While the largest holdings in Warren Buffett’s investment portfolio often attract the most attention, smaller positions are often just as interesting for investors to study. One such stock is Louisiana-Pacific (NYSE:LPX). Why did Buffett buy LPX?
Louisiana-Pacific is a manufacturer of building materials. The company specializes in siding products and oriented strand board (OSB). Louisiana-Pacific also manufactures flooring materials. Many of the company’s products are used in new property construction, giving Louisiana-Pacific significant exposure to the new home market.
How Large Is Buffett’s Stake in Louisiana-Pacific?
Berkshire Hathaway owns 5.8 million shares of Louisiana-Pacific, which is just over 8 percent of the company’s outstanding stock.
Due to Berkshire’s sheer size, however, the Lousiana-Pacific holding represents just 0.10 percent of Buffett’s total portfolio.
Why Did Buffett Buy Louisiana-Pacific?
At first glance, Louisiana-Pacific appears to be a bit of an unusual stock for Buffett’s portfolio. The stock trades at over 21 times forward earnings and doesn’t have the broad brand-name recognition that Buffett often looks for.
Upon further inspection, however, there are several factors that make Louisiana-Pacific make more sense for Warren Buffett.
Due to a slowdown in the housing market and an accompanying reduction in earnings, the company has sold off considerably. Earnings peaked in Q1 of 2022 at $5.08 for the quarter. By Q3 when Buffett was buying his stake, however, earnings had fallen off to just $1.72 per share.
While Louisiana-Pacific is clearly experiencing some short-term difficulties, Berkshire Hathaway seems to believe that the market has mis-priced the company’s long-term cash flows.
Louisiana-Pacific also generates excellent returns on the capital it deploys. With a 54.7 percent return on invested capital and a 64.5 percent return on equity, the company is clearly performing quite well on the profitability front. Louisiana-Pacific also boasts a net margin of 27 percent. Together, these metrics form a strong argument for the company’s ability to remain profitable.
A final point that may have made Louisiana-Pacific attractive to Berkshire Hathaway is the fact that the company carries minimal debt. At a ratio of just 0.24 to equity, Louisiana-Pacific is far from over-leveraged. This makes its return on equity all the more impressive, as the company is successfully reinvesting its own earnings to drive growth without relying on outside financing.
What Is Fair Value For Louisiana-Pacific?
The consensus fair value for Louisiana-Pacific stock is $63, a 14.8 percent jump from the current price of $54.87. The fair value of the stock based on a discounted cash flow analysis appears to be around $72, leaving a potential upside of over 30 percent for investors.
It’s interesting to note here that unlike many of Buffett’s holdings, Louisiana-Pacific hasn’t risen much since Berkshire acquired its position. The Berkshire stake was purchased at an average price of $56.84. As such, investors today have a rare opportunity to copy one of Buffett’s positions at a very similar price.
Investors are also likely to see their total returns from Louisiana-Pacific bolstered by dividends. Although the company has only been raising its dividend for the last five years, Louisiana-Pacific’s 3-year compounded dividend growth rate is over 17 percent.
Today, the stock yields 1.75 percent with a payout ratio of just 7.23 percent. This low payout ratio gives management a great deal of room for future increases and makes the stock a strong potential candidate for dividend growth investors.
Will LPX Suffer An Economic Bust?
Inflationary pressures have raised the company’s operating costs. At the same time, a decrease in housing starts and falling prices for the company’s finished OSB products have caused revenues to slip. As noted above, this combination of forces has driven the company’s earnings down drastically over the past year.
The market also expects Louisiana-Pacific to see extremely slow growth over the next several years. The rate of compounded earnings growth over the next five years is expected to be just 5 percent.
It’s worth noting, though, that this projection may reflect broader expectations about the real estate and building materials industries. Given Louisiana-Pacific’s excellent return on invested capital, there’s at least a decent chance that the company could outperform analyst expectations.
Should You Follow Buffett Into Louisiana-Pacific?
Louisiana-Pacific appears to be a decent choice for value investors who are comfortable with somewhat higher levels of risk. Although the company’s profitability metrics are extremely attractive, a prolonged period of lower earnings associated with a cooling housing market could cause the stock to stagnate.
Lower OSB prices and higher costs are both likely to continue affecting Louisiana-Pacific for the foreseeable future. As such, the company could see its earnings continue to struggle as a result of macroeconomic factors. Due to its low debt level, Louisiana-Pacific is in a decent position to ride out this challenging period. The company will, however, need to begin growing again to restore investor confidence and drive share prices up.
Dividend growth investors will also likely want to take a close look at Louisiana-Pacific. If the company cannot continue to find growth opportunities for its capital, management will likely choose to distribute cash to shareholders through higher dividends.
Over several years, Louisiana-Pacific’s dividend could rise considerably above its current level. Investors willing to hold the stock could therefore see sizeable yields on cost several years from now.
Ultimately, Louisiana-Pacific appears to be a strong value buy. While there are risks associated with market perception of the stock, the company itself appears to be a very solid investment. Louisiana-Pacific is also likely to benefit from improvements in the economy later in 2023 or in 2024.
If demand for new housing recovers, the materials Louisiana-Pacific makes will be essential to support new construction projects. Given the company’s low debt, high returns, discounted pricing and potential to distribute cash through dividends, the stock could be an attractive buy for many investors.
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