March 28, 2009

Value Idea: BNI Analysis- part II

BNI the company (Google Finance):

The Company, through its subsidiaries, is engaged
primarily in the freight rail transportation business. BNSF Railway Company (BNSF Railway) is the Company’s principal operating subsidiary. BNSF Railway operates various facilities and equipment to support its transportation system, including its infrastructure and locomotives and freight cars.

Operational Analysis:

I do not want to spend much time here, but I want to highlight the following about BNI operations:

  • They have one of the best intermodal brokerage business in North America. Intermodal traffic is poised for good growth due lower costs of transport, Intermodal is when you combine several modes of transporting to get goods to its destination.

  • 65% of revenue is covered by long duration contractual agreements with customers. Some of these contracts will reprice higher in the coming few years. But this may be a point depending on the economy strength or normalizing before this happen.
  • BNI, more than any other rail company, have somewhat less economic sensitive freight. Review of their business mix shows the following:

    • automotive shipments mainly comes from foreign destination and the bulk of these shipments are parts, which to a large degree will increase or be stable as people will service their cars rather to buy new ones. Moreover the exposure to this sector is very small only 3% of revenue.
    • Industrial represent 24% of revenues . Their industrial products is heavily exposed to construction almost 14.5% of total freight revenue. However with infrastructure spending poised for new government initiatives this could see more growth. Most of this segment transport construction and building products used for infrastructure projects like steel, construction sand, gravel..etc. mostly used for public construction, which under Obama will increase as he will try to simulate the economy.
    • Coal for power generation is almost 25% of their revenue which is less economic sensitive than consumer goods. And the projection of coal use for power generation is posed for growth. ( see risks also)

    • The majority of its Agriculture freight for domestic consumption almost 3/4.

    The freight mix is diverse but for the most part will fare well in slow economy due to long term contracts and less economic sensitive freight.

What could go wrong (Risk Analysis)?:

BNI along with other rails have enjoyed revenue and earnings growth even in lousy economic drop. This growth was mainly from lagging fuel surcharges and lower fuel costs. Going forward the surcharges will disappear and revenue will come under some pressure. However lower fuel costs will soften the impact on earnings.

Risk of Government Intervention

At recent government hearings, shippers from agriculture, coal, chemicals, and other

bulk-commodity industries expressed their dissatisfaction with what they perceive to be a decline in the quality of railroad service and “monopolistic” rates. Actually a recent judgment was levied against BNI for excessive rates; the company is appealing the ruling.

Government intervention in rate setting by rail may happen. Rates for rail roads have been deregulated in 1980 but now there are many senate bills and committee to look in this matter as lobbies for coal and Ag businesses are not satisfied with the prices they are getting from rail operators.

I do no view a return to price setting by government agencies but the risk of increase in litigation costs and litigation reserves should be factored in valuation.

Maintenance and Capital needs

Capital needed to build and operate. Railroad maintenance is very capital intensive because it
involves adding new ballast and replacing worn track and damaged ties.

Trucking companies has an advantage over railroads because they pay only for infrastructure capital and maintenance costs when they use the system, helping to insulate them financially from changes in freight transportation demand. Railroads, on the other hand, bear the full cost of building and maintaining their infrastructure, and a large fraction of this cost is independent of traffic volume. Consequently, railroads are more highly exposed to financial risk from economic changes and are also more conservative about investing in additional capacity.

However, BNI maintenance capex as a percentage of revenues have been consistent over the years compared with other rail operators, which some has been falling behind. In valuation I am not going to deduct the normal maintenance capex percentage of revenue as BNI's network seems to be well maintained.

Risks to Coal shipments

Coal represent a critical element of BNI business mix. There is a risk that Coal shipments may moderate or decline. This will impact BNI very negatively. The new US administration will introduce new measures to penalize carbon emissions, which coal fired plants produces twice as much natural gas fired plants. Coal fired plants produce cheaper energy than gas but with the new expected measures it may equalize the equation making coal produced energy more expensive therefore less demand for coal and more demand for natural gas. This new dynamic may slow BNI shipments. The only mitigating factor here is BNI ships mostly low sulfur coal, which produced lower emission. An additional risk mitigating factor is BNI ships to power plants in regions were nat gas and nuclear power plants are scarce (south central and north central), therefore coal fired plants can maintain pricing power and demand for coal.1 However coal powered plants in the northeast may lower demand for coal as their pricing power will shift to natural gas fired plants and nuclear plants.

Also demand for coal will be stable due to nature of coal shipped (PRB) and prices have not shot up like met coal.

This will get a lot of media but honestly given that 50% of electricity is produced from coal I do not see any replacement over the horizon.

Trade Shift from west Coast to East Coast

Global Trade lanes are shifting constantly. Traditionally the pacific coats ports are the main entry hub from Asia and handles the bulk of total import/export into and out of the US. This may change. The widening of the Panama canal allows ship operators to bypass the busy and congested west coast ports for the the east coats ports reducing their overall shipment delivery. Ship operators used to face wait times at the west coast that far exceeds the travel time through the panama canal to the east coast. Moreover, other trade lanes though the Suis Canal is also preferred by ship operators.

If this materialize BNI will see volume declines as its network link west coast ports with hubs in mid US.

Another shift of trade lies to where is the cheapest ocean freight rates can be sources. This may take volume away from BNI to other carriers. The following is Analyst estimate of the risk:

The spread in ocean rates (i.e., spread between ocean rates from the Gulf to Japan and the Pacific North West to Japan) for bulk shipments of grain was only $10
per metric ton. The ocean spread reached its high of $69 per metric ton in mid-May. The decline in ocean spreads has come as bulk ocean freight rates have declined to their lowest levels in years. The Gulf-to-Japan rate of $29 per metric ton is the lowest level since February 2003 and 79% below the high in May 2008. The Pacific North West-to-Japan rate of $19 per metric ton is the lowest level since December 2002 and 76% below the high in May 2008.

... the sharp decline in ocean spreads will encourage shippers to move grain exports out of the Gulf rather than the Pacific North West. This trend has negative implications for Burlington Northern Santa Fe because it is the biggest rail beneficiary of moving long-haul export grain to the Pacific North West.

Economic Risks

North American railways are increasingly feeling the pain of the recession and erosion of global trade, prompting a leading executive to caution that it's hard to predict the timing of an economic recovery.

Freight carriers across the continent saw cargo shipments such as lumber, metallic ores and autos decline an average of 16.1 per cent in the first 10 weeks of this year, compared with the same period last year. Intermodal business for consumer goods and other items fell 15.2 per cent.



Jae Jun said...

My friend and I have been discussing BNI for a while and just wanted to say your recent articles have been very useful.

Keep them coming.

Sami said...

Thanks Jae.

I have still one more for BNI and that is valuation I should post it within few days.