If you want to build wealth over the long term, quite possibly the best way to do so is to follow the Tao of Warren Buffett: Buy great companies at a decent price, and hold them for the long term. It sounds easy on paper, but in practice it's much harder. One thing that can help, though, is to look for certain traits that a company possesses, and there are three companies in the energy space -- Helmerich & Payne (NYSE:HP), Oceaneering International (NYSE:OII), and Core Laboratories (NYSE:CLB) -- that display several characteristics similar to other energy companies in the Berkshire Hathaway portfolio. Let's take a look at why these companies may be Buffett-worthy and whether they should be in your portfolio.
Who are these guys anyways?
Helmerich & Payne, Oceaneering International, and Core Laboratories aren't exactly household names. All three are in the oil and gas equipment and services business of supplying explorers and producers with the equipment and information necessary to get the job done. Although each of these companies goes about it in very different ways, each taps into some very specific needs for the oil and gas industry for years to come.
- Helmerich & Payne owns the largest fleet of drill rigs in the U.S. that are capable of both directional drilling (necessary to access shale formations) and pad drilling (so operators can drill multiple wells at a single site with minimal downtime).
- Oceaneering owns the worlds largest fleet of remotely operated undersea vehicles, or ROV, used in offshore exploration and production for things like laying undersea pipelines and installing safety equipment on the seafloor. Today the company owns 60% of the global drill support ROV market.
- Core Laboratories specializes in analyzing geological samples from oil and gas reservoirs to optimize production and squeeze out every available barrel of oil. It also uses this data to build diagnostic tools and products for oil and gas drillers to better manage the decline in production of reservoirs over time.
Cash rules everything around me
Warren Buffett makes no secret that he loves businesses with a strong competitive advantage. Almost every letter to his shareholders has made reference to this in one way or another over the years. If we were to use this as a gauge, then Helmerich & Payne, Oceaneering International, and Core Laboratories pass the test with flying colors. From a business standpoint, they each have carved out a unique niche that puts them in the upper echelon of their respective industries.
Then again, there are loads of great companies out there that hold competitive advantages over their peers. What really sets a company apart is one that can take that advantage and generate lots of excess cash. Also, if you look at the track records of some of Mr. Buffett's most recent energy purchases, you will find they each share that common trait.
Sometimes a company's free cash flow can look pretty because of things like asset sales, but H&P, Oceaneering, and Core Labs bring in cash the old fashioned way, through continuing business operations. Excess cash is especially noteworthy for both Helmerich & Payne and Oceaneering because they are actually pretty capital intensive businesses. Since both generate returns from a rental fleet, they need to constantly maintain, update, and expand that fleet.
|Cash from Continuing Operations as a % of Capital Expenditures (>100% means excess cash generated)|
|Company||Last 12 Months||FY 2013||FY 2012||FY 2011||FY 2010|
|Helmerich & Payne||127%||123%||91%||140%||140%|
Thanks to the mountains of cash that each company pulls in, all three also have squeaky clean balance sheets. Both Helmerich & Payne and Oceaneering have negative net debt -- more cash on hand than debt on the books -- and Core Labs generates more EBITDA annually than its total debt load. This means that excess cash can make its way to shareholders in the form of free cash flow, and in the process help each company generate fantastic rates of return.
|Company||Levered Free Cash Flow Margin||Return on Capital|
|Helmerich & Payne||6.5%||13.5%|
Knowing that these companies have been able to consistently generate free cash flow and strong returns on capital over the past several years, it shouldn't come as a surprise that these companies have soundly beat the S&P 500 on a total return basis over the long run.
Why would Warren be wary?
There are two main things that might concern investors who look for these kinds of long-term buy and hold opportunities. The first one is that all three of these companies' advantages are based mostly on technology. While this can be a strong competitive advantage, it can also be disrupted. Helmerich & Payne and Oceaneering aren't as susceptible to this because it would also take lots of capital spending to completely knock them down, but anyone invested in these companies needs to be wary of new technology entering this space.
The second thing to remember is the mantra of investing like Warren Buffett. Its not just identifying great companies like these, but also buying them at a good price when other investors have irrationally shied away. Unfortunately today, it may be the opposite case with H&P, Oceaneering, and Core. By just about every valuation ratio, it appears that investors might be slightly irrationally eager.
|Company||Total Enterprise Value/EBITDA||Price/Earnings per share||Price/Levered Free Cash Flow|
|Helmerich & Payne||7.45x||15.46x||46.6x|
Considering that the industry average price to earnings ratio for the entire energy sector stands at 15, all three of these companies carry a decent premium to the market average today. Then again, this isn't too surprising since these companies have proven to be some of the best companies in the space.
What a Fool Believes
I can't say with any conviction that these companies are on Warren Buffett's "what to buy next" list, but they certainly do exhibit a few characteristics that Mr. Buffett looks for in a company. For investors like you and me, my advice would be to definitely keep a close eye on these companies. Going out and buying them today isn't a bad idea, but it's an even better idea to wait and watch for a time when the market goes on one of its irrational tears so you can pick up these companies at a decent discount.
The Motley Fool recommends Berkshire Hathaway, Core Laboratories, and Oceaneering International. The Motley Fool owns shares of Berkshire Hathaway and Core Laboratories. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.