Wesco reported net income per share of $1.39 for the third quarter and $6.01 for the first nine months of 2009 compared to $2.27 for the third quarter of 2008 and $8.21 for the first nine months of 2008. The company’s results continue to be impacted by weakness in the CORT furniture rental business and Precision Steel’s industrial businesses. In addition, investment income in 2009 has been negatively impacted by lower short term interest rates as well as reduced dividends from Wells Fargo and U.S. Bancorp. These negative developments were partially offset by improvements in underwriting results at the insurance subsidiaries.
Wesco’s balance sheet continues to show significant liquidity and little use of debt. Shareholder’s equity per share at September 30 increased to $353.78 per share, up 5.9% from $333.96 at the beginning of 2009. The increase in equity has been mainly due to increases in the fair value of Wesco’s equity investments. Let’s take a closer look at Wesco’s three reporting segments.
Insurance
Wesco’s insurance segment includes Wesco-Financial Insurance Company and Kansas Bankers Surety Company. Written reinsurance premiums for the third quarter increased by $28.6 million, or 61% over the results for the third quarter of 2008. Year to date, written reinsurance premiums increased by $32.8 million, or 14% compared to the first nine months of 2008. Much of the difference appears to be accounted for by increases in premium volume attributable to Wesco’s participation in the reinsurance transaction between Berkshire Hathaway and Swiss Re. In 2008, Wesco entered into an agreement with National Indemnity (NICO), another Berkshire subsidiary, to assume 10% of NICO’s quota share reinsurance of Swiss Re. Earned premiums associated with the Swiss Re contract were $71.8 million for the third quarter and $203.5 million for the first nine months of 2009, which was 45.1% and 74.1% higher than the figures reported for the respective prior year periods.
Written primary insurance premiums for the third quarter were $2.4 million, a 53.1% reduction from written premium volume for the third quarter of 2008. Written primary insurance premiums for the first nine months of 2009 were $7.4 million, down 54.2% from the first nine months of 2008. This was mainly due to a decision by Kansas Bankers Surety Company to exit its line of bank deposit guarantee bonds. This decision was discussed in The Rational Walk’s coverage of Charlie Munger’s annual letter to shareholders. Mr. Munger included a detailed explanation for this decision in his letter. Our view is that the move shows considerable underwriting discipline given that bank deposit guarantee bonds accounted for a large portion of Kansas Bankers overall business.
The insurance segment posted after tax underwriting losses of $2.035 million for the third quarter, which is better than the after tax underwriting loss of $6.2 million for the third quarter of 2008. For the first nine months of 2009, after tax underwriting profits were $1.074 million compared to an underwriting loss of $4.1 million for the first nine months of 2009. As noted in the introduction, investment income has declined compared to prior year periods due to a combination of lower interest rates on cash deposits and the impact of dividend cuts at Wells Fargo and U.S. Bancorp.
Furniture Rental
CORT Business Services is the only national player in the “rent to rent” furniture industry. The business is very sensitive to overall economic conditions and business formation. Needless to say, the economic climate in 2009 has not been favorable for CORT. Segment net income for the third quarter was $18,000 compared to $5.1 million for the third quarter of 2008. For the first nine months of 2009, segment net income was $592,000 compared to $14.7 million for the first nine months of 2008. On the bright side, third quarter revenue was only down 9.9% from the third quarter of 2008 and year to date revenues were down 4.4% compared to the first nine months of 2008. The company is aggressively seeking to reduce operating expenses given uncertainty regarding the timing of a return to economic growth.
Industrial Segment
Precision Steel Warehouse and its subsidiaries posted a segment net loss of $186,000 for the third quarter compared to segment profits of $521,000 for the third quarter of 2008. For the first nine months of the year, segment loss was $859,000 compared to segment profits of $1.42 million for the first nine months of 2008. Revenues for the quarter declined 41.7% compared to the third quarter of 2008. Year to date revenues were 41.4% lower than for the first nine months of 2008. The industrial segment operates on low gross profit margins and has significant fixed operating costs. Despite management’s attempts to trim expenses, 2009 results have been poor due to decreases in revenues and high fixed costs. A return to economic growth appears to be required in order for this segment to return to solid profitability.
Wesco Common Stock Trading Below Book Value
Investors will note that Wesco’s common stock closed at $334 per share on Friday, November 6 and book value at September 30 was $353.78 per share. Since Wesco is a majority owned subsidiary of Berkshire Hathaway, many investors often compare Wesco to Berkshire. Berkshire currently trades at a premium to book value while Wesco trades at a discount. Does this make Wesco a better value than Berkshire?
Aside from the fact that the two companies are vastly different in terms of business activities and investments and simply cannot be directly compared, investors should note what Charlie Munger had to say about this question in his latest letter to shareholders published on February 25, 2009:
Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but- smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value’s intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway.
All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations.
Disclosure: The author has no direct position in Wesco common stock. However, the author owns shares of Berkshire Hathaway which owns 80% of Wesco.
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. Softdude2000 says on Nov 08, 2009 at 7:50 AM:
I read couple of annual reports of Wesco and Munger said in both that BRK is better than Wesco. So I stopped following Wesco completely. Do you have any idea on intrinsic value of Wesco and at what price it is attractive buy?
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2. Rnagarajan says on Nov 08, 2009 at 8:21 AM:
I have not come up with a specific IV estimate for Wesco. However, it is worth noting that tangible book value (subtracting goodwill) is around $315/share. I would consider it highly unlikely for Wesco to have an IV under tangible book value, or in fact under book value. However, I have never considered a purchase of Wesco primarily due to my already large existing indirect exposure via Berkshire.
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3. Batbeer2 says on Nov 08, 2009 at 10:09 AM:
A calculation of Wesco IV by one Charles Munger:
The foregoing $266-per-share book value approximates liquidation value assuming that all Wesco's non-security assets would liquidate, after taxes, at book value. Probably, this assumption is too conservative.....
Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in effect, an interest-free ""loan'' from the government equal to its deferred income taxes on the unrealized gains, subtracted in determining its net worth. This interest-free ""loan'' from the government is at this moment working for Wesco shareholders and amounted to about $99 per Wesco share at yearend 1999.
After the value of the advantage inhering in the interest-free ""loan'' is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share. This approximation is made by simply adding (1) the value of the advantage from the interest-free ""loan'' per Wesco share and (2) liquidating value per Wesco share. Others may think differently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share. Thus, if the value of the advantage from the interest-free tax-deferral ""loan'' was $20 per Wesco share at yearend 1999, and after-tax liquidating value was then about $266 per share (figures that seem rational to the writer), Wesco's intrinsic value per share would become about $286 per share at yearend 1999......
All this tells me Munger believes Wesco as a going concern is worth significantly more than book.
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