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The Next Energy Company on Warren Buffett's Radar (11/21/15)

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Enterprising Investor Member Level  Sunday, 11/22/15 12:43:24 PM
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The Next Energy Company on Warren Buffett's Radar (11/21/15)

Berkshire Hathaway Inc. is now the largest shareholder of Phillips 66, with an 11.5% stake. What's the next energy company on Warren Buffett's radar?

On Monday, Berkshire Hathaway filed its quarterly report of stock holdings for the third quarter. The most prominent new addition was Phillips 66 (NYSE:PSX), and Warren Buffett did not do things halfway: Berkshire is now Phillips' largest shareholder, with a 11.5% stake worth $4.7 billion at the end of the quarter. Phillips 66 is one of only two energy sector holdings, along with Suncor Energy Inc. Surely the drubbing the energy sector has suffered has created opportunities to for a patient, value-driven investor.

With that in mind, we asked three of our analysts to try to identify the next energy stock on Berkshire CEO Warren Buffett's radar:

Adam Galas (Western Gas Equity Partners): An energy company that I think would be right up Buffett's alley is Western Gas Equity Partners (NYSE:WGP).

This MLP owns the general partner, incentive distribution rights, and 35% of the limited units of Western Gas Partners (NYSE:WES), a fast growing midstream MLP that's sponsored by Anadarko Petroleum Corp. (NYSE:APC).

Western Gas Equity has a business model that I think Buffett would really appreciate. It derives all of its revenue from Western Gas Partners and then pays it out to investors. Because its owns the general partners' rights, its distributions from Western Gas Partners grow incredibly quickly. In the third quarter of 2015, for example, Western Gas Partners' cash distributions to Western Gas Equity grew almost 32% year over year.

Those cash flows are also extremely stable, with 98% of Western Gas Partners' adjusted gross margins protected by long-term, fixed-fee contracts. In other words, though Western Gas Equity's unit price has taken a 30% beating this year due to the oil crash, the growing cash flow stream that would attract Buffett's interest hasn't been affected at all.

Better yet, because Anadarko Petroleum owns 84% of Western Gas Equity as well as 8.3% of Western Gas Partners, it has a large incentive to monetize its midstream assets by dropping down or selling them to Western Gas Partners. Such drop downs increase Western Gas Partners' asset base and cash flows, which are then magnified by Western Gas Equity's general partner rights, and thus flow back to Anadarko in a highly tax efficient manner.

Anadarko Petroleum currently has five pipelines and processing plants that it's looking to drop down to Western Gas Partners. This potentially provides immediate and guaranteed growth opportunities for Western Gas Equity and itself, as the majority owner.

With a market cap of $9.4 billion, a large stake in Western Gas Equity Partners is well within Berkshire's ability to buy. With a cash rich, commodity price-immune business model, I think Berkshire might certainly consider taking a large stake in this particular MLP.

Jason Hall (Chart Industries):One company that would make an excellent "tuck-in" acquisition for one of Berkshire's subsidiaries is Chart Industries, (NASDAQ:GTLS). This once high-flying stock has fallen far from grace, down 85% since its all-time high in late 2013, and down more than half in the past year.

And while Chart's stock is way down, the business is in relatively good shape, and significantly undervalued. In short, Chart's stock was bid up to extreme valuations in the market's exuberance for everything natural gas a couple of years ago due to the company's strong presence in natural gas processing and storage equipment manufacturing.

Yes, Chart's sales have fallen this year, but not even 10%, though net income is down 34% over the past four quarters. However, the company has already taken steps to get its cost structure inline, and it's looking like its core business has stabilized.

While Chart may never turn out to be the megagrowth company investors were envisioning two short years ago, it's still a solid business with steady cash flows, and it's gotten downright cheap:

We are talking about a high-quality business trading for multiples its stock hasn't been at since very near the Great Recession. It's maybe too tiny to be on Buffett's radar, but it might be just right for yours.

Alex Dumortier (General Electric): It's true that General Electric (NYSE:GE) is not, strictly speaking, an energy company, but energy is a big part of the conglomerate's activity: in aggregate, the Power & Water, Oil & Gas, and Energy Management segments accounted for 45% of revenues in 2014.

From Warren Buffett's vantage point, GE has (at least) two critical qualities, one of which is related to the business and the other to the stock:

First, as General Electric continues to reduce the footprint of its financing unit, GE Capital, it is increasingly the sum of its core industrial businesses, which are replete with genuine competitive advantages. That "economic moat" is built on the company's scale, its research and development capability, and the switching costs of its customers.

Second: the universe of stocks in which Mr. Buffett can build a position that will "move the needle" at Berkshire is shrinking. With a market capitalization in excess of $300 billion, General Electric meets the entry requirement.

In early September, Buffett told CNBC that he likes to try to buy 15% to 20% of the volume in a stock he is accumulating. Fifteen percent of the total value of all General Electric traded last week is $2.9 billion, according to data from Bloomberg. A few more weeks of buying at the same rate and, pretty soon you're talking about real money.

But wait -- Berkshire Hathaway already owns shares of General Electric worth $267 million at the end of the third quarter. That's true, but Buffett never made an active decision to purchase those shares.

Instead, Berkshire was "gifted" the shares without having to put up a dime when it exercised warrants that were attached to a $3 billion preferred share investment in General Electric in 2008. Besides, a position that size is not a "needle-mover".

Incidentally, if you want to read a comprehensive "Buy" case for General Electric from a value investor, activist group Trian Partners put together an 81-page presentation in support of its $2.5 billion investment in GE. They make a compelling case.


"Someone said it takes 30 years to be an instant success" - Gabriel Barbier-Mueller, CEO of Harwood International
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