Despite service woes, BNSF posts strong earnings

Burlington Northern Santa Fe, the dominant freight railroad in Minnesota, has failed to haul a lot of grain, coal and other commodities on time this year, angering many customers.

There are several factors behind the delays and backlogs, including last year's brutal winter, a huge surge in oil shipped by rail from North Dakota, and big crop harvests. But shippers are the ones who are taking big financial hits while BNSF's fortunes have improved.

A University of Minnesota study estimated that rail shipping delays from March to May this year cost Minnesota farmers about $100 million. And the complaints continue.

Otter Tail Power and Minnesota Power wrote rail regulators recently to complain about coal shipments. Otter Tail spokeswoman Cris Oehler said stockpiles have gone from bad to worse, with fuel supplies about 20 percent below what they should be going into winter.

"We understand they seem to be in a difficult position but we do need coal deliveries to improve our plants or the costs go up to our customers," she said.

At a September rail service hearing in Fargo, BNSF executive vice president Steve Bobb said the railroad has been moving more freight year-over-year but hasn't kept up with the needs of many customers. He promised the carrier will fix things.

"We're going to invest whatever it takes to handle all our customers' business, both current and future," Bobb said.

BNSF is spending billions of dollars on track, locomotives, and other upgrades, while adding thousands of employees.

Despite the pain its customers are complaining about, the railroad has hardly been punished financially. Demand for rail shipping has continued to rise. For the first half of this year, the company had net income of $1.9 billion on revenue of about $10.9 billion.

For the first half of this year, BNSF reported a 5.4 percent revenue increase. Additional spending on equipment and staff pulled earnings down, but just 1.6 percent.

Revenue from agricultural products for the first six months increased 15 percent to about $2 billion, while the volume of such products shipped rose 2 percent.

Rising demand for rail transport paid off for the railroad, which reported a 3 percent increase in cars and units handled and a 2 percent rise in average revenue per car or unit. For cars carrying agricultural products average revenue soared 12 percent.

Morningstar analyst Keith Schoonmaker said BNSF historically has been one of the best-run railroads and is in good shape financially.

"It is hard to comprehend from the outside why the congestion persists," he said. "Still, we think the railroad is well-managed and don't doubt it will be doing what it needs to get things ship-shape again. It has been a struggle for all the rails."

The long-haul rail freight business is dominated by seven carriers that often have their service areas all to themselves.

Railroads have richly rewarded investors, with stock prices soaring about 600 percent since 2003.

Schoonmaker said the big national railroads should deliver fat and steady pre-tax earnings in the range of 30 percent or more for years.

That's about three times the average operating margin of companies in the S&P 500.

Schoonmaker said the railroads are on a financial roll largely because of the smarter use of labor and fuel. Also, he said, most rail freight pricing is beyond the reach of regulators.

For its part, BNSF contends it faces widespread competition from other railroads and trucking and barge companies for business.

The railroad caught the eye of investing guru Warren Buffet. His Berkshire Hathaway holding company already had a large stake in the railroad when it bought the whole operation in 2009.

The $44 billion deal was the biggest in Berkshire Hathaway's history.

Buffet loved BNSF's leading position in carrying inter-city freight and figured the railroad's fortunes would rise with the nation's rising prosperity.

"It's an all-in wager on the economic future of the United States," Buffet said of the deal. "I love these bets."

Last winter, the price to ship grain by rail went up $2,000 to $3,000 per car, said Bob Zelenka, executive director of the Minnesota Grain and Feed Association. A train can include 110 cars.

But Zelenka said farmers have just learned to live with such pricing.

"Railroads, for the most part, are dealing with captive shippers," he said. "So, you don't have an option. It's kind of, 'Take it or leave it.'"

A 2014 study funded by the American Chemistry Council asserted most rail freight shipping rates in 2011 were greater than allowed by a regulatory formula to determine reasonable rates, relative to a railroad's cost.

"With limited competition, freight rail rates increased more than 76 percent over the past decade — nearly three times the rate of inflation and three times as much as truck rates have increased," the report concluded. It noted that shippers were paying billions of dollars more than they should.

Railroad industry representatives insist that rates are reasonable and that they have fallen since the industry was deregulated in the '80s.

The American Railroad Association contends average inflation-adjusted rail rates are down 42 percent.

"This means the average rail shipper can move close to twice as much freight for about the same price it paid more than 30 years ago — saving shippers hundreds of billions of dollars over this period," the association notes.

Shippers can turn to the federal Surface Transportation Board to challenge freight rates. In determining if rates are reasonable or not the STB assesses if a railroad's profits fairly — but not excessively — reward investors and permit the railroad to meet long-term service needs. The board also considers the efficiency of management and a railroad's costs.

Shippers have contested prices only about 50 times since 1996, winning just half of the cases on which the board ruled. Some say that reflects the reasonableness of rates and the hesitation of both railroads and shippers to invite regulatory interference. Others say it reflects the hesitancy of shippers to commit perhaps many years and millions of dollars to battling deep-pocketed railroads.

Shippers and railroads can be like married couples who often squabble but can't split up and end up reaching compromises that keep the relationship going.

Farmers, in particular, have had a love-hate relationship with railroads that provide them with the only way to move massive harvests, University of Minnesota of Minnesota economic professor Jerry Fruin said.

"The railroad is the only way to get your grain to market and the railroad's got a monopoly position," he said. "So, you blame the railroad for everything and sometimes you're right to do it. But if you didn't have the railroad, you could not get your grain to market."

BNSF officials say the railroad is ready for this year's likely record harvest, offering more capacity for the movement of grain than ever before. The carrier also vows to be ready for winter too, delivering customers' freight to its destination as promised.