Is Warren Buffett Missing Something?

After watching the HBO special on John Adams, based on David McCullough's book, I decided to read the book McCullough won his Pulitzer Prize for: Truman. It is a wonderfully great and very informative book. I realized while reading this book that Truman reminded me of another person - Warren Buffett. Both are down-on-the-farm types who lack pretense and place great importance on straight talk, honesty, and integrity. You cannot help but like and admire these men.

Obviously Buffett is a great investor and has built Berkshire Hathaway (BRK.A) into a financial powerhouse. Although BRKA is down around 9% YTD, it has a very admirable long term record. Berkshire's balance sheet, as well as its dominant position in insurance and reinsurance will insure (pun intended) profits far into the future. Buffett got my attention a few years back when he took a big position in PetroChina (PTR) and more recently when he got into railroads. He really got my attention when he took a position in one of my favorite stocks, ConocoPhillips (COP). I was like, wow, this guy gets it! He's thinking peak oil and he's gonna make a ton of money! So, why not buy some Berkshire Hathaway "A" shares?

Then boom, the Wrigley (WWY) deal happened. Huh??

Buffett seemed to be on-board with peak oil realities. The railroads and energy investments made a lot of sense to me. But Wrigley? A company that makes gum? I know, I know, it's been around forever, has a great brand, and is just the kinda deal that has made Buffet billions in the past. But hello, $80/share at 32-time earnings ($23 billion total) for a gum company when we have oil at $120/barrel, food inflation, and a slowing economy? I hear Wrigley's directors took only 1 hour to approve the deal. I am not surprised!

Reading press releases, I see that Berkshire will only take a small $2.1 billion minority stake in the Wrigley subsidiary once the deal is done. From what I can discern, Berkshire was basically a source of financing for this deal - some $4.4 billion of subordinated debt. So, I suppose it all works out great for Berkshire shareholders (and even better for Wrigley's).

Meanwhile, I decided against buying Berkshire Hathaway stock for myself because I am a bit unsure that Buffet believes in peak oil. I thought he did. But after hearing him speak on CNBC once about it, now I am not so sure. I think he'd have done better for Berkshire Hathaway shareholders by increasing his stake in energy. He could have increased his stake in ConocoPhillips, or perhaps bought up a big chunk of a North American natural gas producer like Chesapeake Energy (CHK). Heck, buying some railroad like Norfolk Southern (NSC) would have made more sense to me. I think Berkshire is too exposed to the consumer and housing markets with the bricks and carpets and what-not. Buffet needs to get back to his peak oil friendly investments before I'll jump into Berkshire.

But who am I to second guess Warren Buffett? I just wish he'd use his influence, the bully pulpit that CNBC and the Nightly Business Report give him seemingly every day, and yes, some of his huge fortune, to help educate the US about the impact of the coming oil crisis if the US continues to do nothing to prepare for it. Buffet could be a huge asset if he would lend his support to the adoption of a real US energy policy. I bet Harry Truman would.

Comments

[fxtrader07]

i do not get your point. if you believe in peak oil - well, then invest accordingly - into oil stocks, drillers, oil service companies etc. but what has that to do with berkshire hathaway? would you really buy berkshire, when they own 20% of exxon and 50% of cheasapeake and perhaps some oilsand companies and 10% of slb?? doesn't make any sense imho.

btw, peak oil does not necessarily mean everlasting fat profits for oil companies. replacement costs for diminishing oil fields can rapidly add up. oil companies usually do not have the "moat" buffet likes. if you think oil makes big profits 5 years from now, think twice. they just START to expand their exploration and development budgets. so far, they could exploit the high prices just with existing oil fields. going forward, the costs will rise quickly eating away a lot of current windfall profits.

[BrianPursley]

"We are producing 86m barrels per day or so, more than ever produced." -- Warren Buffett

oilismastery.blogspot....

[The FItzman]

fx: the point i was trying to make is: are people really going to have disposable income for gum when their energy costs are rising and food inflation is going through the roof? that's one of the realities of peak oil - economically, the majority of people on are going to have a very very hard time making ends meet. why then was i looking at berkshire in the first place? well, i wanted a more diversified approach than simply investing in "energy" and i like the insurance/reinsurance business of berkshire as well as their balance sheet. that said, i did not buy BRKA because i am not sure they "get it" when it comes to peak oil, imho. i think they have too much exposure to the consumer, who, i believe will continue to struggle mightily in the years to come (until the US develops an energy policy). also, i respectfully disagree wrt to energy company's earnings...i think they will be very very profitable for many years to come. people need gasoline and natural gas alot more than they need Wrigley's doublemint gum.

[The FItzman]

pursley: your bloggin website is *awesome*

yes, buffet is right that production is at an all-time high. and, i agree it is still rising and will continue to for a few more years. yet, so is demand. the real issue is supply/demand balance. the CEO of ConocoPhillips questioned whether man will ever produce more than 100 million BPD, yet the EIA is projecting 150 million BPD demand in the not too distant future. that is quite a disconnect...

[teriyaki]

And when the Mars family wants to monetize some of their Mars, Incorporated holdings, I suspect Warren will be there again. Mars and Wrigley have survived depressions, world wars, stagflation and oil spikes. Just imagine a couple of billion Chinese and Indians chewing gum.

I suspect Warren is well aware of the future of oil and has decided instead to invest in railroads that will be transporting coal for decades to come and which feed his power company. By the way, he also bought Marmon, which makes rail cars. If you want to invest in ConocoPhillips, then invest in it directly.

[DonSuper]

Nice article, and I agree with several of your points. But you need to do some more DD. Buffett does believe in peak oil:

youtube.com/watch?v=GW...

However, I think the point fxtrader makes is valid, costs will escalate very fast for traditional energy companies. Munger seems to believe even more in peak oil. In the ASM he said solar and wind are the only viable solutions. And BRK utilities are investing a lot of money in wind turbines, Buffett and Munger even had to ask GE to please sell to them, since demand is outstripping supply for wind turbines currently.

On the Wrigley deal, they got a discount from the purchase price, and is a company Buffett has admired for a very long time. And even with oil at $300, people will probably continue to buy candies and chewing gum.

[The FItzman]

SuperDon: yup, that youtube video is the segment i saw on CNBC and mentioned in my article. what i attempted to point out is that if Buffet truly believes in peak oil, the investment in Wrigley puzzles me. i believe in peak oil, and i must say that investing in chewing gum might not be my last choice, but it's definitely toward the bottom of the list. i can't say that carpet or bricks would be near the top either. now, railroads, or ConocoPhillips is another story - it's in the right industry segment, and its earnings and stock price are moving in the right direction. but like i said, who am i to second guess buffet, and, as i also pointed out that it's MARS who really bought Wrigley's, not Berkshire. Buffet is the financier and will take a minority stake in the subsidiary. still, i just gotta think there are better investments for BRKA shareholder's than chewing gum. the other point i tried to make was buffet has given alot of money to worthy causes. if he believes in peak oil, then surely he must know that it is absolutely the biggest national security threat to the US. in that case, why doesn't he use his influence, power, and money to prod our incompetent US government to 1) acknowledge peak oil, and 2) adopt a real energy policy to deal with it. he seems content to make money while waiting for the US to go down the tubes. i think harry truman would have given up the money and done what is right for the country. it's just an observation, but it was the main point i was attempting to make with the article. thanks for your comments.

[Nate C]

Peak oil is a scam thought up by Shell and the other oil companies to create artificial scarcity. It has worked perfectly as we now see $120 oil. The truth is that the world has trillions of barrels left. It is that the oil companies refuse to invest in new projects like the trillion+ barrels beneath Colorado and offshore Alaska. Forget ANWAR.

[Chris R.]

I respect your opinion. And yes, they are paying a hefty premium for Wrigley. But there is no doubt in my mind it is a brilliant deal. Wrigley's profit margins are better than most oil companies! Wrigley is in an industry, where they can easily pass along prices to consumers. People will continue to chew gum and mints. Gum, is also in basically a industry with no generic brands, and is virtually a duopoly. Wrigley, is by far the best brand in the world, in relation to where it is now, to where it will be 10 years from now, relative to its industry. It is a brilliant deal. I'm more excited that Berkshire will have a 10% stake in Wrigley than anything. There is so much room for growth for Wrigley. It can grow 10% annum for the next 20 years, if the trends hold true, and the East wants to continue being like the West.

[RogerScott]

The last I read was that the price BRK was to buy Wrigley was less than that paid by Mars and the BRK was not disclosed. Also, I have no news about the interest rate BRK is receiving. So, I think the deal needs to be considered as a package. Since we know neither the price of the debt nor the equity, I don't know enough to make a judgment. I don't know how someone else can unless he know the terms.
Wrigleys is an excellent company and is probably worth 30P/E.

[bishk1301]

The natural resources energy companies are endangered species at high oil prices. All around the world they are being milked for taxes.What about 90% tax rate for oil above, let's say 100$ a barrel. That will not happen to consumer companies

[GregT]

Wrigley is the perfect inflation protection. Their cost don't go up nearly as much as other types of "candy" like the core products that Hershey and Mars offer. Think about the costs of a pack of gum versus a candy bar for example. Yet, gum "competes" with more inflation prone candy at the check out counter. Thus, Wrigley has been able to increase prices much more than was necessary to cover their own cost increases because Hershey and Mars had to raise prices. Thus, Wrigley is actually a beneficiary of commodity inflation.

I had owned Wrigley and yes I'm happy that we got a nice premium for it in this deal. But quite honestly, I would have rather kept my shares for another 20 years. There are very few companies with the kind of business they have.