Berkshire Hathaway (BRK.B) reported third-quarter results last week, so I figured it was worth taking a closer look.
As usual, the reported profits for Berkshire as a whole don’t provide any useful information: reported pretax profits for the quarter more than doubled year over year to $14 billion (you might remember that they fell 35% in the second quarter). This reflects a few one-time items, most notably a large gain attributable to Kraft Heinz (KHC, Financial) (triggered due to share issuance for the merger). Adjusted for investment gains / losses and derivatives, Berkshire reported ~$6.6 billion in pretax profits in the quarter – a decline of 4% year over year. On the same basis, the company has earned roughly $18.5 billion in pretax profits through the first nine months of the 2015 (flat year over year), or ~$7.50 per “B” share.
Operations: insurance
GEICO reported an increase in earned premiums of ~12% in the second quarter, picking up pace from the first half of the year. After some issues over the previous 90 days, GEICO moved back in the right direction with a ~95% combined ratio in the third quarter. The company is still dealing with a higher than normal loss and LAE ratio, which was at 80% in the quarter (and 81% year to date).
As noted in the quarter, they continue to push for higher rates when necessary. On underwriting expenses, GEICO crushed it in the quarter: the ratio fell to 15.1% of earned premiums, down 160 basis points from the prior year period; as far as I know that’s the lowest figure it has ever reported (by a wide margin). Solid cost controls helped drive ~$260 million in underwriting profits for GEICO in the quarter, in line with a year ago.
Volume remained relatively weak across the reinsurance businesses, with Berkshire Hathaway Reinsurance Group showing a substantial decline in earned premiums as it laps a $3 billion retroactive reinsurance contract with Liberty Mutual in the prior year. In total, Gen Re and Berkshire Hathaway Reinsurance Group reported $370 million less in underwriting profits than it did in the prior year quarter; through the first nine months of the year, that number is north of half a billion dollars. These “losses” are a cost of doing business when rates are inadequate.
Berkshire Hathaway Primary Group continues to show strong gains, with earned premiums up 26% year to date (to $3.95 billion) due to continued volume growth. The pretax underwriting profit increased 49% over the same period, to $566 million (+31% in the quarter).
Cumulatively, the insurance businesses reported a $643 million pretax underwriting gain in the quarter – down by a third from a year ago, but a nice sequential improvement from a small loss in the second quarter. Insurance float at quarter end was $86.2 billion, up 4% from a year ago.
Net investment income from the insurance operations increased 3.5% in the quarter to $840 million, with help from RBI 9% Preferred Stock. The insurance businesses continue to hold ample liquidity ($43 billion of cash and equivalents at quarter end). As has been the case for a long time, Berkshire continues to favor short duration fixed income securities: ~75% of fair value is held in securities that mature within five years, with ~30% due within the next 12 months.
Operations: Other
Despite some top line weakness (revenues fell 5% to $5.6 billion), BNSF reported an 11% increase in pretax profits due to outsized declines in operating expenses (notably fuel). The company reported an operating ratio in the low 60’s, in-line with best in class peers. Unlike Union Pacific (UNP), where volumes have fallen 5% through the first nine months of the year, BNSF has reported a small gain in volumes. Based on the commentary from UNP’s conference calls, this reflects a bounce back from BNSF’s service issues in 2014 more than anything else.
As in the second quarter, the improvement in BH Energy’s top and bottom line results was largely attributable to the inclusion of AltaLink (as well as strong results in “Real Estate Brokerage”). For 2015, BH Energy is on pace to report more than $3.5 billion in pretax profits; that’s an increase of ~100% from where Berkshire’s Utilities and Energy business was in 2010.
Manufacturing, Service and Retailing reported another 5% increase in pretax earnings in the third quarter, primarily reflecting the inclusion of Berkshire Hathaway Automotive (Van Tuyl).
Conclusion
Berkshire ended the quarter with $63 billion in cash and equivalents. Against ~$24.1 billion in cash flow from operations (flat year over year), Berkshire has spent ~$950 million on fixed income investments (net), ~$3 billion on equity investment (net), ~$11.8 billion on capital expenditures (up 16% year over year) and ~$4.8 billion on M&A (primarily Van Tuyl). In total, uses of cash exceeded cash generated from operations in the first nine months by ~$1.7 billion. Inclusive of the spending to acquire newly issued shares of Kraft Heinz, outflows have outpaced inflows by $7 billion year to date; when Warren, Charlie, Todd, Ted and Berkshire’s managers can find ways to intelligently redeploy billions in excess capital, I’m a happy guy.
The Precision Castparts (PCP) deal will draw another ~$23 billion from Berkshire’s coffers (plan is to borrow the other ~$9 billion), and add another ~$2.5 billion in pretax profits to the income statement; the quarterly filing suggests this deal should close by the first quarter of 2016.
Berkshire’s equity holdings have had a tough year so far: the top four holdings (58% of the total) were worth nearly $6 billion less at the end of the third quarter than they were at the end of 2014 (and this doesn’t adjust for additional purchases year to date). The filing singled out IBMÂ (IBM, Financial):
“Unrealized losses at Sept. 30 included approximately $2.0 billion related to our investment in IBM common stock, which represented 15% of our cost. IBM continues to be profitable and generate significant cash flows. We currently have no intention of disposing of our investment in IBM common stock. We expect that the fair value of our investment in IBM common stock will recover and ultimately exceed our cost.”
In the third quarter, book value on the company’s “B” shares crossed $100 per share. The repurchases authorization is now at ~$121 per share, roughly 10% lower than where shares traded on Monday. I’ll reiterate what I said in the second quarter (and at other times in the past): if Mr. Market was feeling generous, I would happily buy more BRK.B near those levels.
Berkshire continues to be my largest position – and that won’t be changing any time soon.
