Is BNSF A Proxy For The U.S Economy? | The Acquirer's Multiple®

During their latest episode of the VALUE: After Hours Podcast, Morris, Taylor, and Carlisle discuss Is BNSF A Proxy For The U.S Economy?. Here’s an excerpt from the episode:

Jake: Let’s switch gears to the railroad. So, revenue coming in at $25 billion last year, which is up 12%. Sounds good. Operating costs up 21% and their fuel costs were up 65%, [Tobias laughs] which that’s not so good, but they have surcharges they can put on there. They still ended up with a 34% operating margin, which is amazing. But here’s the thing. A revenue per average car, plus 19%. Car volumes down almost 6%. So, this is that same story of Home Depot that Alex was just telling is that, price increases, but we’re getting volume decreases. And boy, one, does that say that are we in a recession already? Kind of Using BNSF as a proxy for the US economy, like things moving around, maybe not the worst pulse that you could take.

To me, also, prices up 19% and volumes down 6%. That’s what stagflation looks like, I think. So, I’d be curious to see how this continues. I think we may find that maybe we’re already in worse shape than the other economic data that’s slower to report than necessarily this keyhole into the US economy, which a railroad might represent.

Tobias: Yeah, that’s not a cheery thought, but I think it lines up with just about everything else that I see anyway. I’m somewhat pessimistic about the economy in general, and housing everything at the moment. It all makes me a little bit nervous, honestly. I’m surprised it hasn’t shown up in real estate or housing prices yet. I can’t really square those two. I guess we’re down 6% or 7% over the last 12 months. It’s not much.

Alex: Yeah, I haven’t looked closely at BNSF. I think that’s the point you’re just making, Toby, I think a company like Target to me is interesting because it’s obviously pretty easy to understand. You look at pre-pandemic to now, and it’s like the Home Depot store sales are up very significantly. The difference there is, well, one, their mix of business. They’re much less of a grocery store food retailer in the same way that Walmart is, for example. They’re really grocer more than anything else. Target plays a lot more in these discretionary kind of general merchandise categories. It’s funny. They are not seeing– at least so far from the ones I’ve seen, you’re not really seeing the hit to them in terms of the revenue side of the business. It’s not coming in very significantly, again, at least so far. But in terms of the profitability, they are–

They’re talking about taking three years to get back to mid-single-digit EBIT margins they reported pre pandemic, where they peaked out at eight and a half percent two years ago. They were guiding to either 6% or 8% in 2022, and they came in at 3.5%. So, it’s a business, obviously where if you get caught offsides on cost/revenue assumptions, you can see real pressure on profitability in the short term on top of potentially significant excess inventory that you’re holding.

So, it just strikes me as one where it’s oddly persistent in terms of the challenges that they’re facing and I don’t know what the read through from that is. But it just strikes me as odd that it’s not really settled even though they knew what their problem was six plus months ago now. It just seems odd. I would say the HD guide and the FMD guide also seem odd to me, and I don’t totally understand.

Jake: Well, that dynamic you just described, it describes the entire S&P 500 right now. All margins seem to be coming in. They peaked at 13.3%, I think, in 2021, which was like off the charts, like 2x the long run average, on their way south right now. If you think of PE, where are we now, like 19 or something, if that E is on its way down, which it just seems like all the micromeasurements show that the E is on the way down, that P needs to adjust as well to get to a reasonable evaluation. So, I don’t know. Not to be too bearish, but there’s some concerning elements right now.

Tobias: The difficulty is when you’re analyzing– To take the macro into the micro and you’re analyzing individual stocks, you look at all of these things that have been overearning for a little while. It’s hard to tell if something’s overearning or if it’s just growing very quickly. It’s very, very hard to tell the difference between the two. And so, I look at these things that look cheap on the last five years of comps. That’s just a nightmare to figure out through the last five years, like what is the average earning power, what’s the real earning power through the last five years? Five years now includes 2018, 2019, 2020, 2021, I guess a little bit of 2023. It’s tough. That makes me want to pay a lower price, honestly.

Alex: [laughs]

Jake: One would think that you would want to be conservative with that margin of safety of what you’d be willing to pay with such erratic predictability, huh?

Tobias: Yeah, it is erratic. It’s very volatile. It’s artificially volatile, but it’s also just figuring out what the true earning power is. It’s just hard to figure it out through that. I don’t know. I think it’s an interesting 10 months on deck, 8 months on deck. I think we’re drawing pretty close to the precipice one way or the other. We find out one way or the other pretty quickly here.

Alex: I think an interesting flip side to some of these generally more established profitable just figuring out what P&L looks like in the short term is some of the unprofitable column– product market fit companies that don’t know if they have a business yet, might be a fair way to describe some of them.

Jake: [laughs]

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