Thu, Nov 13, 2014|Sean Goldsmith

Complaining about a 53% gain...

Complaining about a 53% gain... Railroads gushing cash for Buffett... Buffett buys Duracell... Big numbers from Wal-Mart... A new addition to the Hall of Fame... One of our favorite resource opportunities today...

It was the only time I saw Porter complain about a 53% gain in six months...

In April 2009, he recommended railroad operator Burlington Northern Santa Fe (BNSF) in his Investment Advisory. Six months later, Warren Buffett's Berkshire Hathaway bought the entire company for around 40 times cash flow.

It seemed like an expensive purchase, especially for a price-minded investor like Buffett. But we knew the reason Buffett wanted the company: Inflation was coming and BNSF was well-positioned for that environment.

From the November 4, 2009 Digest...

In April of this year, I explained... that inflation was coming and that to survive, we would have to move into segments of the market that perform well during periods of negative real interest rates. I told my readers to buy three stocks in particular – three companies that own irreplaceable assets in the United States and whose debts were denominated in U.S. dollars.

Burlington Northern was one of these three stocks. As you know, Buffett seems to agree with me. He offered $100 per share for the whole company. We paid $65. That's a 53% return in six months. But you know what... I'm sorry to see the deal happen. It's not because I don't like making a huge return so quickly. It's because I know Buffett is right: Burlington is a phenomenal asset to own. Over the next 10 years, the value of its debts will be wiped out by inflation (negative real interest rates), while the dollar value of its irreplaceable assets will soar.

The business has high barriers to entry... And if you want to ship goods by rail out west, you almost certainly will deal with BNSF (or its rival Union Pacific). As prices rise with inflation, BNSF simply increases its rates.

The massive amount of domestic shale oil we're producing also proved a tailwind for BNSF. The company was instrumental in the recent boom in shipments of crude oil by rail in 2009 when it launched the first long oil train.

And shipments of crude by rail grew to a peak of 800,000 barrels a day last October, up from less than 100,000 barrels a day in 2010.

The company hasn't been able to keep up with demand this year... Earlier this year, it started buying and leasing new trains by the hundreds, and hiring new crew. It started building new track in mid-winter, atop snow-covered ground – a job BNSF would have normally stalled until warmer weather.

BNSF's other customers – mainly agricultural – are still facing major delays. Many switched to trucking to move their products. Trucking has similar rates to rail within a 500-mile radius... But the cost can jump by four or five times per ton if you go beyond that.

All of this has meant huge profits for Buffett. By the end of 2014, Buffett should earn back the $44 billion he originally invested in BNSF.

Five years after the $44 billion deal, BNSF is now Berkshire's biggest contributor to profits, accounting for more than 20% of the conglomerate's net income.

For the latest quarter, revenues increased to $5.9 billion, up $200 million from the same period in 2013. The overall year-to-date increase in revenues reflects a 3% increase in average revenue per car.

And earnings before taxes for the latest quarter increased 6% to $1.7 billion versus the same period a year ago.

Again, the oil boom and growth in industrial and agricultural shipments have helped BNSF. Since the Buffett purchase, BNSF's annual revenue has risen 57%... Net earnings more than doubled to $3.8 billion.

In his most recent annual letter, Buffett wrote...

Whatever you may have heard about our country's crumbling infrastructure in no way applies to BNSF or railroads generally. America's rail system has never been in better shape, a consequence of huge investments by the industry. We are not, however, resting: BNSF spent $4 billion on the railroad in 2013, double its depreciation charge and a single-year record for any railroad. And, we will spend considerably more in 2014.

Bloomberg estimates that BNSF is now worth approximately double what Buffett paid for it.

Elsewhere in the Berkshire Hathaway universe, Buffett announced today he would buy battery company Duracell from consumer-goods giant Procter & Gamble. As he said in a statement...

I have always been impressed by Duracell, as a consumer and as a long-term investor in P&G and Gillette. Duracell is a leading global brand with top-quality products, and it will fit well within Berkshire Hathaway.

Buffett is exchanging $4.7 billion of P&G stock that Berkshire owns in exchange for Duracell. P&G will recapitalize Duracell with about $1.8 billion in cash before transferring the company.

The deal allows Buffett to wind down his position in P&G... He has been slowly selling off stock since acquiring 100 million shares in 2008. And due to the swap nature of the deal, Buffett will avoid a large tax hit.

Duracell was responsible for 3% of P&G's $83 billion in annual sales. It controls about 25% of the battery market. P&G acquired the brand when it bought Duracell's parent company, Gillette, for $57 billion.

Under the leadership of CEO A.G. Lafley, P&G has divested its non-core businesses. It sold its Iams pet-food business in April for $2.9 billion. The company plans to sell as many as 100 other brands to streamline operations.

World Dominating discount retailer Wal-Mart reported earnings today.

Third-quarter revenues increased 2.2% to $119 billion, compared with $116 billion in the same quarter of 2013.

U.S. same-store sales were positive for the first time in seven quarters. Wal-Mart's new, smaller Neighborhood Market stores and international operations also did well.

The company also paid $1.5 billion in dividends and repurchased approximately 1.1 million shares (worth $82 million) in the third quarter.

But the standout number from Wal-Mart's earnings report was its free cash flow (operating cash flow minus capital expenditures). Extreme Value research analyst Mike Barrett offered his thoughts...

For the first nine months of the current fiscal year, Wal-Mart generated $7.2 billion in free cash flow. That's almost double what this World Dominator earned in last year's comparable period.

This cash flow gusher is an important part of the story that often gets overlooked with Wal-Mart. Free cash flow for each of the past five fiscal years has exceeded $10 billion. Management then returned this surplus capital back to its shareholders by reducing the share count 18% AND doubling the dividend rate.

Wal-Mart shares rose nearly 5% on the earnings. Extreme Value subscribers are up 86%.

In an update to subscribers yesterday, Dan closed out of the best-performing recommendation in Extreme Value history: over-the-counter health-product seller Prestige Brands Holdings (PBH).

Dan recommended buying PBH shares during the financial crisis in 2009. As he explained in yesterday's update...

When we first recommended Prestige, it was generating $60 million a year in free cash flow. Management expects it'll generate about $150 million this year (not counting $25 million in one-time costs related to its latest acquisition of Insight Pharmaceuticals). If you followed our advice, you've compounded your money at about 35% per year for five years, as of yesterday's close.

Dan's decision to close the position was due to the company's fast-growing debt load. Plus, it didn't pay a dividend or buy back shares. Extreme Value subscribers who took Dan's advice pocketed gains of 406% in five years. Prestige Brands Holdings now holds the fifth spot in the Stansberry Research "Hall of Fame" at the bottom of every Digest. Kudos, Dan.

As we noted in yesterday's Digest, Dan is super bullish on commodities today.

At his presentation at the Alliance meeting in the Dominican Republic, he presented a chart of the TSX Venture Index. We often call the Venture Index the "Dow Jones Industrials" of junior miners. As you can see in the chart below, it has gotten destroyed...

In his presentation, Dan noted the Venture routinely falls 44%-85%... And when it recovers, it's usually good for a 100%-200% gain. But some individual small-cap resource stocks can soar five... 10... 20... even 100 times off their panic lows.

That's the situation we're in today. Investors are indiscriminately selling resource stocks. Plus, at this time of year, we have the added pressure from year-end, tax-loss selling.

While the masses are running for the exits, Dan's conviction on resource stocks continues to grow. In particular, he likes a diversified resource company he calls "by far one of the best opportunities in the natural resource sector I've seen in my entire career." This company profits from a handful of different commodities like gold, uranium, coal, and potash... In other words, its fate isn't tied to the price of a single commodity.

Plus, the company's earnings (and share price) are about to soar – for reasons other than why we believe commodity prices are going to rebound...

It recently completed a deal that will pay huge royalties in the future... Dan says the deal will boost its revenue 10-fold. And he is 100% certain the company will start paying a "substantial" dividend in the next couple years... He thinks it will be a double-digit yield based on today's share price.

Considering today's yield-starved market, once word gets out that this natural resources firm is paying a huge dividend, we expect shares to skyrocket out of buy range.

As we explained, the stock is a great value today... But we think it could jump 50% higher any day now. And we won't feel comfortable recommending this investment at such an elevated price... even though we believe the upside is much greater than that.

If you're looking for a diversified way to invest in beaten-down commodities and purchase a stock before it starts paying out a huge dividend (which will send shares soaring higher by itself), we strongly recommend you consider buying shares of this company.

It's important to remember that commodities are cyclical. (You can learn more about that idea in this classic interview with resource-investing legend Rick Rule.) As Rick says, "the cure for low prices is low prices."

We're nearing the bottom of the cycle... And as we noted above, when small-cap resource stocks rebound, they can soar several hundred percent higher. In addition to Dan, Stansberry Research analysts Jeff Clark and Steve Sjuggerud are both bullish on commodities today, too. And when several of our analysts agree on something, it's usually a good sign...

For more details on Dan's favorite resource stock, click here.

New 52-week highs (as of 11/12/14): Apple (AAPL), Automatic Data Processing (ADP), Deutsche X-trackers Harvest China A-Shares Fund (ASHR), Berkshire Hathaway (BRK), CDK Global (CDK), National Beverage (FIZZ), iShares Dow Jones U.S. Insurance Fund (IAK), 3M (MMM), AllianzGI Equity & Convertible Income Fund (NIE), PepsiCo (PEP), PowerShares Buyback Achievers Fund (PKW), PowerShares QQQ Fund (QQQ), Constellation Brands (STZ), Sysco (SYY), TC Pipelines (TCP), Target (TGT), Travelers (TRV), and Alleghany (Y).

Another quiet day in the mailbag, where S&A Resource Report editor Matt Badiali helps answer a subscriber's question. With the market hitting all-time highs, are you getting complacent? Did the September selloff scare you out of your positions? What's hitting new highs and lows in your portfolio? Let us know how you're doing at feedback@stansberryresearch.com.

"It has probably been explained before, but what are junior gold miners?" – Paid-up subscriber Don Schmidt

Badiali comment: In my mind, if the company is still exploring or developing without generating any income, it's a junior.

Regards,

Sean Goldsmith

November 13, 2014