Hopefully Burlington Northern only gets better from Q1. The $2.25B in dividends paid out
(from acquisition through Q1) were funded by a combination of BNSF’s cash flow - about $1.3B last year plus $400mill in Q1 2011- that's a combined $1.7B from operations - plus an increase in debt.
This compares to ‘book’ earnings of $2.2B last year plus $600mill in Q1, or $2.8B combined. (For purists, my references to ‘last year’ here mean ‘2010 post-acquisition’.) While ‘book’ earnings are good to know - and that 7% or 8% nominal ROE could be considered palatable these days - we need to really look at BNSF’s sustainable cash flow. We want to know our cash return on our cash (or cash-equivalent) investment.
There are a couple of underlying currents here:
• On the positive side, Burlington Northern has a low ‘cash’ tax rate relative to its booked taxes. While it's convenient to focus on pre-tax, which is just as relevant as also-misleading 'reported after-tax' – but perhaps a good way to evaluate Burlington’s earnings going forward is after 'cash-basis' tax. Or coming at it from the other direction, reported net income with the period's deferred taxes added back. Same thing.
• On the other hand, the company is quite capital-dependent - meaning combined capex and working capital spending, which don't show up in the current period P&L are high. Reported earnings generally look better than evidenced by actual cash flow (see Longreit's book recommendation in the nearby thread). When we compare capex to depreciation, we see that rather than capex approximately offsetting depreciation (so that earnings approximate actual cash flows), capex for BNSF typically exceeds depreciation...significantly. At current capex spending rates, we’re essentially re-purchasing the company every decade or so, at what would appear to be today’s replacement cost levels (more on that later).
If we look at Q1, we see that:
• Reported pretax Q1 earnings were $965mil, and the ‘cash-basis’ tax rate is 17% (37% reported on BNSF’s statements, of which is 20% deferred), for cash-basis after-tax earnings of $803mil. Assuming Q1 is representative, that’s $3.2B annualized.
• Depreciation included in that $803mil number was $442mil. Add back that non-cash charge to earnings, and that’s $1.25B generated cash that's available, for either redeployment or return to the parent.
• From that $1.25B in available ‘cash-basis’ earnings, BNSF spent $507mil on capital expenditures (of their $3.5B projected total capex for this year) and $345mil in working capital build-up. That's about $850mill of 'reinvested' to keep things going, out of the $1.25B available.
• Put it all together, and BNSF’s cash generated from operating activities is just under $400mill for the quarter.
Extrapolating that onto the full year:
• If Q1 were representative, $400mill for the quarter would translate to $1.6B for the year.
• Looking at it more specifically, if we assume ‘no more working capital build-up’ after Q1, but at the same time, that the company spends its (recently reaffirmed) remaining $3B capital expenditure projection for the year, that’s $1B in anticipated capex spending per quarter, for the rest of the year.
• If we assume Q1’s operating performance – the $1.25B in generated cash we figured above – is typical going forward, and supports the planned $1B in capex spending, there’s $250mill per quarter left over. Again, that’s $250mill available for Berkshire, assuming Q1 earnings levels and BNSF’s capex spending plan.
• The Q1 $400M cash generation, plus $250mill-per-quarter for the remainder of the year, gives us $1.2B in cash generation from operations for the year -- available to Berkshire.
Annualized returns:
• Taking some cues from the earlier post on this thread -ie, if we apply last year’s cash generation as a reduction to capital investment (rather than a return on investment) and throw in the May dividend to get to a $30.7B investment base (net ‘sunk costs’), that $1.2B cash return represents just under a 4% return. If we stretch the cash generation this year up to $1.6B, that’s just over a 5% return.
• We'll feel better about this if we rationalize the ‘excess’ capex over depreciation as ‘investment’ toward future earnings. BNSF is spending $3.5B this year. Time will tell, of course. But does history support this optimism? For the five years pre-acquistion – 2005 through 2009, BNSF spent $11.9B in capex, compared to the company's $6.5B in depreciation expense. Capex was 1.8-times depreciation over the five year period -- and was over every year.
Presumably we should be seeing the benefit of that now. But considering that capex consistently exceeds depreciation, another explanation may be that capex and maintenance projects -- even at replacement levels (ie, to keep the railroad running now and into the future) -- are significantly greater than the original costs of the depreciated equipment (and infrastructure). If that’s the case, that’s a cost of doing business that’s delayed on the P&L, but nonetheless accurately reflected in cash flow.
Again, we can hope that BNSF’s future operating returns will be much more generous than we’ve experienced in Q1. We have a ways to go.
(from acquisition through Q1) were funded by a combination of BNSF’s cash flow - about $1.3B last year plus $400mill in Q1 2011- that's a combined $1.7B from operations - plus an increase in debt.
This compares to ‘book’ earnings of $2.2B last year plus $600mill in Q1, or $2.8B combined. (For purists, my references to ‘last year’ here mean ‘2010 post-acquisition’.) While ‘book’ earnings are good to know - and that 7% or 8% nominal ROE could be considered palatable these days - we need to really look at BNSF’s sustainable cash flow. We want to know our cash return on our cash (or cash-equivalent) investment.
There are a couple of underlying currents here:
• On the positive side, Burlington Northern has a low ‘cash’ tax rate relative to its booked taxes. While it's convenient to focus on pre-tax, which is just as relevant as also-misleading 'reported after-tax' – but perhaps a good way to evaluate Burlington’s earnings going forward is after 'cash-basis' tax. Or coming at it from the other direction, reported net income with the period's deferred taxes added back. Same thing.
• On the other hand, the company is quite capital-dependent - meaning combined capex and working capital spending, which don't show up in the current period P&L are high. Reported earnings generally look better than evidenced by actual cash flow (see Longreit's book recommendation in the nearby thread). When we compare capex to depreciation, we see that rather than capex approximately offsetting depreciation (so that earnings approximate actual cash flows), capex for BNSF typically exceeds depreciation...significantly. At current capex spending rates, we’re essentially re-purchasing the company every decade or so, at what would appear to be today’s replacement cost levels (more on that later).
If we look at Q1, we see that:
• Reported pretax Q1 earnings were $965mil, and the ‘cash-basis’ tax rate is 17% (37% reported on BNSF’s statements, of which is 20% deferred), for cash-basis after-tax earnings of $803mil. Assuming Q1 is representative, that’s $3.2B annualized.
• Depreciation included in that $803mil number was $442mil. Add back that non-cash charge to earnings, and that’s $1.25B generated cash that's available, for either redeployment or return to the parent.
• From that $1.25B in available ‘cash-basis’ earnings, BNSF spent $507mil on capital expenditures (of their $3.5B projected total capex for this year) and $345mil in working capital build-up. That's about $850mill of 'reinvested' to keep things going, out of the $1.25B available.
• Put it all together, and BNSF’s cash generated from operating activities is just under $400mill for the quarter.
Extrapolating that onto the full year:
• If Q1 were representative, $400mill for the quarter would translate to $1.6B for the year.
• Looking at it more specifically, if we assume ‘no more working capital build-up’ after Q1, but at the same time, that the company spends its (recently reaffirmed) remaining $3B capital expenditure projection for the year, that’s $1B in anticipated capex spending per quarter, for the rest of the year.
• If we assume Q1’s operating performance – the $1.25B in generated cash we figured above – is typical going forward, and supports the planned $1B in capex spending, there’s $250mill per quarter left over. Again, that’s $250mill available for Berkshire, assuming Q1 earnings levels and BNSF’s capex spending plan.
• The Q1 $400M cash generation, plus $250mill-per-quarter for the remainder of the year, gives us $1.2B in cash generation from operations for the year -- available to Berkshire.
Annualized returns:
• Taking some cues from the earlier post on this thread -ie, if we apply last year’s cash generation as a reduction to capital investment (rather than a return on investment) and throw in the May dividend to get to a $30.7B investment base (net ‘sunk costs’), that $1.2B cash return represents just under a 4% return. If we stretch the cash generation this year up to $1.6B, that’s just over a 5% return.
• We'll feel better about this if we rationalize the ‘excess’ capex over depreciation as ‘investment’ toward future earnings. BNSF is spending $3.5B this year. Time will tell, of course. But does history support this optimism? For the five years pre-acquistion – 2005 through 2009, BNSF spent $11.9B in capex, compared to the company's $6.5B in depreciation expense. Capex was 1.8-times depreciation over the five year period -- and was over every year.
Presumably we should be seeing the benefit of that now. But considering that capex consistently exceeds depreciation, another explanation may be that capex and maintenance projects -- even at replacement levels (ie, to keep the railroad running now and into the future) -- are significantly greater than the original costs of the depreciated equipment (and infrastructure). If that’s the case, that’s a cost of doing business that’s delayed on the P&L, but nonetheless accurately reflected in cash flow.
Again, we can hope that BNSF’s future operating returns will be much more generous than we’ve experienced in Q1. We have a ways to go.
