Panama Canal expansion threatens Buffett's rail strategy

Did the Oracle of Omaha miss the boat on this one? Perhaps.

By Jamie Dlugosch Feb 1, 2010 1:20PM

Continued work on the expansion of the Panama Canal may throw a monkey wrench into Warren Buffett’s profit estimates for his Burlington Northern trains.

 

When completed in 2014, the wider canal will offer a more affordable route of passage from China to the eastern United States. For now, ships from the Far East generally have to unload goods on the West Coast.

 

From the ships, freight moves on trains for the trip east.

 

Given that exports from China are expected to grow at a double-digit rate, the train business is expected to do quite well. It is that growth that has Warren Buffett brimming with confidence with respect to his purchase of Burlington Northern. (Train profits may grow, but so too should these 10 stocks)

 

What happens if there is a cheaper alternative to rail? Freight charges will drop or trains will lose the cargo entirely. In other words there is risk to the rail strategy.

 

Ironically, Buffett claims that his purchase of the giant railroad is a bet on the American economy. In fact, it is a bet on the American consumer’s thirst for cheap goods from China, a thirst that will keep trains full for years to come.

 

The only problem is that if shipping by boat is cheaper than train transportation, those trains may not be so full after all. Instead short haul transportation from port to final destination may give trucking a boost.

 

While it is true that trains are less expensive than trucks on long-haul routes, trucks actually have the advantage in short haul. Perhaps Buffett may have been better off buying a trucking company instead of a train business.

 

Of course, there is more to the story with trains. Commodity shipments and such moving from the center of the country to ports will keep trains plenty busy, but even there the same dynamic is in play once the Panama Canal expansion is complete.

 

It is clearly an important factor in valuing these businesses.

 

The good news for Buffett and anyone following his footsteps by investing in train companies is that the Panama Canal expansion will not be finished until 2014. Buffett is a long-term investor, but in this case investors may be better off by focusing on the short term.

 

I expect train companies to continue to be strong right up until they see price weakness from competition with Panama shipping. At that time, I would turn my attention to the trucking industry.

 

(Each year I put together a list of Top 10 Stocks for the year. Get your free copy here.)

 

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