After a a year of saying Berkshire Hathaway (BRK-A) (BRK-B)was no value, I'm thinking it just may be getting there.
In July 2008, I said:
Wholly-owned subs such as Shaw Industries, Clayton Homes, Jordan's Furniture (the are 4 furniture companies), Benjamin Moore, Home Services and Acme Brick and directly tied to housing and will suffer in the downturn.
For all its holdings, Berkshire is essentially an insurance company. It has operated under "perfect" conditions for the last two years according to Buffett and eventually to run must end. Premiums are already falling and as houses are re-poed and fewer new cars are purchase, insurance premiums derived from those products will fall accordingly. I know people who are looking at homeowners and auto policies for way to decrease coverage and save money. Whether or not this is a good idea is irrelevant (I do not think it is), it is happening. Throw in a hurricane or two (we are due) and insurance could suffer quite a poor year.
For more on Berkshire's insurance read this former post:
Back in March when shares sat at $133,000 I argued they were not a "value". Today they sit at $111,000. Are they a value now? Perhaps but one also has to expect that the near term, if Tilson is correct is fraught with potholes for Berkshire and earnings ought to take a hit.
Based on that, share price ought to suffer also meaning you will probably be able to pick them up cheaper down the road. If I owned shares would I sell? If I needed the money in the next year, yes. If I had a multi-year time frame would I sell? No. If that was the case I would be watching down the road for a cheaper entry price, I think you'll get it.
What has happened since then?
Berkshire agreed to purchase $150 million of 10 1/8% notes due in 2015 and $250 million of 10 3/8% notes due in 2018 from Birmingham, Ala.-based Vulcan. The note sale was reported in late January, but Vulcan didn't identify the buyer of the notes until Tuesday's earnings conference call.
Other recent Berkshire bond purchases include $300 million of Harley Davidson Inc. (HOG) 15% notes due in 2014 and $150 million of Sealed Air 12% notes due in 2014.
These purchases follow big transactions in the fourth quarter, when Berkshire purchased $5 billion of 10% preferred stock from Goldman Sachs (GS) and $3 billion of 10% preferred from General Electric (GE). Both those deals came with a sizable amount of equity warrants. During October, Berkshire also bought $4.4 billion of 11.45% subordinated notes and $2.1 billion of 5% preferred stock issued by Wrigley, which was purchased by Mars in a leveraged buyout.
One deal that Buffett probably regrets is his agreement to purchase $3 billion of convertible preferred stock in Dow Chemical Co. (NYSE:DOW) if it goes forward with its deal to buy chemical maker Rohm & Haas Co. (ROH) for $15 billion. Berkshire's purchase is contingent on the consummation of the deal.
Buffett may be hoping that the deal dies, or that Dow comes back to Berkshire with more generous terms to get a larger investment from Berkshire if Dow goes forward with the deal. Dow is resisting completion of the transaction, arguing that the debt that it would have to take on would be ruinous financially. As it stands, the Dow convertible preferred that Berkshire agreed to purchase will carry an 8.5% interest rate and a conversion price around $40, way above Dow's current share price of $10.
If we do some simple math, Bekshire has put roughly $17.9 billion to work at 10%. That will provide Berkshire $1.7 billion a year for the next three years (some of it may convert to equity at that point). When one considers Berkshire has earned $7.8 billion of the last 12 months (Q4 2008 numbers not released yet), Buffett's recent moved will add 21% to those earnings.
Now, insurance. Yes as stated above, the party is over but, rates are scheduled for increases. As insurance companies look to cover losses in investment portfolio's, the aggressive pricing that has taken place in the past few years will abate, causing industry rates to rise. Also, one should expect those insurance companies feeling the pinch to take fewer larger risks. Since this is an area Berkshire loves to play in, fewer players will mean stronger pricing power on the part of Berkshire.
We will not a resurgence to the "glory years" in insurance, but conditions for the first time in a few years will improve. Remember, Berkshire is essentially an insurance company, since that business seems to have stabilized, being the best of that lot, we must assume Berkhsire has.
Berkshire's investment portfolio has been hurt this year by the weak showing of some of its major equity investments, Wells Fargo (NYSE:WFC), U.S. Bancorp (NYSE:USB), Kraft (KFT), Coca-Cola (NYSE:KO) and Procter & Gamble (NYSE:PG). While prices here are depressed, there is no permanent impairment to earnings and that is a point being missed by folks. To believe these companies will be at depressed prices 3 years from now means the global economy will not recover. If you believe that, buying any equity is a waste of time.
Berkshire is big holder of those three companies' shares and it also is short $37 billion of long-dated put options on the S&P 500 and other equity indexes. As the market has dropped, Berkshire has taken a charge to earnings (no cash) in the write-down of the value of these options. When the market rises, the opposite will happen (write-up). Again, to assume no improvement here implies US business is stagnant for the next decade.
Now, Berkshire is down roughly 33% since my fist post on it. The difference now is that several of its businesses are showing signs of life and Buffett has put billions to work at 10% vs the pittance is was getting previously in Treasuries.
The next piece of the puzzle is the Berkshire manufacturing businesses listed above. They will turn when the economy does. If you believe that is the 2nd half of this year, the time to buy is now. If you believe that is 2010, you have time to wait.
Will Berkshire go lower? I do not know but I do know that there isn't a good reason for it to go much lower barring further dramatic worldwide economic collapse.
Time will tell but I think Berkhsire at its current levels do not have much more downside....
Disclosure ("none" means no position):Long WFC, none