"In business, I look for economic castles protected by unbreachable 'moats'." --Warren Buffett.
Warren Buffett loves to buy companies with an economic moat, which is a competitive advantage over its competitors that protect long-term profits. These are tough to find in any industry, and even tougher to find in the commodity price driven energy industry. However, I have uncovered three energy stocks that seem like perfect fits for Warren Buffett's portfolio.
1. Core Labs (NYSE: CLB)
One of the key characteristics of a company with a strong economic moat is the fact that its profitability vastly outperforms its peers. That's certainly the case at Core Labs as it turns more of its revenue into free cash flow than any other oil-field service company in the industry. In its first-quarter earnings release the company boasted that it "converted 34 cents of every revenue dollar into free cash, the highest conversion rate for all major oilfield service companies."
One reason why Core is able to turn such a high percentage of its revenue into free cash flow is because it is focused on achieving returns on capital invested, or ROIC, in the top 10% of its peer group. The company currently is actually exceeding that goal as it has the highest ROIC in its oilfield service peer group as well as the highest ROIC to weighted average cost of capital ratio in its peer group. These are numbers that would make the Oracle of Omaha drool.
2. Kinder Morgan (KMI 3.32%)
Another key aspect of an economic moat is that the company has a competitive advantage to protect its long-term profits. Unrivaled size and scale fit that bill, which is exactly what Kinder Morgan has as we see on the following chart.
Source: Kinder Morgan Investor Presentation
As that slide points out Kinder Morgan is the largest energy infrastructure company in North America and the third largest energy company overall. It is a truly massive company with the largest natural gas network in the U.S. while it is also the largest transporter of petroleum products and carbon dioxide. It also owns the only oil sands pipeline serving Canada's West Coast.
This asset footprint is virtually impossible to be replicated by a rival. First of all, Kinder Morgan operates in a regulated industry and a regulator would have to approve rival pipelines. Not only that, but it is really hard to get a pipeline built as even Kinder Morgan, for example, is having trouble expanding its oil sands pipeline because of opposition from environmentalists and locals. Because it's virtually impossible for a rival to cut into its business, Kinder Morgan expects to continue earning uninterrupted fees on its pipeline and storage capacity for years to come, which is steady income that the Oracle of Omaha would love.
3. Halliburton (HAL 0.98%)
Buffett loves to buy great businesses, which are those that can consistently earn better returns than their peers. That's exactly what we find at Halliburton as it has consistently outperformed the returns of chief rival Schlumberger (SLB -1.33%) throughout the years as we see on the following chart.
SLB Return on Equity (TTM) data by YCharts
Halliburton actually has a chance to boost its lead over Schlumberger even further as it's buying Baker Hughes (BHI) to create an oilfield service giant that can rival Schlumberger in size. The combined company expects to drive nearly $2 billion per year in cost synergies out of the business, which will drive improved returns over the long term. Suffice it to say, Halliburton is a great company and Buffett loves to buy great companies.
Investor takeaway
Warren Buffett loves to own companies with strong economics moats. While that leaves fewer options among energy stocks as most companies in the sector are commodity producers, there are three strong candidates for his portfolio. Core Labs, Kinder Morgan, and Halliburton all have strong economic moats protecting their robust profitability, which is why each should be under consideration by the Oracle of Omaha.
