Buffett’s Railroad Bonds Cheap to U.S. Peers: Corporate FinanceCharles Mead and Noah Buhayar
In Warren Buffett, Burlington Northern Santa Fe has one of the biggest safety nets in corporate America. You wouldn’t know it from the way the railroad’s bonds trade.
While Buffett’s Berkshire Hathaway Inc. doesn’t officially guarantee debt of the railroad operator it bought in 2010, the parent would still probably offer support to BNSF should financial trouble arise, according to Joel Levington, who follows industrial borrowers for Bloomberg Industries. That means securities including BNSF’s $1 billion of 4.9 percent notes due in 2044, which yield more than similar-maturity bonds of lower-rated competitor Norfolk Southern Corp., may be cheap.
“The market is crediting it with very limited or no support from the parent,” said Levington, who published research on BNSF’s bonds this week. “But if you look at Berkshire and its history, it’s always supported its companies.”
That presents a challenge for bondholders seeking to decipher the value of corporate connections without the benefit of a legally binding promise. Following the $26.5 billion acquisition of BNSF, the railroad company terminated a $1.2 billion credit facility, signaling it could potentially turn to Berkshire for that type of funding if needed, according to Levington.
Michael Trevino, a spokesman for BNSF, declined to comment on the company’s bonds. Buffett didn’t respond to an e-mail sent to an assistant.
While BNSF’s finances are similar to other investment-grade railroad borrowers, the company “compares better than average in terms of its size and implicit parent support,” Jeff Wichmann, an analyst at CreditSights Inc. with an “outperform” recommendation on BNSF bonds, wrote in a May 5 report. Still, “it’s hard to say exactly how the market treats the likelihood of support,” he said yesterday.
Its April 2044 bonds issued in March and ranked A3 by Moody’s Investors Service traded May 27 at 106.3 cents on the dollar to yield 4.51 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s 0.15 percentage point more than the yield on Norfolk’s $500 million of 4.8 percent debt due in 2043, which Moody’s ranks a level lower at Baa1.
The BNSF bonds jumped 1.8 cents on the dollar to yield 4.4 percent at 11:49 a.m., Trace data show. The Norfolk notes traded at 107 cents to yield 4.37 percent.
Standard & Poor’s rates both notes BBB+, though BNSF ranked fourth in a Bloomberg Industries analysis of eight rail companies’ credit metrics, ahead of Norfolk as well as Kansas City Southern, CSX Corp. and Genesee & Wyoming Inc.
Berkshire has previously helped a unit whose bonds lacked a guarantee from the parent. In 2006, Buffett’s holding company said it would allow its energy business, then called MidAmerican, to request as much as $3.5 billion of capital to repay debt.
That equity commitment was later extended and reduced before expiring this year. The unit, now called Berkshire Hathaway Energy, said in an April presentation that the agreement “was allowed to expire as our standalone credit metrics now support our credit ratings.” The business is ranked A3 by Moody’s and BBB+ at S&P.
“If liquidity ever became an issue for Burlington, something similar could likely be set up,” Wichmann said. “They clearly don’t need it now.”
BNSF’s cash holdings have doubled to $2.56 billion since Berkshire bought the company, whose track network is concentrated west of the Mississippi River, pitting the company against Union Pacific Corp. In September 2011, BNSF ended its revolving credit facility a year before it was set to expire. While losing the bank loan “effectively ended” its access to the commercial paper market, BNSF said in a February 2012 filing that the action wouldn’t materially affect its ability to manage liquidity.
Debt also has increased, reaching a record $17.9 billion on March 31, according to data compiled by Bloomberg. That’s the most of any U.S. rail freight company, and one reason why the bonds “trade a little bit cheap to the sector,” said Wichmann, whose report estimated as much as $1.5 billion of new issuance in the third quarter.
BNSF has been tapping credit markets as it boosts capital spending. The railroad said in February that it planned a record $5 billion outlay this year to buy locomotives and maintain track as it hauls more crude oil drilled in shale fields. That exceeds Union Pacific’s proposed $3.9 billion and is an increase of about 25 percent over the goal set a year earlier.
The railroad’s borrowings are primarily unsecured, and Berkshire doesn’t guarantee any of BNSF’s debt, according to a May 2 regulatory filing.
Berkshire, which held $49 billion of cash on March 31, has acquired dozens of businesses since Buffett took control in 1965 and rarely sells assets. He has built Berkshire into a company with a $315 billion market value that controls Dairy Queen, Benjamin Moore and Geico.
It would make sense for Berkshire to support the railroad operator if it needed help, said Bill Smead, chief investment officer at Smead Capital Management, which oversees about $940 million including Berkshire shares. “If Dairy Queen’s refrigerators were out, he’d stand behind it.”