Why did Berkshire Hathaway buy Lubrizol Corp (LZ)?
In my view, Lubrizol is a company that Mr. Buffett found to be understandable, found to have sustainable competitive advantages, found to have able and trustworthy managers, and found to be available at a bargain price.
The Lubrizol Corporation (Lubrizol) is a specialty chemical company. It supplies technologies and produce additives, ingredients, resins and compounds for the Company’s products in the global transportation, industrial and consumer markets. The products are used in a range of applications, and are sold in markets, such as those for engine oils, specialty driveline lubricants and metalworking fluids, as well as markets for markets, such as personal care and over-the-counter pharmaceutical products, performance coatings, medical products and compressor lubricants.
With headquarters in Wickliffe, Ohio, The Lubrizol Corporation owns and operates manufacturing facilities in 17 countries, as well as sales and technical offices around the world. Founded in 1928, Lubrizol has approximately 6,900 employees worldwide. Revenues for 2010 were $5.4 billion. Return On Equity (5-Year Avg.) 17.9 and it shows a progressive growth in book value from 12/01 of $15.12 to 12/10 book value of $34.25.
The specialty chemical products also are used in a range of industries, including the construction, sporting goods, medical products and automotive industries. The Company operates in two business segments: Lubrizol Additives and Lubrizol Advanced Materials. Lubrizol produce products with brand names, such as Anglamol, Carbopol, Estane and TempRite.
Last Price 105.44
52 Week High 117.62
52 Week Low 77.6
Does LZ make for an intelligent investment or intelligent speculation today? Starting with a base estimate of annual Free Cash Flow at a value of approximately $513,000,000 and the number of shares outstanding at 64,100,000 shares; we used an assumed, and a bit more conservative, FCF annual growth rate of 14 percent for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here: http://quicktake.morningstar.com/stocknet/CashFlowRatios10.aspx?Country=USA&Symbol=LZ&stocktab=keyratio
The resulting estimated intrinsic value per share (discounted back to the present) is approximately $199.25.
Market Price = $105.4
Intrinsic Value = $199.25 (estimated)
Debt/Equity ratio = .62
Price To Value (P/V) ratio = .53 and the estimated bargain = 47. percent.
Before we make a purchase, we must decide ( filter #1 ) if LZ is a high quality business with good economics. Does LZ have ( filter #2 ) enduring competitive advantages, and does LZ have ( filter #3 ) honest and able management.
The current price/earnings ratio = 10.
It 's current return on capital = 18.2
Using a debt to equity ratio of .62, LZ shows a 5-year average return on equity = 17.9
Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.
Growth benefits investors only when the business in point can invest at incremental returns that are enticing; only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The wonderful companies sustain a competitive advantage, produce free cash flow, and use debt wisely.
Does LZ make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today?
Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. In terms of Opportunity Cost, is LZ the best place to invest our money today?
MANAGEMENT AND SEC FILINGS: http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=LZ&type=10-K&dateb=&owner=include&count=10
TIME FORWARD PROJECTION:
How will LZ compete going forward? Keep in mind that a financial report like this is a reflection of the past and present. It may be used to project a future, but it may not account for factors yet unseen. Therefore, pay attention to competitive and market factors that may affect changes in profitability.
In summary, using a debt to equity ratio of .62, LZ shows a 5-year average return on equity = 17.9. My estimated intrinsic value per share (discounted back to the present) is approximately $199.25. The Market Price = $105.4 and the Debt/Equity ratio = .62
The estimated Price To Value (P/V) ratio = .53 and the estimated bargain = 47. percent. Going forward, are there any transformational catalysts or condition indicators imaginable on the horizon?
As always, I appreciate hearing your views,
Author of the book 'Price To Value'
and 'The Four Filters Invention of Warren Buffett and Charlie Munger'