2024-01-18 07:48:22 ET
Summary
- Warren Buffett consolidates ownership of Pilot Travel Centers under Berkshire Hathaway, making it a larger and more profitable enterprise.
- Berkshire Hathaway purchases the remaining 20% ownership stake in Pilot Travel Centers after settling a lawsuit with the Haslam family.
- Berkshire Hathaway continues to load up on shares of Occidental Petroleum, owning approximately 34% of all shares outstanding.
- These are all great moves aimed at creating and preserving value for shareholders for the long haul.
Warren Buffett is at it again! Recently, the billionaire investor made a move to further consolidate ownership over a rather large asset under the umbrella of his holding company, Berkshire Hathaway (BRK.A) (BRK.B). In addition to that, using some of the hefty cash that the company has on hand, it has become clear that he has been loading up on additional shares of Occidental Petroleum (OXY). Both of these show that, despite his age and even in the light of both personal tragedy and uncertain economic times, he has not stopped building his corporate empire. These moves will ultimately go on to make Berkshire Hathaway a larger and more profitable enterprise for shareholders, including those who might be new to the business and just getting in. Furthermore, they demonstrate that my own optimism regarding the company, a level of optimism that led me to initially rate the business a 'buy' back in 2019, is not misplaced.
Consolidation continues
Although Berkshire Hathaway has been made famous for its purchase of various companies over the years, it does not always buy them up in one fell swoop. Some firms, the company never seeks to acquire all of at all. And in other cases, management makes purchases over a window of time. An example of the latter case involves Pilot Travel Centers, which has historically always been a privately held business. Prior to 2023, Berkshire Hathaway owned 38.6% of Pilot. That stake was initially purchased by the conglomerate in 2017 for $2.76 billion. At the time, that valued the enterprise at about $7.15 billion.
The long-term plan had always been for Warren Buffett to bring a majority ownership of Pilot into the fold. It was agreed upon during that time that Berkshire Hathaway would acquire another 41.4% ownership interest in Pilot at what ultimately became a price of $8.2 billion. That transpired in early 2023, valuing the company in its entirety at $19.81 billion. Part of the agreement between the prior owners of Pilot, the Haslam family, was for said family to be able to force Berkshire Hathaway to acquire the final 20% ownership of the enterprise at a price that would be based on the earnings of the business for the year prior to which the transaction would be completed.
Unfortunately, an issue arose. The Haslam family ended up filing a lawsuit against Berkshire Hathaway late last year, alleging that the conglomerate was trying to use an accounting change to result in lower earnings for Pilot with the goal of ultimately lowering the purchase price on the remaining equity. In turn, Berkshire Hathaway alleged that the Haslam family engaged in bribery in an attempt to get executives at Pilot to inflate earnings. What was working up to be a significant and nasty lawsuit was quickly resolved earlier this month when the two sides agreed to an undisclosed settlement. That was followed up on January 16th with the news that Berkshire Hathaway would be purchasing the remaining 20% of Pilot for an undisclosed sum as well. Based on the $8.2 billion purchase price paid in January of 2023, Pilot should have cost around $3.96 billion. But in all likelihood, the ultimate price is lower. I say this because the Haslam family made the claim that the remaining stake in the company was worth at least $3.2 billion, a claim that Berkshire Hathaway pushed back on.
Regardless of how much the conglomerate ultimately is paying for the remaining ownership stake, investors should view this as a positive development. Because the company is a travel center operator and because it generates a large portion of its revenue from the sale of fuel, its revenue and profits can vary significantly from year to year. This does make it difficult for us to gauge just how attractive the purchase is for shareholders. But we do have some data that helps us to arrive at an answer.
During the first nine months of 2023, Pilot generated revenue of $42.45 billion. This was down from the $55.98 billion reported the same time one year earlier. This drop was driven by a combination of factors, including a drop in fuel prices and a decline in the amount of fuel sold from 13.6 billion gallons in the first nine months of 2022 to 12.2 billion the same time of 2023. Even with this drop, Pilot will end up being one of the largest sources of revenue for Berkshire Hathaway moving forward. Outside of the Insurance segment, which is comprised of multiple insurance groups, and both McLane and the Manufacturing segment, Pilot should be the largest entity under the Berkshire Hathaway corporate umbrella.
With the drop in revenue for the company came a decline in profits as well. Pre-tax income went from $1.26 billion in the first nine months of 2022 to $702 million for the same window of time in 2023. It's never great to see a drop in profits. But given the industry that we are dealing with, it's not a surprise. What's really important is that, over the long haul, Pilot looks set up to achieve success. Operationally speaking, the business is quite large. And it is growing rather quickly. I say this because, while we do not have more detailed data, we do know that, in its 2022 annual report, Berkshire Hathaway claimed that the enterprise had over 650 travel centers that it operates. By the third quarter of 2023, this number had grown to over 750. It also has over 150 retail locations, plus some other assets such as what management describes as a 'large wholesale fuel and fuel marketing' platform, plus a water hauling and disposal business that's dedicated to servicing the oil fields sector.
For those worried about the transition away from traditional fossil fuel powered vehicles, keep in mind that Pilot is already making great strides to prepare itself for the future. As of the end of 2022, the company sold around 1.5 billion gallons per year of low carbon fuels such as renewable diesel, biodiesel, and ethanol. It also, during that year, entered a partnership with General Motors ( GM ) to develop a nationwide electric vehicle fast charger network of 2,000 charging stations spread across 500 US locations by 2026. It's also working with Volvo to develop a nationwide public charging network to help support the expansion of battery powered electric trucks. With a physical presence across 44 states and six Canadian provinces, Pilot truly is a behemoth.
It's also likely, in my opinion, that Berkshire Hathaway can have a positive impact on the financial performance of Pilot and it can do so rather easily. You see, part of the decline in pretax profits for the business in the first nine months of 2023 compared to the same time one year earlier came from a $166 million increase in interest expense. Clearly, at least some of the roughly $6 billion in debt that Pilot had at the time was variable. The weighted average interest rate on that debt was 7.2%, which was well above the 4.4% to 5.9% range seen by the other operating segments under the Railroad, Utilities, and Energy arm of Berkshire Hathaway. Every 1% decline in interest rates that Berkshire Hathaway is able to get because of its own health and stability will result in an additional $60 million in pre-tax profits coming to shareholders each year.
Mr. Buffett continues loading up on OXY
One of the largest investments that Berkshire Hathaway has made in recent years has been of stock in Occidental Petroleum. In addition to buying $10 billion worth of preferred units that carry an 8% annual distribution, the conglomerate has also purchased hundreds of millions of common shares in the business. I already wrote at length about the preferred units and how they operate. The short version is that they cannot be forcibly repurchased directly by Occidental Petroleum until 2029, though if distributions paid out to common shareholders in any trailing 12-month window exceed $4 per share, then Occidental Petroleum must buyback, dollar for dollar, with a 10% premium attached, the preferred units equivalent to those distributions. This resulted in $1.5 billion worth being bought back, leaving $8.5 billion remaining. Attached to these units was also warrants granting Berkshire Hathaway the ability to buy 83.86 million shares for up to one year after the last preferred unit is bought back. The purchase price there is $59.62, which is only slightly above where shares are trading at this moment.
Clearly, the $10 billion of preferred units and the roughly $5 billion worth of warrants was not enough for Mr. Buffett. This is because the company has been loading up on common shares. And as of the end of the third quarter of 2023, Berkshire Hathaway owned 224.129 million shares. At a current price of $56.22 per unit, this is worth $12.60 billion. It was also, at the time, 25.3% of all common shares outstanding for Occidental Petroleum when adding the warrants to the picture. Well, since then, management has continued to buy additional units of the energy giant. On January 10th, a filing revealed ownership over 327.57 million shares. This includes the aforementioned warrants. So stripping those out of the equation, we can see that Berkshire Hathaway has bought another 19.59 million shares of the company worth around $1.10 billion as of this writing. With the warrants added to the picture, this equates to approximately 34% of all shares outstanding for Occidental Petroleum.
It is worth noting that the recently announced purchase of CrownRock by Occidental Petroleum in exchange for $12 billion will decrease this ownership stake to just under 33%. That's because $1.7 billion worth of the purchase price is being done in the form of shares of Occidental Petroleum itself. But clearly, Mr. Buffett is happy with that transaction or else he would not be buying additional units. In the investor presentation covering the purchase of CrownRock, management said that, if oil averages $70 per barrel, the combined company should generate around $4.20 billion per annum in free cash flow. That implies a price to free cash flow multiple of 13.3, which I consider to be attractive.
At this point, I would imagine that many investors are wondering what is next in this particular saga. Some are likely wondering whether a purchase of the entire company could be in the cards. After all, in August of 2022, regulators gave Berkshire Hathaway the green light to buy up to 50% of the energy giant. But earlier in 2023, Mr. Buffett made clear that they have no intention of buying up the entire business. This doesn't mean they couldn't. As of the end of the most recent quarter, Berkshire Hathaway had $157.24 billion worth of cash and cash equivalents, plus short-term investments like U.S. Treasuries. Given Mr. Buffett's statements, I would be surprised to see a deal eventually announced. However, I would not be shocked to see additional purchases of units moving forward sense Berkshire Hathaway is likely looking for ways to deploy its massive capital before interest rates start falling again.
Takeaway
The past few months have been challenging to say the least. In addition to having to contend with broader economic uncertainty, Mr. Buffett also had the personal tragedy of losing longtime business partner and friend Charlie Munger. Fortunately for shareholders, these kinds of setbacks have not stopped Berkshire Hathaway from continuing to make large and interesting investments. With so much cash on hand, I would be surprised if we don't see additional sizable transactions throughout this year. This, combined with the outperformance of Berkshire Hathaway relative to the broader market since I initially rated it a 'buy' back in May of 2019, makes me feel confident that what moves the business makes, the end result will be positive for investors in the firm.
For further details see:
Warren Buffett's Berkshire Hathaway Keeps Scoring Big