Whenever they think of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), most investors and analysts think of Warren Buffett (Trades, Portfolio)'s equity portfolio.
Berkshire's insurance business is one of the stars of the group. The conglomerate owns and operates one of the most extensive insurance operations in the world, and can underwrite risks that no other insurer would ever dream of, thanks in part to its large cash balance and the size of Berkshire's equity portfolio.
There's also the group's railroad business BNSF. The size of this enterprise means it is a crucial barometer for business health across the United States.
However, there's one side of Berkshire that does not attract a tremendous amount of attention, even though it should - that's the relatively boring business of Berkshire Hathaway Energy (aka BHE).
Berkshire Hathaway Energy
BHE could be one of the most efficient and well-run utility companies in the United States or even in the world, in my opinion. The business has been part of the wider Berkshire group for two decades now, and during this time, it has made a massive amount of progress.
BHE started out as MidAmerican Energy, which formed in 1995 by the merger of the Iowa-Illinois Gas and Electric Company. Buffett made an offer for the business in October 1999, and Berkshire paid $2.2 billion for the company and assumed $7 billion in debt.
Since the completion of this deal, Buffett has overseen a host of bolt-on acquisitions that have increased MidAmerican's size and scale across the country.
Unlike most public and private utility companies, which return the majority of their earnings to shareholders via dividends, BHE has retained all of its earnings since it was acquired. These retained earnings, which amount to $28 billion according to Buffett's 2019 letter to shareholders, have been reinvested back into the business.
The results of this investment have been outstanding. BHE is now able to offer its customers cleaner energy at a lower cost than all of its competitors. What's more, it has the financial firepower to take on enormous capital spending projects with unrivaled economies of scale. As Buffett explained in his 2019 letter:
"When Berkshire entered the utility business in 2000, purchasing 76% of BHE, the company's residential customers in Iowa paid an average of 8.8 cents per kilowatt-hour (kWh). Prices for residential customers have since risen less than 1% a year...
In contrast, here's what is happening at the other large investor-owned Iowa utility: Last year, the rates it charged its residential customers were 61% higher than BHE's...
The extraordinary differential between our rates and theirs is largely the result of our huge accomplishments in converting wind into electricity. In 2021, we expect BHE's operation to generate about 25.2 million megawatt-hours of electricity (MWh) in Iowa from wind turbines...that output will totally cover the annual needs of its Iowa customers...
BHE has never paid Berkshire Hathaway a dividend since our purchase and has, as the years have passed, retained $28 billion of earnings. That pattern is an outlier in the world of utilities, whose companies customarily pay big dividends – sometimes reaching, or even exceeding, 80% of earnings.
Today, BHE has the operating talent and experience to manage truly huge utility projects – requiring investments of $100 billion or more – that could support infrastructure benefitting our country, our communities and our shareholders."
Capital allocation success
BHE's success and growth is a great case study in capital allocation (and why dividends are not always the best to use of capital).
As an independent public company, it is likely shareholders would have pushed for higher distributions from the business. However, by being part of Berkshire, BHE has been able to retain its earnings and invest in the future. That's helped the firm deliver a better outcome for its owners and customers.
This strategy might not yield results in the short-term, but for business owners that are prepared to take a long-term view, it certainly seems to be the right course of action.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Berkshire 2019 Shareholder Letter: Warren Buffett on Mistakes
- What's Going On wtih Berkshire Hathaway's Stock Repurchases?
- A Look at Berkshire Hathaway's Insurance Performance in 2019
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