As a relative newcomer to the Australian markets, it only took me a few days to hear oodles about the likes of CSL (ASX:CSL), Wisetech (ASX:WTC) and Xero (ASX:XRO). It took me a bit longer to come across Washington H Soul Pattinson, or Soul Patts (ASX:SOL), which is older than the previous three firms combined.

In my research I saw a couple of articles calling Soul Patts ‘the Berkshire Hathaway of Australia’. To me, that seems a lazy comparison. Soul Patts isn’t fueled by insurance subsidiaries, and what is Berkshire (NYS:BRK.A) without insurance? The two firms do have a few things in common, though.

Both can trace their history back to the 1800s. Both own public and private companies with a staunchly long-term mindset. And both have a solid track record of beating the market.

From pharmacies to much more

Soul Patts started off as a chain of pharmacies but, over many years, morphed into a collection of several investments. As you may know, most of the firm’s net asset value (NAV) stems from long-term holdings in three ASX shares:

Together, these investments account for around 40% of Soul Patts’ total assets. This figure was more like 70% until their takeover of listed investment company Milton in 2021 brought with it with a large portfolio of equities. A decent chunk of this portfolio appears to have been sold and freed up for investment in private assets.

Despite the uptick in diversification and a growing private portfolio, sentiment towards Soul Patts continues to be dominated by the fate of Brickworks, TPG and New Hope. So, how do Morningstar analysts view the prospects and valuation of these shares?

If you aren't familiar with how Morningstar analysts arrive at their Fair Value estimate, Moat Rating, Uncertainty Rating and Star Rating, you can learn more at the foot of this article.

Brickworks ★★★★

Soul Patts has a 43% interest in Brickworks, which comprised around 17% of Soul Patts’ NAV as of 31 January. Brickworks, in turn, owns 26% of Soul Patts in a cross-shareholding initiated in 1969 to protect both firms from hostile takeovers. This predated the current Corporation Act and would not be permitted today. Our analysts are not aware of a similar ownership structure in the ASX 200, and it could help Soul Patts take a longer term view.

Brickworks is a conglomerate consisting of building product manufacturing operations, property management and its 26% shareholding in Soul Patts. Our Brickworks analyst Esther Holloway estimates that about half of the firm’s enterprise value comes from its holding in Soul Patts, 40% from its property segment and less than 10% from its Australian and North American building products businesses.

In conjunction with 50:50 joint venture partner, Goodman Group, Brickworks’ property business is focused on warehouse property development in Western Sydney. This large residential and industrial area has warehouse development potential due to its proximity to Sydney’s major highways and the soon-to-be-completed Badgerys Creek international airport. With an undersupply of warehouses in the area, and Goodman’s established relationships with national and international companies, our analysts are bullish about this opportunity. Its current development in Western Sydney’s Eastern Creek has high quality tenants such as Amazon, Coles, and Woolworths.

Brickworks' building products segment is trying to reinforce its position as the lowest-cost brick manufacturer in its two segments of Australia and North America. Brickworks entered the United States in 2018 via the acquisition of Glen-Gery, a building product company similar to Brickworks. In both geographies, Brickworks follows a strategy of plant rationalization and plant upgrades to improve efficiency, capacity, and sustainability. Product innovation such as a high-end range in bricks, cladding and pavers aids higher gross margins. As a cyclical business, our analysts like Brickworks’ strategy to continuously improve unit costs.

Our analysts do not think Brickworks has a moat. The industrial property sector lacks significant barriers to entry. Meanwhile, Brickworks’ building materials business doesn’t appear to have any scale-based cost advantages, the most common moat source in commodity businesses.

Morningstar’s fair value estimate for Brickworks is currently $31 per share. This comprises discounted cash flow valuations for the firm’s property rental income and building materials segment, and equity valuations for the Soul Patts stake and property joint venture. At a current price of around $26 per share, Brickworks looks undervalued.

New Hope Corporation ★★★

Soul Patts own around 39% of New Hope, having first bought a 50% stake in New Hope Collieries in the 1970s when it was still a private company. As of 31 January, Soul Patts’ stake in New Hope comprised around 16% of its net asset value.

New Hope offers exposure to global energy demand via increasing thermal coal production at a time when many other miners are winding down or selling their thermal coal assets. The strategy relies on demand for high quality thermal coal remaining robust longer-term. The purchase of a further 40% interest in the Bengalla coal mine in New South Wales in 2018 took its ownership of Bengalla to 80% after the company purchased its initial 40% stake in 2016. Along with the development of New Acland Stage 3, this sees New Hope reliant on thermal coal.

Our mining analyst Jon Mills recently raised his fair value estimate for New Hope to $5.90 per share, driven by higher thermal coal prices and a weaker Australian dollar. He does, however, allocate a Very High Morningstar Uncertainty Rating to New Hope. Although New Hope has a strong balance sheet and its mines are in or around the lowest quartile of the thermal coal cost curve, much of New Hope’s fair value is driven by near-term earnings, which are dependent on volatile coal prices. He also sees the potential for lower thermal coal use due to environmental concerns as a longer-term risk.

Due to this Very High uncertainty rating, New Hope shares only have a 3-star Morningstar rating despite currently trading around 15% below Jon’s fair value estimate.

TPG Telecom ★★★★★

TPG Telecom’s merger with Vodafone in 2020 saw it join Telstra and Optus as Australia’s third heavyweight telco. Soul Patts have a 13% equity interest in TPG Telecom, a position arising from its purchase of NBN Television in the 1980s. As of January 31, this investment comprised around 11% of Soul Patts’ net asset value.

Morningstar analyst Brian Han thinks TPG shares screen cheaper than any other company under our telecoms coverage in Australia and New Zealand. Although the rollout of Australia’s National Broadband Network (NBN) poses a real threat to profitability in TPG’s consumer broadband segment, he thinks TPG earnings can recover over the medium term thanks to a more rational mobile market and growth in its fixed wireless and corporate segments.

Our analysts have assigned TPG a narrow moat due to the scale of its fibre infrastructure and existing customer base in Australia. This means that TPG can spread the costs of technology upgrades, advertising and content rights bidding over a large customer base, which reduces per-subscriber costs and puts TPG in a superior position against many competitors. The capital costs required for a new entrant to replicate even a small part of TPG’s infrastructure, scale, and brand power would be prohibitive, especially in a relatively small country such as Australia and a relatively mature industry with low single digit annual growth.

TPG’s shares have been weighed down by slower earnings growth as it invests heavily in rolling out 5G. Han thinks this is more than reflected in the share price, especially given TPG’s longer-term tailwinds from 5G adoption and an increased focus on mobile. At a price of $4.57 on May 27th, TPG shares were around 30% below Morningstar’s fair value estimate of $6.60.

Is Soul Patts undervalued?

Soul Patts’ three biggest investments seem rather cheap. But as I alluded to before, they make up a smaller portion of net assets than was once the case.

As of 31 January, Soul Patts had around $650 million in other strategic long-term holdings, a $2.4 billion portfolio of large-caps and a total of around $3.2 billion across private equity, “emerging companies” and credit investments. The company’s biggest private holdings include electrical engineering company Ampcontrol, several farms under Soul Patts Agriculture, Ironbark Asset Management and Aquatic Achievers, which appears to be rolling up swimming schools across Australia.

As an ASX50 stock with a market value of over $11 billion, Soul Patts is also under Morningstar coverage. Our analyst Esther Holloway assigns it a fair value of $33 per share – of which 20% stems from its investment in New Hope, 17% from its holding in Brickworks and 15% from its investment in TPG Telecom. The balance comes from its other investment holdings. At a current market price of around $32, Soul Patts shares look fairly valued.

Terms used in this article

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.