Net income per share for the third quarter more was $2,087 per A share, more than triple the net income recorded in the third quarter of 2008. However, because net income includes the effects of investment and derivative gains and losses, it is more meaningful to focus on operating earnings per share rather than net income per share.
For a number of reasons, the “headline numbers” reported when Berkshire releases quarterly results are often misleading. For more introductory information regarding the nuances of Berkshire’s quarterly reporting, please refer to coverage of second quarter results.
Book Value Hits Record High
Book value per A share on September 30, 2009 was $81,247, which was up 10.1% for the quarter. Book value includes the impact of both realized and unrealized investment and derivative gains and losses. It must be noted thatour estimate for Berkshire’s book value was far too conservative. The estimated range for book value was between $78,500 and $79,200 which is well below the reported results. It should be noted that Berkshire’s book value was at a record high on September 30. Whether book value has much meaning for valuation purposes was discussed in a previous article.
Insurance Results
Berkshire Hathaway management evaluates insurance underwriting and investment results separately. Underwriting results are the responsibility of each subsidiary’s management while investment results are handled by Berkshire’s corporate management under CEO Warren Buffett’s supervision.
Underwriting
Berkshire’s insurance subsidiaries posted after tax underwriting gains of $363 million in the third quarter and $665 million year to date compared to $81 million and $622 million of underwriting gains in the third quarter and first nine months of 2008 respectively. GEICO, General Re, Berkshire Hathaway Reinsurance Group, and Berkshire Hathaway Primary Group all posted underwriting gains for the third quarter and the first nine months of 2009.
GEICO’s underwriting profits continue to lag the results posted last year despite higher levels of premiums earned and an increase of 662,000 voluntary auto policies-in-force since the start of the year. This was due to a higher loss ratio for both the third quarter and first nine months of the year compared to prior year periods. In addition, underwriting expenses increased due to higher policy issuance costs and higher salary and employee benefit expenses.
Underwriting results at General Re improved for both the third quarter and year to date compared to the same periods in 2008 in large part due to a quiet Atlantic hurricane season which reduced catastrophe losses compared to the third quarter of 2008 which covered the period when Hurricanes Ike and Gustav made landfall.
In the section of the report covering Berkshire Hathaway Reinsurance Group, it is interesting to note that the company continues to constrain the volume of business written. Earlier in the year, this reduction in volume was partially due to Berkshire’s temporary decline in net worth. However, even though net worth has reached record highs, Berkshire plans to continue to constrain premium volume due to the impending acquisition of Burlington Northern Santa Fe. In addition, premium rates have not been attractive enough to warrant increasing volume, demonstrating Berkshire’s continued underwriting discipline. As noted recently, a “hard” insurance market is nowhere in sight.
Investment Income
Net investment income increased by 20.6% to $976 million compared to $809 million for the third quarter of 2008. The improvements continue to reflect Berkshire’s large investments in Goldman Sachs, General Electric, Wrigley, Swiss Re, and Dow Chemical which were made at various points over the past year. This improvement has been partially offset by lower earnings on cash equivalents due to very low interest rates as well as lower cash balances.
Utilities and Energy
The Utility and Energy group posted net earnings attributable to Berkshire of $346 million for the third quarter which is 6.8% higher than the results for the prior year period. For the first nine months of 2009, the group posted net earnings of $802 million, a decline of 5.4% compared to the first nine months of 2008. The group was impacted by lower revenues due to the decline in average per-unit cost of natural gas sold along with declines in electricity demand at PacifiCorp due to the ongoing recession.
Few people realize that MidAmerican owns the second largest real estate brokerage in the United States. The real estate group’s revenues have declined in 2009 compared to 2008 levels. However, earnings have actually increased this year reflecting lower commission costs and other operating expenses. The real estate group has seen lower sales prices but this has been somewhat offset by higher transaction volume. Much of this is probably due to government stimulus efforts and particularly due to the $8,000 first time buyer tax credit which has recently been extended and expanded.
Manufacturing, Service, and Retailing
Berkshire Hathaway’s operating companies continue to be heavily impacted by the global economic recession. The group posted earnings of $336 million for the third quarter, a decline of 49.5% compared to the third quarter of 2008. For the first nine months of 2009, the group posted earnings of $833 million, a decline of 55.5% compared to the first nine months of 2008.
All business units with the exception of Retailing, which had flat results, posted declines in pre-tax earnings for the third quarter compared to the prior year. For the first nine months of 2009, all units except for McLane have reported declines in earnings as well. NetJets continues to depress the results of the “Other Service” group with a 41% decline in revenues for the third quarter compared to the prior year period. Additionally, NetJets has produced pre-tax losses in the third quarter of $183 million and $531 million for the first nine months of the year. However, “green shoots” may be emerging. Management is hoping for a modest profit at NetJets in 2010 barring further deterioration of the economy and an absence of punitive regulations aimed at private aviation.
From a high level perspective, it is encouraging to note that Marmon, Shaw, and the Other Manufacturing units have reported higher revenues and pre-tax earnings in the third quarter compared to the second quarter. To again use an overused expression, perhaps there are “green shoots” emerging in light of these quarter-to-quarter comparisons.
All Things Considered, A Solid Quarter
Many early articles on third quarter results are loudly stating that Berkshire Hathaway managed to triple earnings compared to the third quarter of 2008. Such loud proclamations of success are no more enlightening than the proclamations of doom earlier this year when year-over-year net income fell significantly. Operating earnings are a much better measure to focus on and by this measure, Berkshire Hathaway did indeed produce very solid results for the quarter under the circumstances. With book value per share at a record high, it appears clear that the company has navigated the worst economy since the Great Depression very well.
To gain insight into Berkshire Hathaway’s performance, it is critical to look behind the headline numbers and the consolidated financial statements. Examining segment revenues and profitability can reveal facts that aggregate statistics obscure. In the current environment, it is particularly useful to examine quarter to quarter results of the reporting segments in order to spot turning points in performance. To facilitate this review, we have prepared an Excel workbook with two spreadsheets. The first sheet shows Berkshire’s revenues over the past seven quarters and the second does the same for pre-tax earnings. This file can be found under the resources listed below.
Ravi Nagarajan
[www.rationalwalk.com]
Ravi Nagarajan is a private investor and writer focusing on the application of value investing techniques to find securities trading well below the intrinsic business value. Ravi has over 14 years of experience in the financial markets and started investing on a full time basis in 2009. Over the past 13 years, Ravi held a number of executive level positions in the commercial software industry. Ravi graduated Summa Cum Laude from Santa Clara University with a degree in finance. Visit his website www.rationalwalk.com.
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User Comments:
1. Dew_nay says on Nov 07, 2009 at 2:36 AM:
A few things here. BRK has not been priced as low as it is today based on price to book value. Less than a ratio of 1.3. Stripping out the impact of derivatives which cause the headline numbers to swing from quarter to quarter, its operating businesses are all doing fine, and as you said, solid considering the current environment. We can see the uptick in the results for its utilities and manufacturing arm of businesses compared to Q2 - a sign that the worst could have been avoided for the economy though retail still seems weak in terms of revenue.
Lastly, the only major equity BRK seems to have added is Wells Fargo. They had increased their holdings for WFC by $277 million or about 10.72m shares.
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