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Berkshire, ExxonMobil, And A Valuation "Tail"
Berkshire, ExxonMobil, and a Valuation Tail
By Bud Labitan
Recently, Berkshire's portfolio shows a new position of 40.1 million shares valued at $3.4 billion in ExxonMobil (NYSE: XOM). ExxonMobil is the largest of the vertically integrated oil companies. It is also the second largest publiclytraded corporation in the world by market cap and revenue. With a market value of $417 billion, ExxonMobil has longevity, and it pays a 2.7% dividend yield.
In his 2011 shareholder letter, Buffett wrote: "A century from now... ExxonMobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions..."
Recent investments in shale and natural gas production indicate that ExxonMobil will be earning cash for its shareholders for the next several decades. It has invested more in natural gas. ExxonMobil completed a $30 billion project to develop the world's largest natural gas field. This field is located in the Persian Gulf state of Qatar. It is expected to boost the company's gas production and make ExxonMobil the world's largest natural gas producer. The North Field is expected to contain 900 trillion feet of natural gas. ExxonMobil also agreed to a joint venture with Royal Dutch Shell and Chevron to construct a liquefied natural gas facility on Barrow Island off the coast of Australia. Chevron will own 50% of the facility while Shell and Exxon will each have 25%.
Exxon strengthened itself in Natural Gas by the acquisition of XTO Energy (shale). XTO has a strong hold in shale, including the Marcellus, Haynesville and the Bakken basins.
XTO drove a surge in U.S. fuel output by exploiting fracking. XTO Energy's resource was reported to consist of 45 trillion cubic feet of gas. The XTO acquisition complimented Exxon's presence in other shale areas such as the Piceance Basin in Colorado. The company has been producing natural gas from the basin for more than 50 years and it has a reported estimate of 1.5 trillion barrels of inplace oil shale resources.
So, what about an estimate of ExxonMobil's stock value?
Here, I propose to you that ExxonMobil has created a sustainable competitive advantage that I did not appreciate prior to reading about Buffett and Berkshire's recent investment.
If you do a simple one or two stage DCF valuation estimation based on 10 to 15 years, a big piece of value is missed. I argue that ExxonMobil has created a valuable advantage for itself and its shareholders that stretch the Excess Return Period (yrs) to at least 20 years, and maybe more.
So, here is my argument simplified. For the sake of simplicity and estimation, let's take a look at the DCF estimate posted at Valupro.net
Is it reasonable? Did Buffett and Berkshire get a good bargain?
http://www.valuepro.net/cgi/valuate.pl?required=stock_symbol&stock_symbol=XOM
Here is one view to consider. For the sake of conservatism, we may drop the growth rate to 5% at their model. However, I argue that, in view of long rage planning and investments in shale and natural gas, you may also conservatively extend the Excess Return Period (yrs) to 20 years. This would result in an estimated intrinsic value of about $135 per share.
If Buffett and Berkshire purchased XOM at an average cost of $85, they got a bargain of around 37% in a large business leader.
Over time, the world economies will demand more energy production. In consideration of ExxonMobil's added durable competitive advantages, the "Yield On Cost" of this investment may prove to be even more profitable.
* * * *
Bud Labitan is the author and editor of "MOATS : The Competitive Advantages of Buffett & Munger Businesses." Moats discusses the competitive advantages of 70 Berkshire Hathaway businesses and it is targeted towards business school students, investors, and business managers. He is also the author of other books on investment decision framing and decision making. These include the "1988 Valuation of CocaCola", "Price To Value", "Valuations", and "The Four Filters Invention of Warren Buffett and Charlie Munger."
Disclosure: I am long XOM.
Yield On Cost Is Warren Buffett's CocaCola Magic
Yield On Cost Is Warren Buffett's CocaCola Magic
By Bud Labitan
A nagging feeling came over me while finishing this latest book with the help of my friend Scott Thompson. While I was happy with our new book "1988 valuation of CocaCola: Estimated Intrinsic Value," I felt like we did not fully explain the importance, value, and power of that bargain purchase. How could a man who wrote a book on Buffett and Munger's "Four Filters Invention" investing process, "Price To Value," and "MOATS," fail to understand the power of this purchase?
I started emailing friends and doing simple, somewhat crazy math estimations to see if I could find the truth myself. I am even embarrassed to say that I sent an email to Mr. Buffett with flawed math. Friends, with their good intentions, would tell me to return to "Time Value of Money" calculations, and learn those well. They would say something like, CocaCola is a great company with nice rate of returns and steadily increasing dividends, but it only gives you a range of 911% returns.
I would think, "How can that be?" "My investing heroes, Warren Buffett and Charlie Munger" always smile and resist cries from shareholders to sell the the CocaCola, KO shares. What I rediscovered is; the Magic of Warren Buffett's and Charlie Munger's 1988 purchase of CocaCola stock is: "YIELD ON COST."
Think of "Yield On Cost" as "Yield Relative To MyCost" or "The Yield received PerShareCost" or Yield / PerShareCost. No, those are not typo errors. I intentionally removed the spaces. It can be described as "yield / cost per share."
I sort of backed into finding that bond concept. My initial thinking went something like this: Think of it as getting an average of a $570,000,000 dividend every single year from that principal investment cost of $1.299 Billion in CocaCola. If you multiply $570,000,000 x 24 years, we get 13.15 billion. Add this 13.15 to the 1.29 billion principal, and we get very very close to the current value of $14.44 billion in BRK's ownership of CocaCola.
Bear with me on this basic "noncompounding" math below and you will see how Warren received about $570,000,000 for every year of that his principal investment of $1.299 Billion in CocaCola. Keep in mind, I was trying to stay with simple math. Look at their cost of 1.299 billion, 0.44 rate of average annual return, and 0.57, which represents my assumption of $570,000,000
0.57 x 23 (23 because of end of year adjustment), Plus ½ of year of approximately 0.29, so 1.299 + 13.43 = 14.73, is darn close.
I found an old 2010 article that said: When Buffett began purchasing stock in Coca Cola in 1988, many Wall Street analysts were skeptical because it seemed only a matter of time before other beverage companies would take away its market share. In addition, CocaCola had reported earnings down 2 percent from the previous year, and had an unimpressive P/E ratio of between 14 to 19. At the time, shares of KO were worth between $35 and $45. The stock has split three times since then, and is now priced in the $60 range. By 1995, Buffett owned 100,000 shares of the company with a cost basis of roughly $1.2 billion. As of September 2010, Buffett's unrealized gains on KO were $10.4 billion. This comes out to a 766 percent increase in value. This is one of Buffett's greatest investing triumphs. Google that article above.
Using the same simple logic... When $2 grows into $6, no matter the duration, we say 6/2=3 and 3*100 = a 300% increase in value, no matter if it takes 1 or 900 years. In this simple math, duration is irrelevant.
Now, by 2013, KO stock had split 4 times and BRK has 400,000,000 shares with a cost basis of $1.299 billion, and a market value of $14.5 billion. Forget for a moment that it took about 24.5 years to get there. Furthermore, suspend the idea of splits because we know the cost and the present dollar value that is already splitadjusted.
When 1.299B grows to 14.500B, we say 14.500/1.299=11.16 and *100 is a 1,116% increase in value. Again, in simple math, how much can we allocate to each year? Let us use a simple average and make it even. Now, a simple rough average of 1116/24.5years=45.55% approximate gain per year, and this does not even count the value of the dividends.
(NEXT, I GET A LITTLE THEORETICAL…) Let us add in the lowball but fair figure of 5 billion for all the dividends (with no major Time Value of Money adjustments). When 1.299 grows to 19.500, we say 19.500/1.299=15.01 and *100 is a 1,501% increase in value. Now, a simple rough average of 1501/24.5years=61.27% gain in value (on top of the 1.29Billion) per year, or around $570,000,000 million each year.
Now, I felt like I was getting close to why Warren Buffett's 1988 bargain purchase of KO is so powerful and important. Next, I got a nice email from Richard Griebe. Richard said he was starting to see the way I was looking at this investment in KO. "Rather than looking at the compounding of value over time, you are looking at the average annual increase in value against the original $1.299 B invested. So, if I think of the original stock purchase as buying a bond instead, that "bond" has paid a continuously increasing interest rate over time. Following your computations to where you included dividends to calculate an average 61.27% gain per year or, in my bond model, Warren bought a bond for $1.299B that has paid on average coupon of 61.27% annually. This is a feat that would make gangsters jealous… Thanks for patiently discussing this fascinating case study with me.
With Richard's positive words, I felt encouraged, and I thanked him. Next, I kept searching the internet for this "yield" concept that I was looking for. I was looking for Warren Buffett's effective yield per share compared to my yield per share. I stumbled upon the concept of YIELD ON COST.
WOW ! That is it ! Yield per "Share Cost"
Did I realize that 1.299b/400m shares = Warren Buffett's $3.25 per share cost per share of KO? Did you?
From the website Investopedia: www.investopedia.com/terms/y/yieldoncost.asp Yield On Cost, YOC is defined as: "The annual dividend rate of a security divided by the average cost basis of the investments. It shows the dividend yield of the original investment. If the number of shares owned by the investor does not change, the yield on cost will increase if the company increases the dividend it pays to shareholders; otherwise it will remain the same.
To calculate yield on cost for a stock, an investor must divide the stock's annual dividend by the average cost basis per share and multiple the resulting number by 100 (to get a percentage). For example, an investor who purchased 10 shares of stock at $15 and 20 shares at $18 would have an average cost basis of $17/share ($15*10 + $18*20)/(10 + 20). If the annual dividend is $0.90 per share, the yield on cost would be 5.29% ($0.90/$17 * 100).
Using this information, and knowing that Buffett's cost per share of KO is $3.25, can I calculate his yield on cost for 2012? The 2012 dividends per share were: March 13, 2013 $0.28, Nov. 28, 2012 $0.26, Sept. 12, 2012 $0.26, June 13, 2012 $0.26, March 13, 2012 $0.26 and the sum is $1.30
So, $1.30 / $3.25 = .40 and .40 * 100 = 40%. Warren Buffett and Berkshire Hathaway received a 40% YIELD ON COST just for the year 2012 dividends alone!
Alternatively, and again thinking in bondlike thoughts, if we believe the $570,000,000 average return per year on top of the 1.299 billion principal. $570,000,000 / 400,000,000 shares is 1.43 and that is like a gain of 43% each year over the initial investment.
PREDICTION: Since 45% + 40% = 85%, I predict that the total yearly return will soon surpass the initial $1.29 billion cost basis of this CocaCola investment.
Disclosure: I am long KO, BRK.A.
Coca Cola's Valuation For Warren Buffett's 1988 Purchase
For years, I, like many value investors, have wondered how Warren Buffett valued Coca Cola (KO) stock at such a deep bargain in 1988.
This writeup is my basic estimation of the value of Coca Cola's Intrinsic Value Per Share in 1988.
First, I describe my 2stage "discounted cash flow" valuation model. My estimating model is strict. It assumes a business will only "live" for 15 years. Within the model, I apply compounding growth to the first 10 years. Then, I take the cash flow from the 10th year and assume that there is no additional growth for years 11 thru year 15.
This restriction of zero growth in years 11 thru 15 mean that those yearly free cash flows are identical to the number obtained in year ten. And, this restriction imposes a degree of conservatism to optimism during the compounding growth years.
After we sum up all the individual end of year cash, we should apply a discount rate and bring that sum back to present value. At this point, we divide by the number of shares outstanding.
First, keep in mind, Warren Buffett said: "Intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure. This figure will change both as estimates of future cash flows are revised and as interest rates move. Despite its fuzziness, however, intrinsic value is allimportant and is the only logical way to evaluate the relative attractiveness of investments and businesses."
Again, I emphasize that my model is an "estimation method" that imposes conservatism by limiting the duration to 15 years and no growth in the final five years.
In 1988, KO stock traded between $35 and $45.25 and the preceding years' free cash flows were growing around the annual average of 21%.
After I found a copy of their old financial statements on the web, I started with a base estimate of annual Free Cash Flow at a value of approximately $1,096,883,333. This is the 3yr average for 1986, 1987, 1988.
Their number of shares outstanding in 1988 was 364,612,000 shares. I used a discount rate of 8.65% because Treasuries had that 8.65% yield in 1988.
I used an assumed FCF annual growth of 20 percent for the first 10 years and assume zero growth from years 11 to 15.
The resulting estimated intrinsic value per share (after discounting the sum back to the present) is approximately $85.99.
Assuming that Warren Buffett bought at a Market Price of $45, and our resulting estimated Intrinsic Value is $85.99, his estimated bargain Warren Buffett obtained was estimated at 48 percent.
Alternatively, if I had used an assumed FCF annual growth of 15 percent for the first 10 years and assume zero growth from years 11 to 15. The resulting estimated intrinsic value per share (discounted back to the present) is approximately $62.5. At the Market Price of $40, the estimated Intrinsic Value is $62.5 and the estimated bargain would have been 36 percent.
Either way, keep in mind that Buffett bought an understandable business with sustainable competitive advantages, able trustworthy managers, and a significant bargain relative to its intrinsic value.
Bud Labitan
frips.com
Disclosure: I am long KO, BRK.A. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.