Berkshire Hathaway (BRK.A, BRK.B) reported second quarter financials after the close on Friday, and the results were spot-on. Looking across the entire company, it’s difficult to find an area where Berkshire’s struggling: year-to-date, Marmon is the only segment with lower sales (revenues are down 3%), with every segment reporting operating income growth from the first six months of 2012.
Premiums earned across the insurance businesses increased nearly 10% in the first half (to $20.7 billion), with the underwriting gain over the same period more than doubling, to $2.2 billion. GEICO reported double digit premium growth (as well as a 115% increase in underwriting gain, largely driven by depressed earnings in the previous period due to a change in GAAP accounting related to deferred policy acquisition costs), with the majority of that growth coming from an increase in policies; in the first six months of the year, the company’s added 587,000 auto policies-in-force, good for about half a point of market share gains.
Across the insurance groups, Berkshire reported $4.7 billion in operating income for the first half of the year, with the gains over the comparable period all but entirely driven by underwriting improvements (investment income was unchanged at $2.5 billion). Insurance float at June 30th was $75 billion, an increase of 2.5% from year end, and nearly $10 billion above year end 2010.
Within the filing, the discussion on investment income concluded (as in the first quarter filing) with the following two sentences: “We continue to hold significant cash and cash equivalents balances earning near zero yields. However, our management believes that maintaining ample liquidity is paramount and strongly insists on safety over yield with respect to cash and cash equivalents.” For those individuals who have stretched for yield as of late, and are likely feeling quite giddy for having done so with such prescient timing (see: blind luck), consider this a fair warning from the Oracle of Omaha.
At Burlington Northern, revenues surpassed $10.6 billion in the first half of the year, an increase of more than 5%; a continued improvement in the railroads operating ratio, driven by lower fuel and compensation/benefit costs as a percentage of sales, resulted in double digit operating income growth from the mid-single digit revenue improvement. As always, it’s quite amazing to consider just how brilliant Warren’s purchase of BNSF looks with hindsight; assuming the company can duplicate its first half results, Berkshire’s price tag for the railroad will be right around 6X pre-tax earnings for 2013.
Across the remainder of the company’s operations, there is very little that jumps off the page; in business after business, Berkshire is reporting solid and steady financial improvements. If there’s any part of Berkshire that is prone to unexpected change, it’s the derivative book; in the first half of 2013, derivatives accounted for a gain of $1.67 billion, compared to a marginal loss in the first half of 2012. In 2013, the gains were primarily attributed to changes in the fair value of the company’s equity index put option contracts, reflecting higher equity index values. Derivative gains/losses in any one period are subject to material moves in either direction.
Berkshire ended the quarter with right around $60 billion in cash, equivalents, and fixed income investments, lower than the $74 billion on the book at year end 2012; more than $12 billion has moved from cash to “Other Investments” over this period, where it was transferred to a newly formed holding company that acquired Heinz on June 7th. Those funds will stop earning “near zero yields” and start adding more than $700 million per annum to Berkshire’s coffers.
Another use of cash to date has been equity investments, with the total spend coming to $6 billion; this is a slight increase in pace from fiscal 2012, when $5.2 billion in equity investments were made over the first six months of the year. DaVita HealthCare Partners (DVA) has undoubtedly been a primary source for these funds; at last check, Berkshire owned 15.6 million DVA shares – with a market value exceeding $1.8 billion. Considering that this stake was worth less than $1 billion at year end (per Warren’s shareholder letter), significant additions have been made to Berkshire’s holding of DVA common stock over the past two quarters.
The purchase of Heinz was primarily funded by cash from operations, with the sale/redemption of fixed income & equities actually slowing from 2012 (the $10 billion in equity and fixed income purchases made in the first half of 2013 outnumbered the total dollar value of sales and redemptions by $3 billion). Finally, the managers of Berkshire’s operating companies continue to do their part as well: capital expenditures have resulted in a use of $4.8 billion for the first six months of 2013, up 4.3% from the $4.6 billion spent in 2012.
Since the beginning of the year, shareholders’ equity has increased $14.4 billion, and book value increased 7.6% ($122,900 per “A” share and $82 per “B” share); after adjusting for the $1.2 reductions in shareholder’s equity due to the purchase of additional shares in Iscar and Marmon, the six-month gain in book value per share has exceeded 8% (as noted in the 2012 shareholder letter, Warren, Charlie, and Berkshire’s CFO Marc Hamburg have yet to find an explanation that makes any sense as to why this reduction is required under GAAP). After including a 20% premium to book value, the threshold for share repurchases is just shy of $100 per “B” share.
As I noted in my portfolio review at the start of the year (here), Berkshire is my largest holding, and accounts for one-quarter of my net assets; I have no plans of changing that anytime soon, and completely agree with Charlie's advice from this year's annual meeting-- "Don't be so stupid as to sell these shares".
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.