Warren Buffett, the chairman, CEO and largest shareholder of Berkshire Hathaway Inc. likes to invest in businesses that:
- he understands and can demonstrate a consistent, stable and profitable operating history
- are run by rational and honest management teams that are also able to resist the institutional imperative (defined as a company's propensity to do dumb things such as spending money on a deal just because the money was available)
- exhibit good to pristine balance sheets that use low to nil leverage and can demonstrate high margins on its products
- have good long-term prospects
- that are considered to be reasonable value
Given all of the above, how would Mr Buffett perceive ARB Corporation Limited (ASX: ARB) at today's price of around $18?
Using the metrics above, here's how ARB would be judged:
- ARB demonstrates consistent but steady growth in sales revenue and net profit after tax with each averaging a 10.4% and 13.0% compound annual growth rate respectively over the last 10 years
- Andrew and Roger Brown (current Managing Director and Chairman respectively) have been running the business since it became a listed entity back in 1987 and have grown the business organically with the odd bolt-on acquisition here and there (there have been no 'transformational' transactions over its almost 29 years as a listed company). They're also good communicators via their half-yearly and annual reports
- The company has operating margins of 20.9%, which have been remarkably consistent over the last 10 years, and the company has no net debt with cash of $13.7m in the bank
- The company sells globally with sales teams in Australia, Thailand, the USA, Europe and, more recently, Dubai. Its exports now comprise 26% of company sales and are growing at 12.6% (in part, thanks to the current AUD/USD exchange rate)
- ARB currently has a PE of just under 29 times earnings and supports a fully-franked dividend of 1.9%. Relative to its earnings in any given year, ARB is trading at its highest valuation at any time since 2007
I wrote back in August that buying shares at around the $18 mark would pose risks for any new investment.
Last week though, ARB reported at its AGM:
- incremental additions to its Australian warehousing capacity
- improved fitting capacity
- improved distribution and warehousing capacity in the USA, Thailand, Europe and now in the Middle East,
- the establishment of a design engineering capability in the USA to cater to that market's specific requirements, and
- 8% sales growth for the quarter to the end of September
Foolish takeaway
Today, there are other stocks on the ASX with better value – such as Retail Food Group Limited (ASX: RFG), Blackmores Limited (ASX: BKL) and iSentia Group Ltd (ASX: ISD), which all provide a much lower PE and higher dividend yield than ARB.
For this reason, today, ARB would probably not meet Warren Buffett's intrinsic value test.
If you're investing for a timeframe of less than five years, I'd leave ARB alone and look for better opportunities elsewhere.
However, if you can mimic Warren Buffett's investing timeframes of greater than five years, and preferably 10, 20 years or longer, ARB would not be out of place in most investors' portfolios.
The company's export operations, and the expansion of its sales operations internationally, provide shareholders with real prospects for above-average returns over the longer term, and given the quality of management running the show, I'm certainly holding on to my shares to see how its business strategy plays out well into the future.
