Would Warren Buffett buy QR National?

Financial journalist
Print This Post A A A

A lot of people say they want to invest like Warren Buffett invests – but not many can.

That’s not to say they can’t make the same kind of investment decisions, it’s just not many people can take the time horizon that Berkshire Hathaway, Buffett’s investment company, can.

In November 2009, for example, in Berkshire’s largest-ever deal, Buffett invested $34 billion buying Burlington Northern Santa Fe Corp., the second-largest railroad in the United States. Asked how long Berkshire Hathaway saw itself owning Burlington, Buffett replied that it was “a good asset for Berkshire to own over the next century.”

Buffett described Burlington Northern as an “all-in wager” on the future of the US economy due to its status as the biggest carrier of food products like corn, and coal for electricity. It also moves imported consumer goods from Asia from the US West Coast ports at which they arrive. Buffett clearly sees the company as an indicator of the USA’s economic health. At the time, he said he saw value in railroads as a “cost-effective and extraordinarily environmentally friendly way” to move goods.

US railroad companies are enjoying a mini-boom on the back of the demand for transport of crude oil out of the emerging shale areas such as North Dakota, where pipeline capacity falls well short of the burgeoning production. (You won’t be surprised to learn that Buffett’s Burlington Northern operation is up to its cabooses in this traffic.)

Australian rail

Railroads are not a major part of the Australian sharemarket, but they certainly hit the news this week with the deft sale by the Queensland government of more than half the 34% stake it held in railroad group QR National (QRN), which it floated on the stock exchange in 2010. The Queensland Treasury managed the noteworthy feat of selling just over 17% of QR National at a premium to the prevailing share price, when normally an ‘overhang’ of this size has to be offered at a discount – especially when the sale has been widely expected.

Without going into the mechanics of the deal, what would have jumped out of the financial pages at Switzer Super Report readers was the glowing reports of QR National as a growth prospect, based mainly on the movement of coal – mainly metallurgical, or steel-making coal – from mines in Queensland and New South Wales to end-customers and ports. Its largest customer is BHP Billiton.

QR National also moves other bulk mineral commodities (including iron ore) and agricultural products throughout Queensland, New South Wales and Western Australia, as well as general freight; and moves containerised freight throughout Australia. The company has only one meaningful competitor, in Asciano’s Pacific National, but the critical difference is QR National’s monopoly ownership of the regulated Queensland coal network track.

You can largely forget the freight operations, though. In effect, QR National is a huge bet on the China story – the demand for Australian coal and iron ore.

This is the story in which the stock was floated in 2010, at $2.55 a share. It has been a good performer, peaking at $4.03 in April this year, and even in the face of concerns over a Chinese slowdown – as the sick state of Europe and a tepid US recovery bite into demand for China’s exports – the stock has only staged a mild retreat, to levels around $3.60.

Moving mainly steel-making coal, the driver for QR National’s health is the gigantic urbanisation process under way in China. In 2011, according to China’s National Bureau of Statistics, China’s urban population exceeded its rural population for the first time in the nation’s history.

Growth potential

According to the Reserve Bank of Australia’s economics group, China’s urban population is expected to increase by 42% over the next two decades to about 70% of the total population by 2030.

By comparison, 90% of Australia’s population already lives in urban areas and the US has an 80% urbanisation rate. This level of urbanisation is expected to continue to drive the demand for Australian iron ore and steel-making exports for decades to come.

There is no doubt that QR National will pick up on this growth – although there will be short-term air pockets for the share price. It has stood up fairly well lately, given that, for example, major customer BHP froze $50 billion of expansion projects in August; and wider market concerns about China can be starkly seen in the spot iron ore price falling by 36% in the September quarter (before pruning that quarterly fall to 22%.)

QR National brought out a full-year profit for 2011-12 of $441 million, a 22% lift on the previous year, and ahead of analysts’ consensus expectations by about the same proportion. It is a solid performer, every way you look at it.

SMSF potential?

But is it a self-managed super fund stock? No, for two main reasons.

The first is, you are probably already gaining Chinese exposure through BHP or Rio Tinto. Holding QR National would cannibalise that to some degree.

The second reason is the yield – or lack of it.

QR National is expected to pay a dividend this financial year of 8.5 cents, with the same again in 2013-14. At $3.62, that is a princely nominal yield of 2.3%. The yield is so low because QR National reinvests most of its profit, and has large capital spending needs (it will spend about $1 billion this financial year.)

Even worse, there is no franking because the cash tax paid by QR National is minimal, due to capital allowances available for current, past and anticipated capital expenditure. As a result, tax payable by QR National is expected to be minimal. Unfranked dividend flows and SMSFs are not really compatible.

The bottom line

The stock does have a growth story, but the paucity of yield is the deal-breaker. Even Buffett, who wants to sit on Burlington Northern for 100 years, is unlikely to be enthused about the 1.6% yield it offers him in the meantime.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Also in the Switzer Super Report

Also from this edition