing rail lines more efficient and able to haul more and different types of freight. Some of the railroads are building massive new terminals that resemble inland ports. They are turning their networks into double-lane steel freeways to capture as much as they can get of U.S. freight demand that is projected to grow by half, to $27.5 billion by 2040, according to the U.S. Department of Transportation. In some cases, rail lines are increasing the heights of mountain tunnels and raising bridges to accommodate stacked containers. All told, 2013 stands to be the industry's third year in a row of record capital spending—more than double the yearly outlays of $5.9 billion a decade ago.

[jay21]

People often look at housing starts and US vehicle sales to gauge the housing and auto markets.  Is there any equivalent for railroads?  Maybe total freight cars moved or something?

[racemize]

People often look at housing starts and US vehicle sales to gauge the housing and auto markets.  Is there any equivalent for railroads?  Maybe total freight cars moved or something?

 

Sanjeev used to post freight cars weekly, until they looked pretty good.  I don't remember where the links went to though.

[fareastwarriors]

http://online.wsj.com/article/SB10001424127887324034804578348214242291132.html?mod=WSJ_hps_LEFTTopStories#articleTabs%3Darticle

 

 

Boom Times on the Tracks: Rail Capacity, Spending Soar .

[jay21]

Found a fixed income presentation on BNSF website:  http://www.bnsf.com/about-bnsf/financial-information/fixed-income-investors/pdf/fixed-income-investor-presentation-3rd-quarter-2012.pdf

 

- Maintenance Cap-Ex looks to be about $1.6b (half of Cap-Ex).  They booked about ~1.8b in DA.

- Buffet has been receiving dividends from BNSF

- There was a good overview of oil by rail in the presentation

 

[jay21]

Good article on Kansas City Southern in Barrons today:  http://online.barrons.com/article/SB50001424052748704382404578565481704373550.html?mod=BOL_twm_fs#articleTabs%3Darticle

 

Rails still have plenty of years of growth ahead, imo.

[JBird]

Found a fixed income presentation on BNSF website:  http://www.bnsf.com/about-bnsf/financial-information/fixed-income-investors/pdf/fixed-income-investor-presentation-3rd-quarter-2012.pdf

 

- Maintenance Cap-Ex looks to be about $1.6b (half of Cap-Ex).  They booked about ~1.8b in DA.

- Buffet has been receiving dividends from BNSF

- There was a good overview of oil by rail in the presentation

 

Just read through the fixed income presentation. What was your process for estimating maintenance capital?

[oddballstocks]

Good article on Kansas City Southern in Barrons today:  http://online.barrons.com/article/SB50001424052748704382404578565481704373550.html?mod=BOL_twm_fs#articleTabs%3Darticle

 

Rails still have plenty of years of growth ahead, imo.

 

I've always thought Kansas City Southern was the best rail to own, the problem was the price never came down low enough for me to buy.  I haven't read Barrons yet, was there word on their Mexican port yet?  If I remember correctly they were going to have this high speed route from a deep water port in Mexico that could get trains deep into the heartland of the US quicker than what Union Pacific or Burlington could do. 

[jay21]

Found a fixed income presentation on BNSF website:  http://www.bnsf.com/about-bnsf/financial-information/fixed-income-investors/pdf/fixed-income-investor-presentation-3rd-quarter-2012.pdf

 

- Maintenance Cap-Ex looks to be about $1.6b (half of Cap-Ex).  They booked about ~1.8b in DA.

- Buffet has been receiving dividends from BNSF

- There was a good overview of oil by rail in the presentation

 

Just read through the fixed income presentation. What was your process for estimating maintenance capital?

 

I forget exactly how I came up with that number, but slide 37 gives Maintenance Capex and Other Adjustments as 1.8B. That D&A to Maintenance Capex ratio surprised me as I thought it was going to be more unfavorable.

[JBird]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

That way, these businesses can absorb the billions flowing into BRK, without him needed to continuously find new investments. Also, there's probably few attractive non-capital intensive businesses at that scale for WEB to invest in.

 

Several posts have discussed an aim of achieving returns higher than their cost of capital. How do you calculate Berkshire's cost of capital? I'm curious after reading Buffett's 2003 comment, "Charlie and I have not the faintest idea what our cost of capital is and we think the whole concept is fairly crazy, frankly."

[twacowfca]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

That way, these businesses can absorb the billions flowing into BRK, without him needed to continuously find new investments. Also, there's probably few attractive non-capital intensive businesses at that scale for WEB to invest in.

 

Several posts have discussed an aim of achieving returns higher than their cost of capital. How do you calculate Berkshire's cost of capital? I'm curious after reading Buffett's 2003 comment, "Charlie and I have not the faintest idea what our cost of capital is and we think the whole concept is fairly crazy, frankly."

 

Simply defined, it's the opportunity cost of investing in something similar.  For BRK as a huge, diversified company, that could be the return one might expect to get by investing in a large cap US index fund, perhaps about 9% based on historical returns or almost 6% real returns.  Or perhaps a percent or two more than that if one thinks that BRK is "riskier" than such an index fund.

 

BRK has done much better than that, more than double the nominal return or triple the real return since WEB took over BRK 's management in the 1960's.  Interestingly, BRK has continued to make  about twice the return of a large cap index over the last 12 years, while equity index returns generally have been relatively low by historical standards .  :)

[JBird]

Thanks. That sounds like a synonym for opportunity cost. If that's true, surely Charlie and Warren know roughly what the figure is?

[redskin]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

That way, these businesses can absorb the billions flowing into BRK, without him needed to continuously find new investments. Also, there's probably few attractive non-capital intensive businesses at that scale for WEB to invest in.

 

Several posts have discussed an aim of achieving returns higher than their cost of capital. How do you calculate Berkshire's cost of capital? I'm curious after reading Buffett's 2003 comment, "Charlie and I have not the faintest idea what our cost of capital is and we think the whole concept is fairly crazy, frankly."

 

Warren and Charlie dismiss any calculation that involves using beta like a cost of capital calculation.

 

[twacowfca]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

That way, these businesses can absorb the billions flowing into BRK, without him needed to continuously find new investments. Also, there's probably few attractive non-capital intensive businesses at that scale for WEB to invest in.

 

Several posts have discussed an aim of achieving returns higher than their cost of capital. How do you calculate Berkshire's cost of capital? I'm curious after reading Buffett's 2003 comment, "Charlie and I have not the faintest idea what our cost of capital is and we think the whole concept is fairly crazy, frankly."

 

Warren and Charlie dismiss any calculation that involves using beta like a cost of capital calculation.

 

Yup. CoC calculations often use CAPM, and that is deeply flawed., But the idea of thinking of  CoC as an opportunity cost isn't necessarily something they would reject. Using an index as a benchmark or, so to speak, as a proxy for their CoC is an idea  they have embraced.  CoC is a useful concept although problematic to calculate precisely. It's interesting to keep the idea of CoC, broadly defined, in mind, not unlike that other useful concept, intrinsic value.  :)

[jay21]

Plan tweeted this link, which I thought was really good:  https://www.aar.org/keyissues/Documents/Background-Papers/A-Short-History-of-US-Freight.pdf

 

"Between 1970 and 1979, the rail industry’s return on investment never exceeded 2.9 percent and averaged just 2.0 percent. The rate of return had been falling for decades: it averaged 4.1 percent in the 1940s, 3.7 percent in the 1950s, and 2.8 percent in the 1960s."

 

"Railroads are stronger financially. Return on net investment, which had been falling for decades, rose to 4.4 percent in the 1980s, 7.0 percent in the 1990s, and 8.5 percent from 2000 to 2011. Improved rail earnings are a positive development because they allow railroads to more readily justify and afford the massive investments needed to keep their track and equipment in top condition, improve service, and add the new rail capacity that America will need in the years ahead."

 

I think I have seen some railroads like UNP and CNI say their ROICs are in excess of 10%.  Now that ROICs are much higher than previously we are seeing record capital invested (as opposed to no capital invested) and a much better rail system.

[fareastwarriors]

http://www.bloomberg.com/news/2013-07-25/berkshire-s-bnsf-allowed-to-count-purchase-costs-in-rates.html

 

 

Berkshire’s BNSF Allowed to Count Purchase Costs in Rates