Seeking Alpha
Research analyst, value, small-cap, retirement and income
Profile| Send Message|
( followers)  

In May 2008 Warren Buffett gave a little noticed interview to the German weekly Der Spiegel in which he mentioned another German stock Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) held besides Munich Re (OTCPK:MURGY) (OTCPK:MURGF):

SPIEGEL: Munich Re was the first German company in which you invested directly. Another investment for posterity?

Buffett: We have two different categories at Berkshire Hathaway. There are 76 companies that we own permanently. And then there is a trading inventory. Munich Re is part of the second category.

SPIEGEL: Have you met with the executives at Munich Re?

Buffett: Yes, two years ago. We also bought shares in another German company…

SPIEGEL: Which company?

Buffett: I'd rather not say. Those shares are also part of our trading inventory and can be quickly sold again.

Of course it would be interesting to know which stock he referred to - and I believe it is not so difficult to find out.

There were only a few companies in Germany that fulfilled the most important criterion for a Buffett investment: size. As Buffett was able to keep secret this holding, it is impossible that he reached the 3% holder status which would have triggered a public report according to German regulations. So the minimum market cap of the secret holding at that time must have been about $5 billion, probably even more, because Buffett would probably not invest less than about $150 million. This means that only the 30 members of the most important German index, the DAX, would qualify.

Second, it must have been a "Buffett business": a stable, predictable business with a long history and good returns on capital.

In 2008, the DAX index had the following members:

Deutsche Lufthansa

Airline

Continental

Auto and truck parts manufacturing

BMW

Automobiles

Daimler

Automobiles

Volkswagen Ord.

Automobiles

Volkswagen Pref.

Automobiles

Commerzbank

Bank

Deutsche Bank

Bank

Deutsche Postbank

Bank

Hypo Real Estate

Bank

BASF

Chemicals

Bayer

Chemicals & Pharma

Beiersdorf

Consumer products & Cosmetics

Henkel

Consumer products & Industrial adhesives

Siemens

Engineering and electronics conglomerate

Deutsche Börse

German stock exchange

Fresenius Medical Care

Healthcare

Linde

Industrial gases and engineering

Allianz

Insurance

K+S

Materials

Munich Re

Reinsurance (known Buffett holding)

METRO

Retail

Infineon

Semiconductors

SAP

Software

Adidas

Sports clothing and accessories

Salzgitter

Steel

ThyssenKrupp

Steel

Deutsche Telekom

Telecommunications

E.ON

Utility

RWE

Utility

We can probably exclude all businesses in the automobile, materials, software, semiconductor, steel, airline and financial industries as well as other capital intensive industrials like the utilities, Telekom, Siemens, BASF and Linde. This leaves us with the stocks from the insurance, healthcare and consumer products sectors. I would also exclude Metro, which has very low profit margins compared to other retails stocks Buffett already holds like Wal-Mart (NYSE:WMT) and Tesco plc (OTCPK:TSCDF) (OTCPK:TSCDY) and was far from cheap at that time. In May 2008 Allianz still owned a troubled bank, so I would exclude this stock as well. Healthcare has never been Buffett's forte - and in Europe he already owned Sanofi (NYSE:SNY) at that time. If he had liked the dialysis industry and Fresenius Medical Care (NYSE:FMS), he probably would have bought Davita (NYSE:DVA) much earlier. This leaves us with three stocks: Adidas (OTCQX:ADDYY), Beiersdorf (OTCPK:BDRFY) and Henkel (OTCPK:HENKY) (OTCPK:HENOY). Adidas was still close to its highs in early 2008 and not exactly cheap, Beiersdorf has never been cheap at all and traded at 20 times earnings. On the contrary, Henkel traded at 10 times expected earnings - which was extraordinarily cheap compared to historical standards. In the same period the Tweedy Browne Value Fund and other renown value investors also established a position in Henkel. Warren Buffett knows the company very well, being a direct competitor to Procter & Gamble (NYSE:PG).

So I am quite certain that the secret stock holding in Germany is Henkel.

Henkel AG

Henkel AG & Company, KGaA is a manufacturing company making various chemical products including detergents and adhesives, with brands and technologies for consumer and industrial businesses, that enjoys a very strong position in the emerging markets. It was founded in 1876 and operates in three business areas:

  • Home Care with household cleaning products such as laundry detergent and dishwashing liquid,
  • Personal Care with beauty and oral care products such as shampoo, toothpaste, hair colorants and shower products, and
  • Adhesives with adhesives, sealants and surface treatments for consumer and industrial purposes.


(Click to enlarge)

Henkel has been a family-run business since the beginning and started very early to expand internationally. Today about 80% of its about 47,000 employees work outside of Germany.

The following charts show stable margins and high returns on equity:


(Click to enlarge)


(Click to enlarge)

The company is growing steadily in all its markets, even in Western Europe (at low single digits), with the majority of growth coming from Africa/Middle East and Latin America, and targets an annual EPS growth rate of about 10%.

Business Model

When Henkel presented its 2012 roadmap in 2008, the company could still not foresee the deep recession that would start shortly afterwards. Key objectives were: organic sales growth rate of 3-5%, EBIT margin (2012) of 14%, annual adjusted EPS growth of about 10%. In spite of the severe headwinds Henkel delivered or even over delivered on all these goals, which is a quite remarkable achievement. So how did they do this?

The following slide is from the latest company strategy presentation:


(Click to enlarge)

It is quite easy to spot that what seems to matter most here is execution. Henkel is a champion of operational excellence. The company is all about optimization. Until 2016 it wants to reduce manufacturing sites by 11%, suppliers by 40%, expand e-sourcing to over 10% and drive profitability through standardization and complexity reduction along the entire value chain. The goal is to continue to grow adjusted EPS by about 10% per year until 2016.

Henkel has clearly understood its strengths. To avoid commoditization, a chemical company has only very few levers to pull, after having created its portfolio of products:

  • it can try to strengthen its brands to differentiate its products from its competitors
  • it can try to be as close to customers as possible in order to adapt to their needs faster and better than its competitors
  • it can try to lower production costs in order to beat its competition on price
  • it can try to create a strong business culture of innovation and operational excellence in order to capture the most talented people.

And this is exactly what Henkel does best. Just read the following strategy statement:

We want to leverage the full potential in our product categories in order to gain market shares and thus to outperform our competition by:

- actively managing our portfolio,

- strengthening our top brands,

- launching powerful innovations, and

- focusing on our customers and consumers.

To capture the potential for accelerated growth and increased profitability in our categories, we have segmented them into three clusters:

Core, growth and value

In our core categories, we will continue to invest in strengthening and expanding our leading positions. In our growth categories, investments will fuel disproportionately high growth of existing and new segments. In our value categories, investments will be tailored to maximize our profit potential.

Strengthening our brands

We will continue to focus on our top brands such as Persil, Schwarzkopf or Loctite while further consolidating our brand portfolio. By 2016, our top 10 brands are expected to generate approximately 60 percent of total sales (2012: 44 percent). To achieve this, we will expand our global brands and support our top brands with strong innovations and focused marketing investments.

Innovation and customer focus

A consistent innovation process, driving trendbased innovations that are developed to meet the individual needs of our customers and consumers, will help us to reinforce our innovation leadership. By capitalizing on sustainability and on trends such as accessible luxury or convenience, we will ensure that our products remain highly attractive and relevant for our customers and consumers.

The company is still controlled by descendents of the founding family and clearly managed for the long term. Having done extremely well even during the recession years and the EU crisis period indicates that the business model works and will probably continue to do so (or even better) in the years to come.

Personal Experience

A few years ago I worked for one of Henkel's competitors, a very small and agile company in the adhesives sector that was proud of its close proximity to its customers. We frequently adapted products to very specific industrial processes, believing that this would make our client relationship rather sticky and give us some pricing power. However, Henkel managed to take over many of our clients. Especially frightening for us was that it not only managed to compete on price and quality (which we expected them to do easily, given the huge scale advantage), but even on added services and proximity to our customers. Henkel had products of different quality levels and adapted them easily and quickly to the specific needs of our clients.

This experience perfectly fits other accounts of operational excellence in all of Henkel's business areas. E.g. the company is said to have one of the best performing sales networks in the emerging markets (sales growth rates seem to confirm) and to be one of the most innovative companies in its field when it comes to marketing and brand strengthening.

All in all, I strongly believe the company will deliver once again on its targets stated in the above mentioned strategy presentation.

Stock

Henkel preferred shares are publicly listed since 1985, the ordinary shares since 1996. Both share classes are predominantly traded on the Xetra electronic market of the Frankfurt Stock Exchange:


(Click to enlarge)

In the USA, investors are able to acquire Henkel preferred and ordinary shares by way of stock ownership certificates obtained through the Sponsored Level I ADR (American Depositary Receipt) program. Depositary Bank is the Bank of New York. The number of ADRs representing ordinary and preferred shares outstanding at the end of 2012 was about 3.5 million:


(Click to enlarge)

The ownership structure of the preferred shares (the significantly more liquid class of stock) shows a free float of 100 percent, while members of the Henkel family own 53.65% of the ordinary shares.

As the preferred shares are more liquid and included in the German DAX index, they usually trade higher than the ordinary shares, in spite of enjoying no voting rights and only a non materially higher dividend.

Valuation

While I think the stated 10% EPS growth objective will likely be achieved, the stock has currently priced in probably even more than this, trading at 21 times expected earnings for 2013. As the German stock exchange is full of cyclical businesses (many related to the huge automobile industry), the few non-cyclical ones are very rarely available at reasonable prices and never during bull markets. Investors interested in establishing a position in Henkel need to prepare for a long wait. However, being that the company is a strong player in the industrial adhesives market, during strong downturns, when too optimistic views suddenly invert, it is often perceived as cyclical, providing nice entry opportunities.

Source: A Stock Warren Buffett May Secretly Hold