Warren Buffett's annual letters to Berkshire Hathaway (BRK.A, news, msgs) shareholders are always a fun read. My favorite line from this year's? "Charlie (Munger) and I enjoy issuing Berkshire stock about as much as we relish prepping for a colonoscopy."
Yet that is exactly what Buffett did (issue stock, that is) when he directed Berkshire Hathaway to buy the railroad company Burlington Northern Santa Fe.
However, stock was not enough to close the deal. Berkshire also paid $16 billion in cash, raising half that amount by issuing debt. In addition, it assumed Burlington's $9.7 billion debt. The transaction caused Berkshire to lose its coveted triple-A credit rating.
Buffett's purchase is a huge bet on America's long-term economic health. It's also a bet that oil prices, which once again are closing in on $100 a barrel, will remain elevated for years to come. After all, when it comes to moving freight, high oil prices give trains a considerable cost advantage over trucks.
Buffett, of course, is the consummate long-term investor. Given the 30% premium Berkshire paid for the 77% of Burlington shares it did not already own, Buffett might have to exercise more patience than usual before this deal pays off for shareholders.
I wish Buffett and his shareholders lots of luck in the railroad business. In the meantime, I would rather buy stocks that the "old Buffett" might have preferred.
Let's begin with just one word: plastics.
One Hefty play
Pactiv (PTV, news, msgs) is one of my current favorites. The company makes food-packaging products for consumers and food-service businesses. These products include plastic sandwich bags commonly found in school lunchboxes, as well as plastic clamshells that supermarkets use to package berries and other fruits. It also makes plastic kitchen garbage bags. Hefty is the company's best-known brand.Last year, Pactiv generated revenue of $3.4 billion. Because more than 90% of that amount came from within the U.S., the company has only minimal exposure to the risks of a strengthening dollar.
However, Wal-Mart Stores (WMT, news, msgs) was responsible for 21% of sales. Indeed, Wal-Mart's dominant market position represents one of the most significant risks Pactiv faces. Just a few weeks ago, Wal-Mart threatened to remove Hefty-branded food storage bags from its shelves. Fortunately, the dispute was quickly resolved. Hefty bags will remain on Wal-Mart's shelves. In addition, Pactiv will make bags sold under Wal-Mart's cheaper Great Value brand.
Rising raw material prices represent a second major risk. Because plastics are made from chemicals derived from crude oil and natural gas, higher crude prices could squeeze Pactiv's profit margins. Therefore, by recommending this stock, I am taking a decidedly opposing position to Buffett's wager that oil prices will remain elevated for the long term. The stock is cheap, selling for just 11 times expected 2010 earnings.
