Re: RAL, I also would characterize this as a classic Buffett business.
My opinions:
Economic characteristics are fantastic, except maybe for reinvestment/growth opportunities (they may be excellent as well, I'm just not knowledgeable enough to feel sure). But even without the ability to reinvest all the free cash flow, the business is still great for owners as long as the excess goes to dividends or share buybacks (at good prices).
Management has been doing the right things for the past 5 years or more by eliminating investments in lower-return businesses. If they continue on this path and do the right things with all the free cash flow they are now generating, I will be an ecstatic owner.
I think $18 to $20 is an excellent price; maybe even fantastic. My conservative estimates are:
$425 to $450 million cash flow from pet food operations before debt service.
subtract $150 million debt service, leaving
$275 to $300 million free cash flow.
Add $150 to $250 million for owner earnings on investments,
get $425 to $550 million owner earnings (trailing 12 mo.).
If correct, P/E for price of $19.50/share ($5.87 billion)
is 10.7x to 13.8x. Yield is 1.4%
I estimate they should be able to grow at a rate of at least 11% without reinvesting much of the free cash flow in either business expansion or share buybacks. Of the $275 million free, they are now paying $85 million in dividends (1.4%). I'm assuming they could at least double the dividend to (roughly) 3.0% and still grow at an 11% or faster rate, which means a price of about 14x earnings should provide an annual return of just below 14% on a 5- to 10-year horizon investment.
Again, $19.50/share is 10.7x to 13.8x my estimate of trailing 12 mo. owner earnings, so my conservative annual return estimate for a 5- to 10-year holding period is about 14%.
I think all these assumptions are conservative. Based on the expected return, its predictability, my understanding of the opportunity, and my experience in looking for similar opportunities, I expect to find fewer than 10 opportunities as good or better than this over a typical decade. Based on the rarity of the opportunity, I have purchased what for me is a small-to-medium-sized position for the portfolios I manage at price below $19.50/share. If through further analysis of intangibles like management quality and growth potential my confidence in the predictability or in a higher growth rate increases, I may buy more, making it a solid medium-sized position. I don't believe at this time that I will ever be convinced that the conservatively-estimated expected growth rate is high enough for me to take a large postion (vs. medium). This is again based on my expectation that there will be a few opportunities in the next decade to buy businesses with even better economic characteristics and predictability.
I would appreciate reading others' opinions regarding the accuracy of these estimates, the validity of my assumptions, and the quality of my reasoning.
Thanks,
Brendan |
