Rudi On Thursday

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(This story was originally published on Wednesday, 04 November, 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).

“In the market, perception is reality”.
(BTIG Chief Market Strategist, Mike O’Rourke)

As far as market symbolism goes, one would be hard pressed to find a better example than Tuesday’s announcement that Warren Buffett’s investment vehicle, Berkshire Hathaway, wants to gain full ownership of US railway company Burlington Northern Santa Fe Corp. As far as symbolism goes for the much doubted US economic recovery, a company that facilitates goods transports across the US must be pretty much in the bulls eye of the discussion. And as far as investment nouse goes, Warren “the Oracle of Omaha” Buffett is pretty much the Champion amongst Champions in our life time.

Buffett’s status was again confirmed in a poll conducted by Bloomberg last month, when professional investors voted him number one in the world as “the best assessor of financial markets”, beating Bill Gross, the founder of bond manager Pimco, billionaire investor George Soros and reputed market bear Nouriel Roubini.

As far as Buffett’s target is concerned, The Los Angeles Times reports “Burlington Northern is the nation’s largest rail transporter of coal and grain and provides a vital link for consumer goods from Asia to the Midwest”.

At a time when equity and commodity markets look very vulnerable, America’s number two richest man (only preceded by Microsoft founder Bill Gates) is prepared to spend some US$27bn on an old school rail-transport company that will only flourish if the US economy heals from its present wounds.

Note: the widely reported US$34bn is the total value that reflects back on the company as a result of the public offer made. Berkshire Hathaway already owns a sizeable equity stake, so it only has to fork out US$27bn to achieve full ownership. You can blame the confusion on lazy journalism and the fact that nobody in the finance sector seems to have a natural urge to check such details, it’s all just copy and reproduce these days.

In fact, digging down into the finer details of the deal teaches us that Berkshire Hathaway’s intention is to only pay US$9bn in hard cold cash from its own funds. If the deal goes through, Berkshire would assume US$10 billion of BNSF debt, leaving it to pay some US$17 billion in cash, of which US$8bn would come from debt.

The symbolism doesn’t stop here, not yet. The deal, if successful, will be Buffett’s biggest-ever acquisition. Some commentators have already started to speculate that, because this deal is so big, it may prompt Berkshire Hathaway to sell some of its other investments. The statement issued to announce the deal stated “It’s an all-in wager on the economic future of the United States”.

There you have it, all the symbolism you ever wanted at this point of the cycle in one sentence to explain the “why” behind what one commentator described as the “greatest investor of the past half century placing the biggest bet of his career”.

Berkshire Hathaway’s takeover proposal offers a premium of 31.5% over BNSF’s closing stock price on Monday, valuing the railroad at US$34bn. According to Thomson Reuters, this equals close to 20 times estimated 2010 earnings. More importantly, maybe, is that the offer trumps the mean price target set by some 18 stockbrokers covering the stock in the US. Most of them rated the shares Hold/Neutral. No doubt, all this will help to convince the likes of Capital Research, Vanguard, Barclays, UBS and State Street to hand in their shares in exchange for an unexpected, quick double digit-profit.

Some more details to lend more insight into Buffett’s thinking: Burlington Northern has a fiscal year that runs until late December. So it is still in its fiscal 2009 year. On this year’s forecasts, the Price-Earnings Ratio is 15.3. For 2010 it is a little less than 20 (19.8) – in other words, company profits are likely to take another dive first. On 2011 estimates Buffett is still paying 17.5 times consensus earnings per share. The number drops to 15.2 in FY12.

Note the similarity between PERs in 2009 and 2012.

Warren Buffett is a value-investor. The Bloomberg poll confirmed him as “the best assessor of financial markets”, not as the world’s greatest market timer. In October last year Buffett wrote a personal statement for the Op-Ed page of the New York Times. It was titled “Buy American. I Am.”

I remember many stockbrokers in Australia sent it around to their databases in order to convince their clients that sitting on cash was not the smart thing to do. I doubt whether these stockbrokers had any success with their intentions at the time. After a brief uptick -some people called it a rally- the US share market tanked once again during the first two months of calendar 2009.

But we all know what happened after that.

Buffett’s Op-Ed contribution last year starts with the sentence: “The financial world is a mess, both in the United States and abroad.” But, continues Buffett, I have been buying American equities. Why?

“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”

“Fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month – or a year – from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

Those who want to read the whole piece, they can at: http://www.nytimes.com/2008/10/17/opinion/17buffett.html

Because of its wider-reaching symbolism, it is probably fitting that Warren Buffett announced the deal of his life, with the usual inherent characteristics, at the same time as Dalbar Inc released the results of its annual Quantitative Analysis of Investor Behavior in the US. It is my understanding that each and every survey since 1994 has shown that investors are by far not achieving the returns that market indices suggest they should, simply because they don’t have the nerve to sit tight and wait for time to perform its wonders on sound investment decisions made. Instead, most cannot help but jump from momentum to momentum and collect so many costs in the process, or become one of the Johnny-come-latelies, they end up achieving lousy returns.

The financial sector had ultra-conveniently gone well overboard in its short-USD, long everything else market positioning. Global equity markets are at present paying the price for this. Investors should ask themselves whether this is the right message to take guidance from?

With these thoughts I leave you all this week,

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team at FNArena)

P.S. I – The no longer weakening US dollar remains the main game in town, as again illustrated by the chart below (thanks to BTIG Chief Market Strategist, Mike O’Rourke). To read more about the how and what about the US dollar’s devastating role this time around, see various of my Weekly Insights and Rudi On Thursday-editorials over the past months in the FNArena archive on the website.

 P.S. II – I note that on Wednesday’s closing share prices, ANZ Bank ((ANZ)) shares are trading at 11.2 times FY11 consensus earnings per share, CommBank ((CBA)) is at 12.5, and National ((NAB)) is at 10.4. Westpac’s ((WBC)) forecasts will rise over the next few days post its FY09 report. BHP Billiton ((BHP)) is at 13.9 at today’s AUD/USD value. Bradken ((BKN)) is at 10.2.  Orica ((ORI)) is at 11.6. Downer EDI ((DOW)) at 12.6. For more insights see Stock Analysis and R-Factor on the FNArena website.

P.S. III – This one is for the momentum seekers among you. Analysts at RBS Morgans are keeping a close eye on any announcements by Silex Systems ((SLX)). At present, their price target of $8.11 is well above the share price, but… a decision on the commercialisation of the company’s Uranium Enrichment program by Global Laser Enrichment (GLE) is expected before Christmas. If positive, RBS Morgans expects the shares to re-rate well past its present target. As always, no guarantees are included. Only investors with a big appetite for risk need to consider.

P.S. IV -  The TechWizard confided to me on Wednesday morning he’s concerned investors in the share market may miss out on the end of year rally for a third year in a row. From a technical point of view, says the Wizard, the Dow Jones Industrial Average has now tried to puncture four times through a support line that dates from August this year.

This seems to indicate that the bears will continue trying and that at some point technical support will give in. Such event will trigger a wave of selling, predicts the Wizard, not only because many short term traders will instantly reverse their attitude towards the direction of market, but so too will all automated trading programs that have been supporting US equities throughout the post-March rally. This could get ugly, says the Wizard.

For good measure: the Wizard believes one more rally that will take the market to a new high seems the most plausible scenario, but after that it might get really ugly.

P.S. V – All paying members at FNArena are being reminded they can set an email alert for my editorials. Go to Portfolio and Alerts in the Cockpit and tick the box in front of Rudi On Thursday. You will receive an email alert every time a new editorial has been published on the website.

P.S. VI – For short term considerations only: if not even the biggest deal in Warren Buffett’s iconic career can provide the US share market with positive momentum, not even for just one day, then you really know this market is not looking for reasons to go up. Not right now.

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