As we discussed last week in our coverage of Berkshire Hathaway’s second quarter results, the company’s newly acquired railroad subsidiary posted improved results for the quarter. Burlington Northern Santa Fe posted net earnings of $603 million on revenues of $4,094 million. Since the consolidation of Burlington Northern at the close of the acquisition on February 12, 2010, the company has posted net earnings of $885 million on revenues of $6,167 million. Revenues for the second quarter were 23 percent higher than revenues for the second quarter of 2009 reflecting the sharp improvement in economic conditions since the depths of the recession. In this article, we will focus on Burlington Northern’s somewhat surprising $250 million dividend payment to Berkshire Hathaway in the second quarter and what meaning this has, if any, on plans for future capital expenditures.
Controversy Regarding Acquisition
Warren Buffett’s decision to acquire Burlington Northern was not without controversy in the value investing community. Some observers, including Columbia University Professor Bruce Greenwald, thought that Berkshire was overpaying given the price paid versus the true economic earning power of the business. Others, including Bruce Berkowitz, made the case that Berkshire was making a good investment given that much of the purchase would be funded with very low cost float generated by the insurance subsidiaries.
Shortly before the close of the acquisition, we speculated that Mr. Buffett may be planning on rapid expansion for Burlington Northern. This seemed to be validated in a May interview with Burlington Northern CEO Matthew Rose in which he quite clearly indicated that Mr. Buffett was leaning toward expansion:
There is no doubt that Warren has been very clear he wants to us reinvest in the railroad. And if you think about, if you are a public company, in terms of generating free cash flow, you really have three different alternatives. Buy back your stock. Dividend out to your shareholders or reinvest in your company either your own company or through a strategic acquisition. We no longer can buy back our own stock because we don’t have any so we’re down to dividending (ph) up to Berkshire as the parent or reinvesting in our company. And I think Warren’s made it clear that he wants to see us reinvest back in the railroad.
Mr. Buffett has also made a number of comments indicating that Burlington Northern represents a good destination for Berkshire Hathaway’s prodigious cash flows.
Interpreting the Dividend
According to Burlington Northern’s second quarter 10-Q report, the company paid a $250 million dividend to National Indemnity, its parent company and one of Berkshire Hathaway’s insurance subsidiaries. As we pointed out in an article earlier this year, as an independent public company, Burlington Northern has pursued a policy of restricting its capex mostly to maintenance of the existing network, using free cash flow to repurchase shares and pay dividends to shareholders. In the five years ending December 31, 2009, the company paid out $1.97 billion in dividends and used $3.96 billion to repurchase shares. This was roughly equal to free cash flow.
One way to interpret the $250 million dividend is to view it as a continuation of the cash management policies pursued prior to the acquisition. The transaction took place very recently and management may still be formulating plans for expansion or reinvestment in the network. There was certainly plenty of free cash flow to cover the dividend. It is also possible that Berkshire is using the dividend payments to service the debt that was taken to fund a portion of the acquisition.
It is definitely premature to draw any conclusions regarding Burlington Northern’s plans for expansion or the dividend policy going forward. However, the payment was somewhat surprising in light of Mr. Rose’s comment in May, as quoted above.
Disclosure: The author owns shares of Berkshire Hathaway.