Berkshire Hathaway (BRK.B) reported second quarter results after the close on Friday; let’s dive right in.
The balance sheet, predictably, looks pristine: Berkshire ended the quarter with ~$55 billion in cash and equivalents, with another ~$29 billion in fixed income securities; the fixed income investments remain weighted towards the short end, with roughly three-quarters (dollar value) due in the next five years and more than 25% due in the coming twelve months.
At quarter end, Berkshire’s equities were worth more than $119 billion, with just four companies – American Express (AXP), Coca-Cola (KO), International Business Machines (IBM), and Wells Fargo (WFC) – accounting for nearly 60% of the total; the company’s stake in Wells Fargo, with a fair value of more than $25 billion, singlehandedly accounted for more than 20% of Berkshire’s equity book. Berkshire is sitting on nearly $60 billion in unrealized gains.
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In the first six months of the year, Berkshire’s generated nearly $12 billion in cash flow from operations, with half of the funds being reinvested as capital expenditures. To date, Berkshire has purchased just $2 billion of equities, compared to $6 billion in the first six months of 2013; after $3 billion in sales, Berkshire’s been a net seller of equities in 2014. The remaining line items were essentially a wash, which explains the $7 billion increase in cash on the books year to date.
Unsurprisingly, the 41% increase in earnings per share reported for the quarter requires some adjustment for an apples-to-apples comparison. Pretax investment gains in the quarter were $500 million higher than a year ago, and $1 billion higher year to date, related to the transactions with Phillips 66 (PSX) and Graham Holding Company (GHC); these items were partially offset by lower pre-tax gains related to derivate contracts in 2014 than in the year ago period. If we adjust the results for these components, the comparable gain in operating earnings was roughly 10%.
As usual, we need to look at the operating segments to get a better view of the underlying business trends; let’s start with the insurance businesses.
GEICO reported more than $5 billion in premiums earned in the quarter, and just shy of $10 billion year to date; both figures are up more than 10% from 2013, with the company continuing to take market share. The bottom line was solid as well, with GEICO reporting a combined ratio well under 95% in the quarter and year to date. It’s pretty astounding to consider that GEICO’s ad spending might exceed $1 billion in 2014; the company spent $935 million on advertisements in 2013 – nearly three times the average spend of the remaining auto insurers in the top ten.
The remaining insurance businesses collectively reported premiums that were flat with the year ago period (declines related to the Swiss Re contract in Berkshire Hathaway Reinsurance Group masked premium growth at General Re and BH Primary Group). Year to date, those three groups reported underwriting gains of ~$600 million, with BHRG accounting for the majority of the decline. Particularly in BHRG, volumes remain constrained as Berkshire waits for better pricing.
Float reached $78.5 billion at the end of the second quarter – up from $77 billion at year end and continuing to defy Warren’s warning of an eventual slowdown. Berkshire is on pace to report its 12th consecutive year of operating at an underwriting profit in 2014 – with the amount of float nearly doubling, from a starting $41 billion, in that same timeframe (a CAGR of ~6%).
Burlington Northern reported 7.7% revenue growth in the quarter, bringing the year to date increase to 5.4% (with contributions from both price and volume). Pretax profit growth slightly lagged revenue growth in the quarter (+5.3%) and was essentially unchanged in the first six months of the year ($2.6 billion). As noted in the quarterly filing, and has been covered in the press, the business has been negatively impacted by adverse weather conditions and service-related challenges to date. As the company has worked to address operating issues, compensation and benefit expenses has outpaced revenue growth in the quarter and year to date. While concerning, this comment from Union Pacific (UNP) CEO Jack Koraleski on the company’s second quarter call suggests this is likely to be a temporary issue:
“In all likelihood, as the BNSF service returns, and they're able to take the business back, it's going to shift back to them.”
Berkshire Hathaway Energy reported $4.2 billion in revenues in the second quarter, from $3 billion in the year ago period (with earnings moving considerably higher as well); while the inclusion of NV Energy (which was acquired in December 2013) skews the year over year comparison, BH Energy still reported a solid 10% increase in revenues in the second quarter after accounting for the acquisition. Year to date, Berkshire Hathaway Energy has reported double digit EBIT growth, with the inclusion of NV Energy boosting the gain to +25%.
McLane and Berkshire’s manufacturing businesses have pulled their weight as well, with combined pre-tax earnings growth of 14% year to date; the gains were largely driven by the Manufacturing businesses, with bolt-on acquisitions and organic growth at Lubrizol (LSPI) and Marmon (IMI) pushing revenues and earnings higher in the quarter. The company’s retailing businesses also reported solid profit growth – but they’re simply too small to move the needle.
Finally, let’s close with an update on book value: Since the beginning of the year, Berkshire Hathaway’s reported shareholders equity has increased $12 billion (+5.6%) to $234 billion, with book value per “A” share up to $142,483 ($95 per “B” share). At 120% of book, the repurchase limit is now $114 per B share; the stock currently trades at roughly 1.3X book (~$126).
Berkshire Hathaway continues to be my largest position – and there’s little here to suggest that will change; if anything, it might become larger with a bit of help from Mr. Market.
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.