(BRK.A), (BRK.B)
Fresh off his purchase of Kraft in conjunction with 3 G Capital, Warren Buffett looks to have an even bigger target in the sight of his famed “elephant gun.”
News that Berkshire Hathaway is acquiring aerospace manufacturer Precision Castparts Corp. (PCP) for roughly $37 billion highlight’s Berkshire’s continued pursuit of companies with durable advantages that create a wide moat. While manufacturing for aerospace doesn’t have the same moat as a regulated utility or a railroad, it still has a huge barriers to entry due to the high cost of manufacturing specialized parts, and the unlikelihood that a customer will switch suppliers once a plane begins its production run. In short, it’s just the sort of company Warren Buffett loves.
What Buffett also must love just as much is Precision Castparts’ annual growth rate of 23% over the past ten years.
The deal will be Berkshire’s biggest ever, topping its $26 billion purchase of BNSF Railway in 2009.
Berkshire already owns 3% of the Portland, Oregon-based company.
About the Company
Precision Castparts manufactures structural investment castings, forged components, and airfoil castings for aircraft engines and industrial gas turbines. It is a world-leading producer of complex forgings and high-performance alloys for aerospace, power generation, and general industrial applications, and its customers include Airbus, Boeing, GE, and Rolls-Royce, among others.
With annual revenues of approximately $10 billion, the company reported $2.412 billion of revenue in the second quarter of 2015. Of that revenue, 72% came from aerospace, 15 % came from power, and 13% came from general industrial and other sales. Operating margins in the last quarter were a healthy 25.7%. The company has a 15% return-on-equity.
The company has 29,350 employees at 157 manufacturing plants.
Management in Place
Unlike both Heinz and Kraft, where 3G Capital took on the duties of replacing senior management, Berkshire is likely to leave Precision Castparts’ management in place. After all, traditionally that has been one of Berkshire’s acquisition criteria, stating “Management in place (we can’t supply it).”
In the case Precision Castparts, the company has a strong leader in CEO Mark Donegan, who during his thirteen years at the helm has led the company to an 11-fold return. Among his strengths, Donegan has a keen eye for the type of “bolt-on” acquisitions that Buffett likes.
Why It’s a Great Buy for Berkshire
With the Great Recession now in the rear view mirror, airlines are placing large orders to replace aging fleets. Those orders, which are primarily to Airbus and Boeing, benefit Precision Castparts, as it supplies key components to both the A320neo and 737 MAX.
Doubling the Market
While Precision Castparts manufactures everything high-pressure blades for power generators to medical prosthetics, it is complex metal components for the aerospace industry that not only brings in the majority of its revenues, but also offers solid opportunities for growth.
As large as the commercial market for jets already is, it is expected to double by 2030 due to strong demand from India and China. By 2030, the Asia-Pacific market is expected to grow to 30% of all world-wide passenger mileage.
Boeing predicts that 38,050 new aircraft with a total value of $5.6 trillion will be needed in the next two decades. Roughly 10,500 commercial jets are needed just to replace fleets of old, fuel-guzzling aircraft that are aging out of service.
Locking in a Customer
With the needs of the aerospace market highly specialized, whether its engine turbine blades, or the large wing ribs for the Airbus’s giant A380, there is very little company switching among airplane manufacturers. Witness its relationships with both engine makers Pratt & Whitney and GE that go back over 45 years. Berkshire is assured of solid growth in an industry that is highly technical, needs manufacturing on a mammoth scale, and has high cost barriers to entry for potential competitors.
© 2015 David Mazor
Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.