More than a year back in March 2019 we had taken an exposure in Union Pacific (UNP) triggered by the appointment of Jim Vena, protégé of Hunter Harrison, as the COO of the company. Even though the company joined the Precision Scheduled Railroading (PSR) bandwagon much earlier in September 2018, the announcement did not instill confidence to pull the trigger then. The initial investment started with a tumultuous journey as the freight volumes went from a mild recession in late 2019 to one of the worst (in 100+ years of history of freight) in March 2020. While jittery and shaken by the magnitude of destruction, a $ 2.1 m open market purchase by William Laney, former CEO of Sysco and director of UNP could not go unnoticed, as this was the largest purchase by an insider after 2015. After all, at the March-end price the Street was factoring a mere inflation-like growth of 3.5% (vs. 11% last 10 years) to an already depressed 2019 free cash flow implying no benefits of PSR. Subsequently, a marginal increase in allocation was done in June, when signs of volumes bottoming out emerged.
When Berkshire Hathaway put an all-in wager on BNSF
When structural advantages of a long haul, duopolistic market, attractive return ratios are combined with the industry best compensation incentives spearheaded by industry’s best operator, history has been kind in rewarding shareholders. Superinvestors such as Warren Buffet, Bill Ackman and Bill Gates have had a large proportion of their wealth multiplied during similar situations in BNSF, CP and CNI, respectively. We believe that UNP’s situation in April had similarities to the 2009 all-in wager by Berkshire on BNSF. With the overall demand being low, the company is taking advantage of the crisis to accelerate PSR. The true earnings potential is being masked by the still depressed volumes, in our opinion.
“A climate of fear is their best friend. Late in 2009, amidst the gloom of the Great Recession, we agreed to buy BNSF, the largest purchase in Berkshire’s history. At the time, I called the transaction an all-in wager on the economic future of the United States.”
– Warren Buffet at 2013 AGM
Jim Vena – An operator with an outstanding track record
Changing the culture of a firm is the most challenging aspect for the insiders yet thought easy by investors. And transforming a labour-intensive firm with innate productivity inefficiencies rather runs a risk of destroying value. As a result, banking on an operator with decades of turnaround experience is a smart move for investors to play the probability in their favour. In the case of UNP – Jim Vena is our bet! With four decades of PSR experience at CNI, including more than 10 years under Hunter Harrison and Keith Creel, he can be easily ranked as the best operator for a PSR turnaround.
For an interesting read on how Hunter Harrison changed the Railroads dynamics and why Canadian National is considered to be the gold standard please refer to my previous post.
Table of contents
Since this is a long post for a blog, readers looking to read only specific portions may refer to the respective page numbers as per the index number below. For example, please navigate directly to page 4 if you’d be only interested to read only about PSR and my opinion on how Berkshire Hathaway owned BNSF fares vs. UNP.