By now surely most of you are aware that Warren Buffett has decided to add all of Burlington Northern Santa Fe (BNI) to his Berkshire Hathaway (BRK.A) fund. He already owned 20% of it – he’s getting the rest for about $36 billion and the assumption of about $10 billion in Burlington debt. (How’d you like to have an extra $46 billion laying around?)

The decision has been met with a few responses… some pleased, most lethargic, and a few passionately dissenting voices. It’s the latter group I find most interesting.

In short, the biggest critics said:

1. It’s a bad deal because he paid too much for it, for too little return.
2. It’s a bad deal because railroads are a 20th century relic built on coal shipping, which is on the way out.
3. It’s not within his normal ‘value’ rules of acquisition.

At first I was more in tune with the dissenting ideas than in support of the Oracle’s choice. As I continued to study things though, I think I uncovered what Buffett is seeing.

In the same order listed above….

1. There’s not a lot of ‘value’ in it, but it is a revenue bearing operation that makes a profit in good times and bad.
2. Coal is 40% of rail shipping volume right now, but only 20% of the industry’s revenue. And, that 40% is indeed shrinking… on a relative basis. Non-coal (intermodal) shipping is not only on the rise in the near-term, but is expanding greatly in multi-year timeframes. It’s wildly more cost effective than trucking, and will grow as the economy rebounds, and unless oil falls to under $50 per barrel (or so) again.
3. True, BNI is not in his normal value scope, but he knows it. He just can’t find anything else to buy, but doesn’t want the cash to sit idly. That said, many of his utility businesses can benefit from his ownership of rail lines; it can make his overall conglomerate more profitable, if not drive lots of profit directly.

Now, all that being said, rail’s revival is for real. Check out the drastic plunge - and strong recovery - we’ve seen in railroad volumes over the last four years in the United States.

U.S. Railroad Volume - 10/2009

Now check out the same for Canada.

Canadian Railroad Volume - 10/2009

Buffett’s not grasping at straws here – demand is picking up. It’s been flying since May, and the trend is still solid. We’re not to last year’s levels yet, but we’re on the way. (Just bear in mind there’s a November/January lull.)

So what? The stronger the economy is, the greater oil prices rise. The greater oil prices rise, the more business Burlington will have. Even if coal goes away (which it won’t anytime soon – it powers 45% of this country’s electricity generation), it won’t matter since intermodal transportation is growing so well, and will do so in the future. 2009 was a big blip, but the rail traffic is recovering – the data verifies it.

As for BNI, that’s a done deal. However, the same upside that Buffett seen in BNI, I see in companies like Canadian Pacific (CP), and Canadian National Railway (CNI). Both do a big intermodal business, and neither rely on coal a great deal. Even a tepid global recovery could full rejuvenate our northern neighbors’ materials business (to and from).

Bottom line, I like the railroads at current prices as long-term holdings. Buffett was right – it’s a bet on a U.S. recovery. He just didn’t do the explanation justice, as the payoff of railroad stocks with a recovery could be enormous.