In searching for global investment prospects that might interest Warren Buffett we have established that newly allocated capital would most likely pursue companies that pay a dividend and make products or operate in sectors that are well established and have a high level of certainty to exist decades into the future. This is basic to "my pal Warren's" investment philosophy, and there is no reason to think this will change.
In Part 2 of this series we then examined the size of a potential investment settling on a general range from $4 billion to $24 billion.
Our next step was to examine markets and locations Buffett might focus on which led to the exclusion of South America, excepting Brazil, all of Africa, and central Europe based on the need for long standing, well-established liquid markets and political stability. It is also clear from past investments that he will not invest in companies that have not been around for decades.
There are other factors that Buffett has made very clear have an impact on his decisions. He requires any company he gets involved with to have a strong management team. He looks for companies that are shareholder focused having a high return on equity and return on assets increasing the book value year over year.
He looks for situations that should be able to produce 15% growth for the next five years. He prefers companies that have strong cash flow and and a large float. He prefers buying below or close to book value without paying a high price for intangibles. Finally, he will not look at companies that have heavy R&D burdens and must regularly invent something to remain competitive.
Berkshire Hathaway currently owns CE Electric in the UK through its subsidiary MidAmerican, a utility holding company. It is quite possible that Buffett might choose to expand a successful existing operation. In particular, one that has the oversight of his protege' and possible successor, David Sokol.
The first stock I came up with is National Grid PLC (NGG) the largest utility in the United Kingdom. It is traded on the NYSE, currently near its 52-week low of $37.28, closing yesterday at $37.81, 33% off its high of $56.59.
While the company serves 52 million people in England and Wales, like MidAmerican it also has holdings in the United States, where it actually gets the larger share of its earnings. If Berkshire were to acquire NGG it seems like a good fit with MidAmerican given that both have holdings on both sides of the Atlantic.
NGG meets most of the other criteria as well. Besides trading at recent lows, it has a valuation of just under $20 billion, it has a strong balance sheet with good cash flow and $2.9 billion in cash (14.6% of capitalization) trading at forward P/E of 8.9 and dishing out over a 9% dividend yield. The dividend payout ratio of 0.68 should be sustainable given the cash flow and cash on hand.
As stated, "my pal Warren" is looking for a high return-on-equity and NGG delivers here to serving up a 36.6% ROE. I think the case has been made, but I will continue because I also like the PEG ratio of 1.25, the price-to-sales around 1.0 and the price-to-cash-flow of 4.77, less than half the stock market average.
In addition to all these points, keep in mind that if Berkshire acquired National Grid the 9% yield would halt, allowing the cash to go straight to the bottom line of Berkshire. Because they both have similar holdings, there would be great savings in a merger, again being accretive to the bottom line.
There is no telling what Buffett is going to do. However, given the depressed Euro and all the opportunities at hand I have not yet found a more enticing story than NGG. I should also disclose that no matter what Buffett does, I may buy some NGG myself, for the yield and stability a utility offers over the long run.
If you want to review this series from the beginning the following are the first three posts.
- Serious Money: Buffett Looking Beyond Our Borders
- Serious Money: Buffett Looking Beyond Our Borders -- Part 2
- Serious Money: Buffett Looking Beyond Our Borders -- Part 3
Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture and planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: He own shares of BRK.B.