After the stock market close last Friday, Warren Buffett's Berkshire Hathaway (BRK.A) (BRK.B) reported its second-quarter results.
Overview
Berkshire ended June with $72.7 billion in cash, up marginally from the start of the year. While cash generation has been strong through the first six months of the year (roughly 10% growth in cash flow from operations to $15.3 billion), this has been more than offset by a cumulative $36 billion spent on acquisitions (primarily Precision Castparts [PCP]) and capital expenditures.
Berkshire was a net seller of equities in the first half of the year, reflecting the June redemption of the company’s Kraft Heinz (KHC, Financial) preferred stock for $8.3 billion. Incremental issuance of long-term debt is the other material item for the bridge to the year to date increase in cash on hand.
The concentration in Berkshire’s four largest equity holdings – American Express (AXP), IBM (IBM), Wells Fargo (WFC) and Coca-Cola (KO) – increased slightly in the quarter; these four stocks, with a combined value at quarter end of $63.3 billion, accounted for 61% of the aggregate fair value of Berkshire’s equities. It’s worth noting that Berkshire’s 26.8% stake in Kraft Heinz, which is not included in the equity bucket, is worth roughly $29 billion (at a recent $88 per share). The fair value of Berkshire’s Kraft Heinz position exceeds the carrying value on the books by more than $13 billion – or roughly $5 per “B” share.
Business summary
As reported, Berkshire had $5 billion in net earnings in the second quarter – up 25% versus the year-ago period. If we account for incremental gains from the investments / derivatives line (driven by the $610 million gain from the redemption of the Kraft Heinz preferred), net earnings increased in the high teens. This comparison does not back out the equity method earnings from Kraft Heinz common, as reported in the “Other” line (recurring item). If we back out investment and derivatives gains / losses as well as the equity income attributable to Kraft Heinz, the year-over-year increase in earnings was in the mid-single digits.
Segment results: Insurance
The insurance businesses reported ~$500 million in underwriting income in the second quarter, compared to a small loss in the year-ago period.
GEICO reported $6.2 in earned premiums for the second quarter, an 11% increase from the prior year. A significant portion of the gain came from premium rate increases that were pushed through in 2015 to account for higher frequency and severity across the business; the remainder came from 4% policy-in-force (PIF) growth, with the growth in new PIFs accelerating in June (and continuing into the start of the third quarter, as noted in the 10-Q).
Loss and loss adjustment expense (LAE) improved slightly versus the prior year due to the rate increases but was still in the low 80s (%). Underwriting expenses, at less than 15% of earned premiums, was the lowest number I’ve ever seen GEICO report (it's consistently moved lower off a trailing five-year average of ~18% of earned premiums). In total, the business reported a 97.6% combined ratio, resulting in $150 million in pretax underwriting income.
GenRe reported a 7% decline in earned premiums in the quarter with significant competition in most P/C reinsurance markets impacting volumes (the business reported an immaterial underwriting gain). In Berkshire Hathaway Reinsurance Group (BHRG), premium growth attributable to the IAG quota share was offset by a tough year-over-year comparison in the Life and Annuity business (BHRG had a single large reinsurance contract in the second quarter of 2015 that resulted in an upfront premium of $425 million).
Berkshire Hathaway Primary Group, a gem in Berkshire’s insurance portfolio, reported 17% earned premium growth in the quarter (to $2.9 billion). The combined ratio, at 90%, worsened by five points, reflecting less favorable prior year development in the current period.
Segment results: Other
As expected, Burlington Northern had a tough quarter; revenues fell 15% (comparable to the first quarter), driven by an 8% decline in volumes. Coal has been particularly difficult with volumes and revenues both falling by more than 30% in the first six months of the year. With revenues falling precipitously, the operating ratio increased by 50 basis points in the quarter, driving a nearly 20% decline in pretax earnings. Until we see an improvement in the energy-related businesses (primarily coal and industrial products), BNSF will continue to struggle.
Berkshire Hathaway Energy had a relatively unimpressive quarter as well with revenue falling 5% to $4.3 billion. A fair portion of the year-over-year decline was attributable to a May regulatory decision at AltaLink that altered the timing to include construction-in-progress expenditures in the rate base billable to customers (applies to related expenditures as well with no impact on earnings). For the quarter, BH Energy reported low-single digit earnings growth.
Revenues in Manufacturing, Service & Retailing increased 9% to $30.6 billion, reflecting the inclusion of Precision Castparts and Duracell (pretax earnings increased 12% to $2.3 billion). If we exclude Precision Castparts and Duracell from both periods, revenues and earnings both declined versus the prior year. Industrial Products was particularly weak, with difficult market conditions at IMC and Lubrizol driving an 8% decline in adjusted pretax earnings (if we back out Precision Castparts).
Finally, in the Finance & Financial Products businesses, revenues increased low double digits in the second quarter to $2 billion, reflecting 15% revenue growth at Clayton Homes (on more than 20% unit growth). Pretax earnings increased by 6% in the segment to $583 million.
Conclusion
At quarter end, shareholders’ equity was $263 billion; this is equal to $160,000 per “A” share and $107 per “B” share. At the repurchase authorization (120% of book value), the company can repurchase its own stock at $128 per share (or 12% below the stock price as of Monday’s close).
Disclosure: Long BRK.B and IBM.
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