Burlington Northern and the Revival of Railroads

The last depression bankrupted them. Now they're positioned to thrive. A look at the nation's most progressive railroad, Burlington Northern Santa Fe

Last April, Warren E. Buffett flew to Kansas City, Mo., to join Matthew K. Rose for a ride in a vintage 1930s railcar. Buffett, the billionaire investor from Omaha, and Rose, the chief executive of Burlington Northern Santa Fe (BN), munched on hamburgers and jelly beans as they chugged 430 miles up to Chicago. Along the way, they talked about Burlington Northern's unlikely turnaround and how the once-stalled railroad could build on its recent momentum.

Buffett's interest was more than academic. A year earlier, his company, Berkshire Hathaway (BRK), had acquired a 10.9% stake in Burlington, later increased to 18.5%, making it the company's largest shareholder. The railroad is the fourth-biggest public stockholding in the famous Buffett portfolio. "He told me very clearly that he doesn't care about what we do next quarter or next year," Rose recalls. But as encouraging as Buffett's long-term perspective was at the time, six months and one global financial crisis later, Burlington faces new obstacles.

U.S. freight railroads have recovered after decades of struggling to eke out profits—with Burlington leading the way—but the industry is heading into tougher times along with the rest of the American economy. High oil prices, which have given the railroads an advantage over rival long-distance trucking companies, are dropping fast. The voracious consumer appetites that have kept Burlington's freight cars stuffed with PCs and flat-screen televisions are shrinking. And lending remains tight, even for the comeback railroad sector. Rose has been forced to put some expansion plans on hold.

Still, unlike many corporate executives who seem shell-shocked by the financial turmoil, Rose sounds optimistic. He believes innovation will allow Burlington to continue to thrive, if at a slower pace.

THE OIL ADVANTAGE

Rose, a compact 49-year-old who once looked at railroads with scorn, argues that a more attentive manner with customers—basically, getting their loads delivered on time—will continue to win the loyalty of shippers such as overnight-package giant United Parcel Service (UPS). Marketing a 200-year-old means of moving freight as the greenest, most progressive way to get the job done will also help sell Burlington, Rose says. Longer term, new safety and monitoring technology could allow him to run trains closer together, increasing efficiency. "Our value to society is much bigger than our market valuation," he says. "The fundamentals of transportation in this country favor rail."

That market valuation—$29 billion—is nothing to sneeze at. Burlington's stock has risen 259%, to about $83, since Rose took over as president and CEO in 2000. The price has remained relatively steady amid the overall market's breathtaking decline. "Burlington, like the rest of the railroad industry, will definitely face challenges, at least on the volume side, in a full-blown recession," says Jason H. Seidl, an industry analyst with boutique investment bank Dahlman Rose. "But it should still be able to maintain its pricing power, as a large percentage of its business is not [facing tough competition from] other modes of transportation."

Burlington, based in Fort Worth, and the country's second-largest railroad after Union Pacific (UNP), has been able to pass hefty diesel fuel increases on to customers because decades of underdevelopment of railroads have left freight capacity extremely tight. "They've been jacking up prices more than they have been able to for years," says John G. Larkin, an analyst with brokerage Stifel Nicolaus. Shippers are calling for new regulation of the industry in Washington. "We are very happy when Burlington does well, but we are not happy when they are pushing costs on captive customers," says Robert G. Szabo, executive director and counsel for Consumers United for Rail Equity, a shippers' lobbying group in the capital.

The railroad revival and prospects for continued success turn on oil prices. As those prices rose over the past several years, locomotives pulling long trains became a cheaper alternative than trucks pulling trailers. Inexpensive oil had inhibited rail expansion for a long period. As booming agribusinesses, coal companies, consumer-goods manufacturers, and even trucking firms began moving more freight by rail in 2002, there weren't enough trains and track to serve the demand. That's what gave Burlington and its sister railroads the ability to charge higher rates—and still undercut trucking companies. Trucks are thirstier for fuel than are locomotives, and near big cities trucks must negotiate increasingly congested roads. Oil has fallen from a high of $145 in July to less than $75. As long as it stays above $25, railroads should retain an edge, Rose says.

To heighten that advantage, Rose has relied on innovation. Last year Burlington acquired 200 General Electric (GE) locomotives that burn 20% less fuel than their predecessors. All told, the company has 6,400 locomotives that pull 220,000 cars over 32,000 miles of track, most of it connecting the West and Southwest to the center of the country. Next year the company expects to deploy the industry's first hydrogen-powered locomotive. The environmentally friendly prototype, developed in-house, is a small 200-horsepower unit that at first will be put through its paces in the rail yard.

AVOIDING CRASHES

Another goal of new technology is to lower the incidence of human failure. After a Burlington train slammed into a commuter train in Placentia, Calif., six years ago, killing two passengers and sending 162 to the hospital, Rose stepped up development of new warning and control devices. This system uses satellites to detect speed-limit violations, improperly aligned switches, and missed signals. If a conductor doesn't respond appropriately, the system is supposed to stop the train automatically. Now the upgrade, which could cost Burlington $500 million, is no longer optional. A deadly freight-passenger collision in September involving Union Pacific in Chatsworth, Calif., has spurred a new law that requires many trains by 2015 to have crash-avoidance technology of the sort Burlington has developed.

Other software improvements allow supervisors at Burlington to monitor more closely how well drivers perform. By following signals and understanding track conditions, a conductor ought to be able to keep braking to a minimum, absent unforeseen events. A train that isn't stopping and starting frequently uses less fuel and arrives sooner. When combined, the new safety and monitoring technologies could allow trains to run closer together, which will let Burlington move more goods more efficiently, Rose says. "This will be the biggest change the railroad industry has been through since the conversion from steam" seven decades ago, he predicts.

Rose is also playing the environmental card. For the last several years, Burlington has supplied customers with data on how carbon-friendly their hauls will be if they use trains instead of trucks. A train carrying 100 tons for 1,000 miles produces 45% fewer greenhouse-gas emissions that contribute to climate change than long-haul trucks bearing the same load, according to Burlington. Environmentalists generally agree that railroads are greener, though the emissions estimates vary.

Truckers dispute such comparisons as misleading, saying that 18-wheelers typically travel much shorter distances and can move their loads to and from far more locations. Moreover, Clayton Boyce, spokesman for the American Trucking Assn., notes that railroads like Burlington work in partnership with trucking concerns that take goods from rail yards to their final destinations. That makes distinctions based on environmental factors more complicated. "The railroads' best customer is now the trucking industry, and this is the thanks we get," Boyce complains.

RAIL AND ROAD

Rose insists that, environmental issues aside, "powerful economics" ought to persuade many trucking companies to shrink their operations and cooperate even more closely with railroads. Two train employees can drive a 9,000-foot, 300-car train. It takes 300 truck drivers to move the same amount of freight. At one logistics center near Fort Worth, Burlington cut turnaround time in half over the past year, in part by computerizing the scanning of truck loads. Other railroads have made similar improvements.

Born in Salina, Kan., the son of a farm company logistics manager, Rose grew up listening to his father brag about outmaneuvering bumbling railroads. "He'd tell me how he got a better deal from one railroad than another and played the two off each other," says Rose. He worked a summer job as a railroad switchman and did an 18-month training program at Missouri Pacific after graduating with a marketing degree from the University of Missouri. But Rose says he was turned off by what he saw as the railroad industry's hidebound culture. He left to join the trucking business, working at Schneider National in Dallas and at two other carriers over 11 years. From that vantage point, he observed Santa Fe Railway begin to strike agreements with trucking companies to carry freight for part of their long hauls. That changed Rose's mind. He saw growth potential and in 1993 joined Burlington which later merged with Santa Fe.

Since then, Rose has striven to meld rail and road operations. Last year, Burlington scored big points with its customer UPS by delivering virtually every load of packages on time during the overnight company's peak holiday season. Giant UPS trailers are received by Burlington and loaded onto a train in as little as 30 minutes at the logistics center near Fort Worth. Now UPS is exploring ways to collaborate with Rose's company on delivering heavier freight, in addition to small packages. "Reliability is a big factor for us," says Kelley Anderson, general manager of rail operations in corporate transportation at UPS. "And our confidence [in Burlington] has gone up."

OBSTACLES TO GROWTH

Until a few weeks ago, Burlington had been expanding rapidly. Rose spent $2.6 billion, or 16% of Burlington's $15.8 billion in 2007 sales, to extend and improve its rail network. Along with expanding its shipment facility outside Chicago last year, he has added a fourth track in Wyoming to carry coal and is finishing a second track along one of its most profitable freight routes: the 2,120-mile line from Los Angeles to Chicago.

But the financial crisis is taking its toll. "We're back to that recession word," says Rose. "If we see continued softening in the consumer side, we will cut our track expansion because it wouldn't be a prudent use of capital." The clogged credit market forced Burlington to decide last month to postpone raising $300 million for a lease of locomotives and cars.

In September, Rose ordered his financial team to examine Burlington's relationship to every company immersed in bad news. He commissioned a list of the 10 worst things that could happen. One warning that came back was that if insurance giant American International Group (AIG) toppled, "we would probably have to pay significantly more for insurance," he says. AIG, which for the moment has survived with the help of a federal rescue, supplies a quarter of Burlington's coverage.

The biggest threat on the list is declining consumer spending. If a deep recession sets in, it could undermine one of Burlington's main growth engines: its consumer-products business. That segment accounts for 37% of revenue and has grown by 16% since 2005, to $5.7 billion in 2007. Other major areas, including the transport of coal and wheat, could soften, too, if electricity use and demand for food in Asia slump.

So far, diesel fuel prices have fallen faster than shipping volumes, allowing Burlington to enjoy lower operating costs. But "we have to read the tea leaves for what's coming in 2009, and there's uncertainty," Rose admits.

When recession fears creep into the conversation, Rose likes to remember his cheerful outing with Warren Buffett. There are always potential new customers to convert. Along with pitching rail service to manufacturers of drilling pipelines and wind turbines, which are bulky to transport on highways, Rose is looking to a business that's not going away: trash. He's courting municipalities to let Burlington transport their solid waste to locations far outside their cities.

"I refer to it as a three-legged stool," says Rose. "Fuel, congestion on highways, and carbon. We like the long-term proposition of the railroad very much."

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