Warren Buffett Bought Lubrizol; You Can Buy Castrol

Warren Buffett‘s latest investment of 9 Billion (Rs. 45,000 crores) in Lubrizol shows how investment decisions should really be made. Warren Buffett‘s investment philosophy appears to be that instead of struggling to find that elusive multi-bagger stock and ending up with ‘multi-beggar‘ stocks, the investor should invest in stocks of well managed companies growing at a reasonable pace of growth year after year and if he holds the stock long enough, the investor will have a multibagger in his portfolio! Warren Buffett‘s portfolio reflects this investment philosophy. Warren Buffett‘s portfolio consists of stocks of well known companies like Coca Cola, Gillette, American Express etc in which he has significant holdings.

We put this investment credo of Warren Buffett to test and found to our astonishment that if the stock compounded just 15% p.a. (not a tall order), in 10 years time, the investment would have quadrupled and at the end of 20 years, the investment would have grown 16 times. If the investor was lucky enough to get into a stock which compounded 25% p.a., his investment triples in just of 5 years, grows 9 times in 10 years and an incredible 86 times in 20 years (see Blue Chips Stock Portfolio: Compounding Multi-bagger).

So, why waste time and energy looking into the nooks and crannies trying to flush out that elusive stock when one can have a truck load of well managed companies like Lubrizol? This appears to be Warren Buffett‘s winner strategy and it appeals very much to us.

Lets’ see what it is about Lubrizol that caught Warren Buffett‘s attention and whether we can find other stocks that mimics Lubrizol.

The factors about Lubrizol that must have caught Warren Buffett‘s attention are the following:

(i) Top quality management with a proven track record: Lubrizol is a company that is more than 80 years old. Over the decades the management has demonstrated its credentials and integrity in managing the business competently;

(ii) Unending demand for the product: Lubrizol makes additives & lubricants for automobiles. The product is a must-have for automobiles and is perpetually in demand whether new automobiles are bought or not;

(iii) Strong brand value gives competitive “moat”: Warren Buffett always emphasizes that the investee company must be able to withstand competition by having powerful brands. Companies like Coca Cola, Gillette & Nestle are Warren Buffett‘s favourites for this reason;

(iv) Consistent: Lubrizol has been a consistent performer over the years with steady increase in turnover and profits. Since 2001, Lubrizol‘s earnings have been growing at a CAGR of 16%;

(v) Reasonable Valuations: At the market price of about $150 and FY 2011 earnings of about $11, Lubrizol is quoting at a PE of about 9.7 times and also offers a dividend yield of 1.4%.

Lets take a look at two stocks that are in the same business as Lubrizol and see whether we can recreate the Warren Buffett magic with these stocks.

The first is Castrol India Limited.

Castrol India Ltd is about 80+ years old with about 71% of its equity being held by Castrol Limited UK (part of BP Group). Castrol India is the second largest lubricant company in India with a market share of around 22%. It is the market leader in the retail automotive lubricant segment.

Castrol India manufactures and markets a range of automotive and industrial lubricants. It markets its automotive lubricants under two brands – Castrol and BP. Castrol India has leadership positions in most of the segments in which it operates including passenger car engine oils, premium 2-stroke and 4-stroke oils and multigrade diesel engine oils. Castrol India has the largest manufacturing and marketing network amongst the lubricant companies in India. It has 5 manufacturing Plants across the country, including a state-of-the-art plant in Silvassa. Castrol India reaches its consumers through a distribution network of 270 distributors, servicing over 70,000.retail outlets.

Castrol India’s financial performance has been very strong over the years. Castrol India is debt-free. Though its 3 year CAGR sales is 9.95%, its 3 year CAGR profit is a healthy 39%. The Return on Equity is a mammoth 78%. Castrol India has also been liberal in rewarding its shareholders. In 20 years, Castrol India has given 8 bonus issues and also distributes hefty dividend. A 1:1 bonus issue was made in April 2010. In the year ended December 2009, Castrol India distributed a dividend of 250% (Rs. 25 per share; including 100% special dividend).

Castrol India‘s Annual Financial results for the period Jan – Dec 2010 were also strong. Net Sales were up 18% to Rs. 2734.7 crores compared to the previous year and Profit after Tax grew by 28.7% to Rs.490.3 crores. Castrol India has paid a total dividend of Rs. 15 for the year ended December 2010 (interim Rs. 7 and final of Rs. 8 ) resulting in a dividend yield of about 3.42% at the CMP of Rs. 438.

Based on the EPS of Rs. 19.83 earned for the year ended December 2010, the CMP of Rs. 438 is discounted 22 times. While this is not cheap (not as cheap as what Warren Buffett paid for Lubrizol), it is not unreasonable either considering the dominance that Castrol enjoys in the market place.

A proxy for Castrol is Tide Water Oil Co (I) Ltd which is a Public Sector Undertaking. Tide Water is also a dominant player in the Automotive and Industrial lubricants in India since 1928 and has five plants at Howrah, Oragadam, Turbhe, Silvassa and Faridabad. Tide Water’s products include engine oils for trucks, tractors, commercial vehicles, passenger cars and two/three wheelers. It also produces gear oils, transmission oils, coolants and greases for automobiles. For industrial application it manufactures industrial oils, greases and speciality products like metal working fluids, quenching oils and heat transfer oils. Tide Water has tie-ups for manufacture of genuine oils with a number of renowned OEMs in the automotive and industrial equipment segment. Tide Water has technical collaboration with JX Nippon Oil & Energy Corporation, the No.1 petroleum conglomerate in Japan.

Tide Water‘s financial performance has also been quite attractive with 3 year CAGR sales of 22% and 3 year CAGR profit of about 86%. Tide Water‘s Return on Equity is 33%. Tide Water is also a virtually debt-free company. For the 9 months ended December 2010, Tide Water had an EPS of Rs. 465 (marginally lower than the 9 month FY 2010 EPS of Rs. 498). Extrapolating the EPS for the full year, the FY 2011 EPS should be close to Rs. 620 (last year’s EPS was Rs. 663). The CMP of Rs. 6,390 discounts that 10 times which is very reasonable.

If one thinks about it, Warren Buffett‘s investment strategy makes immense sense. There are so many companies like Lubrizol, Castrol & Tide Water with excellent management, excellent products & excellent financials waiting to be bought. If one can be patient and buy these stocks at a reasonable valuation, in the long run, one has his coveted multi-bagger!