The Inside Scoop feature at Barron's (see article) is reporting on how Warren Buffett has increased his position in Burlington Northern Santa Fe (BNI). Earlier this week, Buffett bought another 825,000 shares, bring his total position to about 19% of the company. Not only does this recent transaction put approximately one-fifth of the company in strong hands, but Buffett has also recently sold 5.5 million puts in October, with strike prices ranging from $75-$80. The put position effectively places a floor on the stock, since if the past is any indication, the position implies that Buffett is comfortable being a buyer at these strike price levels.

As with the rest of the market, Burlington has fallen over the last month, but not as much as some of its biggest competitors. Since Burlington hauls a higher percentage of coal and fertilizer, as well as other domestic goods, analysts believe they will most likely not be hit as hard by a global recession. Furthermore, any return to higher fuel costs, which will impact global growth, could also help Burlington weather any further downturn as companies continue to shift from trucking to the rails for transporting their goods. As the chart below shows (from BigCharts.com), BNI, the DJIA, and the Dow Transports (DJTA) have diverged somewhat since the beginning of the year.

Source: BigCharts.com

Often the DJIA will follow the transports, but in this case the market sell-off in October has caused the transports to catch-up on the downside with the general market. BNI fared a little better during this time. Each has gained over the last week. Of interest is how the transports are bumping up against resistance levels in place since January, whereas BNI has actually found some support at these levels. If the market can break these levels and continue to build a bottom in November (or even begin to rally), and the six months from November to April do turn out to be bullish after the heuristic-based "sell in May and go away - until November" trades are unwound, than BNI may not only be a potential recession play, but it may also help to lead the market over the next year. Nothing is fool proof, but with the winds of Buffett, energy (coal), and ethanol (fertilizer) at your back, the profit trains could start rolling again for BNI stock holders.

After recently trashing the stock of Berkshire Hathaway just six months ago in December, Barron's is now making a case for its purchase with an article entitled "Cheap Stock?" To their credit the stock has sold off since December. This comes after an article a few weeks ago entitled "The Next Buffett," which discussed how David Sokol, the chairman of MidAmerican Energy, a Berkshire unit, is now the most likely successor to Buffett to be CEO of Berkshire - and more importantly, how he is probably ready for the job. Not wanting to flip-flop too much, or at least provide some balance, this week's issue also has an interview with Doug Kass, the popular short-selling hedge fund manager who is still bearish on Berkshire stock, and has also reiterated this view for readers.

While the criticism of Berkshire has varied over the years, the issues of the exposure of the company to its insurance business and that of Buffett's age are still often cited as reasons for selling and staying out of the stock. As for the insurance business, its impact seems to show up in October, as seen in the weekly chart below (from stockcharts.com), although this is simply a three year view and anecdotal. Nonetheless, for the past three Octobers, after the annual hurricane and storm season is over - and the quarterly results begin to show how much of the float is left for Buffet to invest, the stock will often have a nice end of the year rally before leveling off or making a slower accent to the next October.


The difference of course has been this year, where the stock has sold off and been more volatile after the December Barron's article, and recent news of other hedge fund managers, such as Kass, taking a short position in the stock. The latest positive article and opinion from Barron's may stem the tide, but many of the short-sellers remain. Even Buffett at the recent "Woodstock for Capitalist" shareholders meeting in May alluded that Berkshire may under-perform (at least its historical self), and there may therefore be better opportunities elsewhere. But then again, Buffett is known for lowering expectations and feigning a sense of weakness, only to later make large acquisitions and investment, such as the recent decision to help finance the Mars acquisition of Wrigley, while taking a small position for himself.

While it is difficult to value Berkshire Hathaway, compared to some other public companies, and even more difficult to predict where Buffett is deploying his capital - at least until the quarterly reports are released, it does appear that the recent sell-off of the stock has taken some of the "Buffett premium" out of the stock. This extra boost to the valuation of Berkshire, simply because of his skill and the brand that Buffett has become, is often cited as one of the concerns for the stock as it relates to both the valuation and Buffett's age. In the past the premium has seemed justified based on past performance, and still does, but if Buffett were to step down for any reason, there is an expectation that the premium will be immediately taken out of the stock. Yet, Buffett appears to be in good health and even better spirits, not to mention remaining active in looking for investment opportunities (not withstanding showing up on soap-operas and CNBC at every chance Becky Quick gets).

Still, some investors are waiting on the sidelines for fear that Buffet will be replaced. This seems silly to me since you are missing out on the opportunity of letting one of the greatest investor of all time put your money to work. Furthermore, what happens if Berkshire is then run by someone else, maybe 1, 5, or 10 or more years from now? Will this give you a reason to jump in? Sure, succession will be more clear, but the management of your money will be less so, regardless of Barron's pick (or guess) for a successor - for CEO, not CIO(s). In a sense it comes down to staying out of the stock while you wait for a pullback and possibly new management, compared to staying in the stock and benefiting from Buffett's expertise, even with a lack of succession clarity. I think many current investors will continue to take their chances.

In the end, maybe the biggest hurdle for Buffett may not be his age, or overcoming the "Buffett premium," or worrying about the next catastrophe that will reduce the investment float. What may be more of a challenge is overcoming the law of large numbers. The company's cash for investment is considerable. To make any dent in the stock price of Berkshire, Buffett has to take a considerable position in an outside company in order for it to register enough to potentially affect earnings and move the stock. This takes time, and certainly offers less flexibility to get in and out at an acceptable price. More than likely this is one reason why Berkshire Hathaway has simply made large equity investments and outright purchases of companies in the last few years, although the recent volatility and credit / housing related sell-offs in the stock market have created more of the values that Buffett looks for, and has resulted in more equity positions - recent purchases include Kraft (KFT) , Ingersoll Rand (IR), Burlington Northern Sante Fe (BNI), US Bankcorp (USB), United Health Group (UNH), Wells Fargo (WFC), and Wellpoint (WLP), along with small positions in Carmax (KMX), M&T Bank (MTB), and Sanofi Aventis (SNY) - see previous post for share numbers and dollar values. Of these position, only the added positions in Kraft and Burlington Northern Sante Fe were large enough to generate any interest on the buy side, and even then, they were adding to already existing positions.

So what is an investor to do? Barron's does provide some guidance by referring to an analysis by the hedge fund T2 Partners. T2 highlights that the intrinsic value of Berkshire has continued to grow steadily and significantly over the last few years. From Barrons:

Meanwhile, for a truly big company -- with a market cap of $190 billion, total assets at last count of $281 billion, total equity of $119 billion and book value per share of $77,014 -- it has been enjoying quite impressive growth, especially where it really counts. The value of investments per share has climbed to $90,343 in 2007, from $52,507 five years earlier; during this stretch, pretax earnings per share, excluding investment income, has quadrupled from the $1,479 posted in '02; and intrinsic value -- which T2 calculates as investments per share, plus 12 times earnings per share excluding investment income -- at the end of last year ran somewhere between $156,300 and $158,700 a share, or comfortably more than double '02's $70,000.

As a result, T2 believes that Berkshire is undervalued by approximately 20%. Furthermore, if you are to assuming a 10% growth rate for the intrinsic value of the company, which is not speculative for Berkshire by any measure, with a business and cash buildup of $6,000 per share over the next year, the total intrinsic value could approach $178,700 per share. Given the current price, this represents a 46% premium on the stock. Going out further to two years, the number approaches $200,000. While short-sellers like Kass will continue to short Berkshire, and give good explanations - such as Buffett's age and lack of a visible succession plan, new hedge-fund competition, new uncharacteristic exposure to derivatives, and waining benefits from the insurance industry - it is difficult to bet against someone with so much cash to deploy, as well as a track record for wisely putting it to work. While the stock has been volatile, and is receiving attention from the short side, it is difficult for many investors to sell at these levels until more of the issues that Kass describes come to light. For the time being, most of the current long investors will no doubt hold, and look for others to join in - maybe in October.

A recent report provided some insight into the changes in equity holdings for Berkshire Hathaway. While important knowledge for Berkshire investors, this report has also become a market news event, given that any signal that the Oracle of Omaha is buying or selling a company you currently own could make for either a pleasant or long weekend, even though the Berkshire stock transactions may have occurred over three months ago.

As highlighted in the report, Berkshire Hathaway disclosed that it no longer has a position in Ameriprise Financial - AMP, selling 661,742 shares ($34.3 million), but has added to its positions in Kraft - KFT, buying 5.88 million shares ($182.3 million, giving 138 million total shares), increased its position in Ingersoll Rand - IR, buying 300,000 shares ($13.4 million, giving 936,000 total shares), increased its position in Burlington Northern Sante Fe - BNI, buying 2.96 million shares ($272.7 million, giving 63.8 million total shares), and decreased its position in Iron Mountain - IRM, selling 1.29 million shares ($34.2, giving 3.4 million total shares).

Other new positions include purchases of US Bankcorp - USB (1.05 million shares valued at 33.9 million), United Health Group -UNH (400,000 shares valued at $13.7 million), Wells Fargo - WFC (1.4 million shares valued at $40.6 million), and Wellpoint - WLP (300,000 shares valued at $13.2 million). Berkshire also sold a smaller stake in Trane - TT (60,500 shares valued at $2.8 million), and make smaller purchases in Carmax - KMX (300,000 shares valued at $5.8 million), M&T Bank - MTB (6,300 shares valued at $500K), and Sanofi Aventis - SNY (16,828 shares valued at $600K).

FedEx warned Friday afternoon, cutting its fiscal Q4 earnings forecast for a second time this year (it warned earlier in March), citing increases in fuel prices, which had increased by 7% ($100 million) since giving its last estimate. The company now expects earnings for the quarter ending in May to be in the range of $1.45 to $1.50 a share, compared with previous forecast of $1.60 to $1.80 per share. Not surprisingly, the shares are down in Friday after-hours trading.

A few observations. First, for those that follow FedEx, this was somewhat to be expected given their earlier warning, but troublesome nonetheless. Furthermore, anytime a company warns on Friday afternoon, when they expect that everyone will be home with family or in The Hamptons, this is also sometimes a tell that the company is in trouble. This again is certainly not encouraging.

So what does this mean for the overall economy? Just recently we discussed how the Dow Transports were making a small rally earlier in the year, even as the Dow Industrials were relatively flat. While not a perfect indicator, the transports have at times been a leading indicator for the industrials. From a previous post we discussed why:

The logic behind the indicator being that if product is being shipped from supplier to retailer, than retailers are experiencing lower inventory and increased demand, eventually resulting in both the supplier and retailer booking revenues and earnings. The leading transportation indicator occurs since the transports are the first to signal demand, with the transportation companies also being the first to actually get paid for their services, resulting in higher valuations and stock prices. Both the suppliers and retailers have to wait a few months before seeing increased revenues at the retail level, or increases in accounts payable at the supplier level. As a result, increases in the transports can at times signal future revenues and stock prices for the industrial companies.

A current comparison of the charts for the DJIA and DJTA gives us no real conclusion:


As expected, there was a nice breakaway in transports in late January, followed a few months later in March by the industrials. The recent moves this week in the transports, while down, are still above the current uptrend line. Nonetheless, the industrials have appeared to roll over slightly. Certainly higher oil prices and recent new developments (i.e., problems) with some financial companies are most likely having some impact on the broader market.

Of course, FedEx, and even the over the road shipping companies, such as YRC Worldwide, may no longer tell the whole story. Given the strength and demand of the once maligned rails, it will be important to see results from companies such as Union Pacific, Burlington Northern Santa Fe, Canadian National Railway Company, and Norfork Southern before we can declare that shipping and transportation are weakening, and that lower demand will result in lower profits for the production-driven industrials. With the rails it is also important to see what is being shipped, given that recent agricultural and energy demands have seen an increase in business for moving coal and crude oil, along with wheat, corn, soybeans, and fertilizers. The energy commodities in particular, along with higher levels of corn production, will provide an increase in freight levels, while at the same time signaling pressure on the energy consuming industrials, thereby weakening the significants of the DJTA indicator.

Tickers: FDX, BNI, UNP, NSC, CNI