Among Warren Buffett’s recent spate of acquisitions for the Berkshire Hathaway portfolio, one stock stood out as an unusual purchase for the well-known value investor.
Celanese (NYSE:CE) is engaged in chemical manufacturing, something that has not historically been represented in Berkshire’s investments. This lack of familiarity did not stop Buffett from initiating a 7.9 million share position valued at over $1 billion.
Given that Buffett is famous for investing only within what he describes as a limited circle of competence, the move into the world of chemical manufacturing may seem like an odd one. However, Celanese shares many qualities with some of the Oracle of Omaha’s best-known holdings.
Celanese is a manufacturer of advanced engineered materials, most notably polymers. The company produces acetate, vinyl and acetyl products for a wide variety of commercial applications. Celanese is heavily tied to both the auto and medical markets, but its products are also used in common consumer goods.
So why did Buffett buy Celanese?
Celanese Revenue, Earnings and Growth
Unlike many companies, the first quarter of 2022 was generally positive for Celanese. The company increased its net sales by 12 percent year-over-year to $2.5 billion and reported an operating profit of $531 million. This translated to diluted GAAP earnings of $4.61 per share. Earnings did drop from $4.79 a year earlier, though adjusted earnings were higher than in the 2021 period.
Further growth along these same lines is expected by analysts. EPS is projected to grow by 8.8 percent for Q2, which is impressive in an environment that is generally hostile to higher earnings.
Celanese also performed reasonably well on free cash flow, generating $175 million in Q1. While far lower than the $415 million reported in Q1 2021, this number is quite positive given rising costs and other factors which have tamped down cash flows generally.
Celanese has a good history of raising its free cash flows, with a reported CAGR of 14 percent between 2014 and 2019. While certainly not his only consideration, the ability to generate large amounts of cash has always been a positive in Buffett’s investment decisions.
Target Price and Valuation
While Buffett is famous for paying little attention to short-term returns, Celanese holds an attractive array of 12-month analyst price targets. The median target for Celanese is $171.50, up 54.4 percent from the current price of $111.22.
Celanese also appears quite attractive on valuation, known to be Buffett’s favorite way to select stocks. The stock trades at just 6.41 times forward earnings and is priced at 1.35 times its sales.
Given the generally strong financial nature of the company, these metrics suggest that it could be considerably undervalued.
Does Celanese Have a Moat?
Celanese does have an obvious moat at first glance. Certainly it’s not clear that it has a brand advantage or intangible assets to speak of. In the case of Celanese, the moat is a result of both scale and cost advantages.
Celanese operates at higher profit margins and produces better returns on equity than many of its peers, suggesting that it has economic advantages that its competitors cannot easily replicate.
As noted above, Celanese also produces a good line of free cash flow, which is another indicator of an economic moat.
What Does Buffett See in Celanese?
The most obvious aspect of Celanese that could have attracted Buffett is its seeming undervaluation.
The stock trades at low multiples to earnings and sales, both of which are still growing. This fact ties into the economic resiliency of the business, as it has continued to produce at least respectable growth at a time when many other companies are struggling to do so.
The presence of a moat around the company could also have been a factor. Buffett has always been bullish on companies that have sustainable advantages over their competitors and are already dominant in their markets.
Because of the cost involved in producing chemicals, Celanese is not likely to face pressure from new startups in its field. Its cost advantages against its current competitors, therefore, predict that it will have a solid moat around it for the foreseeable future.
Celanese also appears to have the ability to deploy its excess capital to drive further growth through acquisitions. Earlier this year, the company agreed to an $11 billion deal to acquire a segment of DuPont’s materials business. This strongly suggests that Celanese still has runway left ahead of it. The ability to grow through continued reinvestment would strongly appeal to Berkshire’s strategy of holding companies for the long run.
The one point that makes Celanese unusual for Buffett is the industry in which it operates. The Oracle of Omaha tends to favor financial companies and consumer staples but has shown himself willing to venture outside of these arenas from time to time. Beyond Berkshire’s limited historical dealings with the chemicals and materials industry, Celanese has all of the attributes one would normally expect to find in one of Buffett’s stock picks.
Will Celanese Be Profitable for Berkshire Hathaway
Based on its valuation and analyst forecasts of its 12-month performance, it seems likely that Celanese stock will be a profitable investment for Berkshire Hathaway.
Assuming earnings growth continues apace in Q2, Buffett could see a considerable profit from Celanese by the end of the year. Over the much longer time horizon that the famous long-term investor prefers to use, the stock will likely deliver strong returns.
Celanese will also contribute some cash flow directly to Berkshire in the form of dividends. While not massive, Celanese does yield a respectable 2.35 percent for an annual payout of $2.72.
Over the last five years, this dividend has grown at a compounded rate of 12.05 percent. If future payout increases continue even at a much slower pace, Berkshire could have a good flow of income that it can use for other investments.
Overall, the Celanese buy shows that Buffett is maintaining his value strategy, even though he is applying it to new fields. The long-term outlook for Celanese seems strong, and it will likely be a decent performer for Berkshire over the coming years.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.