Berkshire Hathaway (BRK.B) reported third-quarter results after the close on Friday (here); let’s dive in.
Unsurprisingly, the company’s balance sheet looks pristine: Berkshire ended the quarter with ~$62 billion in cash and equivalents, with another ~$29 billion in fixed income securities; Warren Buffett clearly doesn’t have much interest in long-term bonds, with more than 70% (dollar value) due in the next five years and ~28% of the total due in the coming twelve months.
At quarter end, Berkshire’s equities were worth ~$116.4 billion, down a few billion dollars from the end of the second quarter. As expected, four companies – American Express (AXP), Coca-Cola (KO), International Business Machines (IBM), and Wells Fargo (WFC) – accounted for the majority (58%); the company’s Wells Fargo stake, with a fair value of $25.1 billion as of September 30, 2014, singlehandedly accounted for 22% of Berkshire’s equity investments.
As you may remember from the second quarter, Berkshire reported a 41% gain in earnings per share; some adjustments were needed for an apples-to-apples comparison versus the prior year (with the adjusted gain at ~10%). We saw something similar in the third quarter, but in the other direction: as reported, pretax income declined 8.5% to $6.75 billion. However, this included a few items worth calling out: a ~$1 billion swing on gains related to sales and redemption of investments, a $440 million after-tax other-than-temporary impairment (OTTI) charge related to Berkshire’s investment in Tesco (TSCDY), and ~$100 million in higher derivative related gains in the prior year.
Looking at the year-to-date measures and adjusted for the items that skew the year-to-year comparison, operating earnings have increased by ~11%. The gains came from an improvement in ongoing business results, as well as the benefit of M&A (with the most notable example being NV Energy, which I’ll discuss in a minute). 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’s earned premiums exceeded $5.2 billion in the third quarter and have crossed $15 billion year to date; both figures are up ~10% compared to 2013, with the company continuing to take market share (policies-in-force up 7% over the past twelve months). The bottom line was solid as well, with GEICO reporting a combined ratio of 95% in the quarter and under 94% year to date. In the first nine months of the year, GEICO’s underwriting gain has exceeded $1 billion; underwriting expenses over that same period were just 16.5% of premiums earned – astounding.
Of the remaining insurance businesses, we saw activity in the third quarter: earned premiums for Berkshire Hathaway Reinsurance Group (BHRG) more than doubled year over year, to $4.8 billion. In July, National Indemnity (lead insurance entity of BHRG) entered into a retroactive reinsurance agreement with Liberty Mutual, which accounted for $3 billion of the premiums earned; the agreement covers certain asbestos, and workers comp claims, in excess of an aggregate retention of $12.5 billion and subject to a limit of $6.5 billion. Berkshire has been involved in deals like this in the past, including with Chartis and CNA back in 2010.
Float reached $83 billion at the end of the third quarter – up 6% from the third quarter and up 8% since the end of last year; with some help from the Liberty Mutual agreement, Berkshire will defy Warren’s warning of an eventual slowdown yet again in 2014. Berkshire is on pace to report its 12th consecutive year of operating at an underwriting profit in 2014 – with the amount of float more than doubling, from a starting $41 billion, in that same timeframe (CAGR of ~6%).
Despite the increase in float, investment income for the insurance operations was under pressure in the quarter, falling 12% to $950 million. In addition to stubbornly low rates on fixed income securities, Berkshire had $4.4 billion (par) of Wrigley 11.45% bonds that were retired last October; needless to say, the income generated on that $4.4 billion has plummeted since then.
Continuing with the non-insurance operations, Burlington Northern reported 4% revenue growth in the quarter ($5.9 billion), bringing the year to date increase to 5% (with 2% coming from volume and 3% coming from an increase in average revenue per car). Despite a 6% bump in the third quarter, pretax profit has only increased 1.2% in the first nine months of the year, to $4.3 billion. As noted in the 10-Q, Burlington Northern had to deal with weather related issues this past winter, and has been plagued by continuing service issues (they’ve expanded CapEx and hired employees to increase capacity and improve service levels going forward); as Union Pacific (UNP) has noted on their conference calls, they’ve taken business from BNSF in this period as a result. Whether or not BNSF will regain that business over time is still to be determined.
Berkshire Hathaway Energy reported $4.85 billion in revenues in the third quarter, a more than 40% increase versus the prior year (with earnings increasing at an even faster rate). While the inclusion of NV Energy skews the year over year comparison (acquired in December 2013), BH Energy has still reported a 15% increase in EBIT for the first nine months of the year adjusted for its impact. The company’s push into Real Estate Brokerage is starting to show up in a big way: revenues increased 28% in the third quarter, to $900 million; in that same period, earnings before interest and taxes attributable to Real Estate Brokerage increased 60%, to $182 million.
While McLane managed 5% revenue growth in the quarter, pretax margins slipped and the dollar amount of pretax earnings was unchanged (up 4% in the first nine months after adjusting for a small one time gain the second quarter of 2013). Berkshire’s manufacturing businesses had a good quarter, with 8% revenue growth driving double digit pretax income growth; the gains were fueled by bolt-on acquisitions and organic growth at Lubrizol (LSPI) and Marmon (IMI).
Finally, let’s close with an update on book value: Since the beginning of the year, Berkshire Hathaway’s reported shareholders equity has increased 7%, with book value per “A” share up to $144,542 ($96.40 per “B” share). At 120% of book, the repurchase limit is now ~$116 per B share; the stock would need to fall 20% from a recent $145 before Warren could start buying.
Conclusion
At recent levels, Berkshire Hathaway stock has more than doubled in the past three years; it’s been a fun ride. The improvements in the underlying business are likely to continue: in addition to a stable of outstanding operating businesses, Warren will eventually find another opportunity to fire his elephant gun (hopefully another one like BNSF). That’s a potent combination; despite the stock’s recent success, I personally have no interest in selling any shares near current levels.
