Elephant Hunting With Warren Buffett: 4 Potential Berkshire Targets

Includes: CLX, EXC, HSY, KMB
by: Investment Underground

By Larry Gellar

In a recent letter to shareholders, Warren Buffett wrote,

We will need both good performance from our current businesses and more major acquisitions. We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.

Prior to writing this, Berkshire Hathaway (BRK.A, BRK.B) bought railroad company Burlington Northern, and since then the conglomerate has acquired chemicals manufacturer Lubrizol (LZ). Burlington Northern has done well lately and recently announced plans to build a one-track bridge over the Missouri River. The Lubrizol deal is not completely done yet, but the remaining items that need to be taken care of are quite minor. In fact, 95% of the votes received in regards to the transaction were in favor of it.

Although Lubrizol’s recently reported earnings per share were not significantly higher than a year ago, this is not that surprising given the state of the economy. Additionally, revenues were up significantly which is a good sign because it should not be difficult to reduce costs if need be. One interesting thing about the Lubrizol transaction is that Lubrizol’s top executives will be stepping down once it’s complete. On the other hand, Berkshire Hathaway surely has some capable people in mind to take their place.

So what will the Oracle of Omaha do next? Let’s take a look at 4 companies that could certainly be poached by Warren Buffett in the near future. Keep in mind that Berkshire Hathaway will probably target companies with market capitalizations between $10B and $40B. We also don’t think the conglomerate would be interesting in adding a technology company to its portfolio.

Kimberly-Clark Corporation (NYSE:KMB) – This paper product maker is up since January but has seen quite a bit of volatility this year. Regardless, the company is attractively valued with a P/E ratio of 15.42. Note that this is lower than other competitors in the personal products industry such as Energizer (NYSE:ENR) and Procter & Gamble (NYSE:PG). Shareholders also like the company for its dividends – note that the yield right now is a high 4.20%. There are still more reasons to like this stock.

With a beta of 0.39, this could be an important addition to an overexposed portfolio. Although a poor economy will certainly hurt Kimberly-Clark, the low beta ensures that the stock will not swing wildly downwards during market panics. More specifically, people will still be buying Kleenex tissues and Cottonelle toilet paper regardless of economic problems. More statistics worth consulting for Kimberly-Clark can be found here. As one can see, the DSO (days’ worth of sales still to be received) has been fairly consistent for KMB. Additionally, accounts receivable have moved in a similar direction to revenue. What these two things mean is that Kimberly Clark has not done anything unusual to boost prior revenue – if they were, we would begin to think that future earnings might not be so good.

Clorox Corporation (NYSE:CLX) – The most recent takeover talk for this stock has centered on Carl Icahn, and as a result the price has skyrocketed. The corporate raider has been rebuffed though as Clorox’s board doubts Icahn’s ability to finance such a transaction. The board of directors has also stated the offer undervalues the company. In fact, shareholders across the country are questioning what the point of a hostile takeover would be anyway.

The consensus overall is that current management has done a fine job. In line with this, the company has instituted the infamous poison pill to prevent a takeover for the time being. The company’s products range from its ever-popular bleach to Hidden Valley salad dressing, so the company could be a valuable target in the eyes of Warren Buffett. Also, Clorox now produces natural cleaning products and health/beauty aids, which could be significant as people become more environmentally conscious.

Another interesting point is that the stock price increase from Carl Icahn’s bid has thrown certain valuation measures a little out of whack. Note that Clorox’s P/E ratio and PEG ratio are now a bit inflated compared to Colgate-Palmolive (NYSE:CL) and Procter & Gamble. P/S ratio is still low though at 1.77, which makes sense in light of a possible takeover. Specifically, it’s easier to reduce costs than to raise sales, so the idea on the part of someone like Icahn or Buffett might be that they would be able to ride the strong sales while finding their own ways to cut costs.

Exelon Corporation (NYSE:EXC) – This stock has seen strong gains since the beginning of the summer. While some areas have been experiencing an unusually warm summer, the market has always been aware of increased profits during this time of year, so this will probably not affect the stock price too much. More likely what is happening is that investors feel good about the utility industry as a whole.

There are a variety of new energy sources that many feel will lead to increased profitability for this sector. Shareholders also love EXC for its high dividend yield, currently 4.70%. Regardless, some shareholders question the company’s ability to keep up its strong revenues, and Exelon will likely be a victim of rising costs in the future.

Despite this, the stock’s valuation measures are certainly enticing – P/E is currently 11.75. (Note that smaller rival Ameren (NYSE:AEE) is currently trading for 63.9 times earnings). FirstEnergy (NYSE:FE) has made significant price gains lately. Other measures in Exelon’s favor include operating margin and gross margin – 24.02% and 37.66% respectively. In regards to the recent earnings report, chairman and CEO John Rowe may have summed it up best when he said, “We have again delivered a quarter of solid operational and financial performance.” I think the Constellation (NYSE:CEG) merger is likely to go through without a hitch. Management also pointed out strong performance from its nuclear division despite running into some obstacles.

Hershey Co. (NYSE:HSY) – This famous chocolate maker has been on the rise for quite some time now. With net income nearly triple what it was last year, the company’s strength cannot be doubted. Many analysts have the price for these shares going up to the low-60s, and at least one even has it as high as $67. Additionally, the most recent coverage for this company was Argus’s upgrade from Hold to Buy. Regardless, there are certainly some questions to be answered on the valuation front. Specifically, HSY currently has a P/E of 21.44, higher than rivals Kraft (KFT) and Nestle (OTCPK:NSRGY, [[NSRGF.PK). (Note that Nestle’s P/E is currently only 5.03).

At 2.63, the PEG ratio is extremely high for Hershey as well. The reason for this is that Hershey’s future earnings growth is questionable. The company’s business is currently centered on U.S. and Canada, and many analysts believe that the future of Hershey will depend on its success in emerging markets like India and China. Despite this, Hershey raised its outlook for future earnings at the earnings conference call. As mentioned in this article, many people see chocolate as the “affordable luxury.”

Also, like other food companies, Hershey may be negatively affected by rising supply costs in the future. HSY plans to offset this problem though by increasing prices for many of its products. This will probably be successful since its products are already quite cheap.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.