Berkshire Hathaway (BRK.A, Financial)(BRK.B) recently reported first quarter results, but with limited recognition by the financial media (beyond headline numbers); this quarter tends to get swept aside due to the annual meeting in Omaha. Let’s take a deep dive and see how 2015 has started for Berkshire.
For the quarter, Berkshire reported a 16% increase in pre-tax earnings, to $7.7 billion (I’ll discuss the segment results shortly). The current period included $1.3 billion in derivative gains (from the company’s equity index put options), compared to $236 million a year ago; as it relates to comparing the two periods, this one-time item was largely offset by the $1.1 billion gain Berkshire reported in the prior year period related to a deal with Phillips 66 (PSX). Those two items are essentially a wash, so the reported numbers are meaningful as a comparison between the two periods. Net earnings increased by 10%, with the difference from pre-tax earnings driven by a higher effective tax rate in the current period (the prior year exchange of PSX shares was structured as a tax-free reorganization, resulting in materially lower taxes on investment gains).
The cash pile continues to be substantial, sitting near $63 billion at the end of the first quarter. Because of $4 billion in acquisitions (Van Tuyl) and another $3.45 billion in capital expenditures (with 75% from BH Energy and BNSF), as well as $500 million in net purchases of both equities and fixed income, investing related cash outflows outpaced cash flow from operations by more than $2 billion. Hopefully that’s a trend that can continue going forward (with the help of large scale M&A or bolt-on deals like AltaLink in late 2014). Warren has noted time and time again since the Van Tuyl deal that they plan on adding more dealerships to the portfolio over time, which provides yet another avenue for intelligently investing capital (though they might face issues in the near term on valuation due to strong industry results).
Operating Segments: Insurance
As we’ve come to expect, GEICO reported another double digit increase in earned premiums in the first quarter, taking market share from competitors; auto PIF’s increased by 361,000.
The underwriting expense ratio continues to decline, falling a tenth of a percent versus the prior year period to 16.9% in the first quarter. However, this was more than offset by a substantial increase in the loss and loss adjustment expense ratio, which jumped to 80.1% of premiums earned from 75.8% a year ago. As noted in the quarterly filing, this was driven by an increase in both frequency and severity in certain markets; as a result, GEICO has begun implementing rate increases. The increase in loss & LAE as a percentage of premiums earned drove the combined ratio to 97%, cutting GEICO’s underwriting gain by more than 50% (to $160 million).
Gen Re reported a 16% decline in premiums written in the quarter, with currency headwinds accounting for the majority of the reported decline. The business reported a small underwriting loss for the period.
Berkshire Hathaway Reinsurance Group (BHRG) also reported a pretty sizable decline in written premiums, entirely due to the fact that they didn’t write any retroactive reinsurance in the quarter (versus $225 million worth in the prior year period). As noted in the 10-Q, more than a third of BHRG’s overall premiums in the quarter came from just three contracts; overall, volumes in the business continue to be constrained due to generally inadequate rates.
Warren spoke about reinsurance at the annual meeting, and wasn’t too optimistic; here’s the response he gave to a question on the topic (per part II of the GuruFocus notes):
“Reinsurance has become a fashionable asset class; it is something you can sell to entities like pension funds. If you go to Bermuda and start a reinsurance company, for example, you can run a hedge fund, too. When you get a whole lot of people bringing money in and they need your reinsurance to cover up what their motivations are [tax related], you're likely to get less attractive prices in reinsurance. That's been happening at a fairly large scale. I expect reinsurance in the next 10 years to not be as good as it has been in the last 30 or so years. It's a business whose prospects have turned for the worst and there's not a lot we can do about it.”
Closing out the insurance operations, Berkshire Hathaway Primary Group (BH Primary) reported a 27% increase in premiums earned in the first quarter, driven by volume increases across the board. The pre-tax underwriting gain outpaced premiums growth (+77%) due to a decline in the combined ratio.
Investment income generated by the insurance operations grew solidly in the first quarter, with help from Berkshire’s investment in Restaurant Brand International preferred stock ($3 billion) in late 2014. Even then, “Net Investment Income” in the current period would be much higher if Berkshire wasn’t so conservative with its boatload of cash & equivalents ($42.4 billion in the insurance operations); waiting for the right opportunities to redeploy these funds rather than chasing short term yield is the right way to approach building long term shareholder value.
Operating Segments: Other
The big highlight for the quarter was early signs of improvement at Burlington North Santa Fe. Revenues increased 3% in the quarter, to $5.6 billion, driven by balanced increases between volumes and average revenue per car. On this slight gain in revenues, pre-tax earnings increased by more than 40%, to $1.67 billion; the difference was due to improved operating performance at the rail, with four of the five expense lines (fuel, purchased services, depreciation / amortization, and equipment rents / materials / other) declining versus the year ago period. In the first quarter, the operating ratio fell by nearly nine points, to 66.3%; for the sake of comparison, Union Pacific (UNP) reported an improvement of 2.3 points in their first quarter results, for an OR of 64.8%.
BH Energy had an uneventful quarter, with revenues increasing marginally versus the year ago period (to $4.33 billion). Gains attributable to the inclusion of AltaLink (reported in “Other Energy Businesses”) and solid results at NV Energy were offset by a 22% decline in revenues at MidAmerican Energy, reflecting a drop-off in regulated natural gas and electric revenues in the quarter (these declines are offset in cost of sales).
Finally, the collection of businesses that Berkshire calls “Manufacturing, Service and Retailing” had a decent quarter as well, with an 11% increase in revenues driving a 17% increase in pre-tax earnings. Improvement versus the prior year period was across the board, reflecting a gradual improvement in end markets, as well as the benefit of lower energy costs in certain businesses.
Conclusion
Shareholders’ equity at quarter end was $241.5 billion; on a per share basis that’s nearly $147,000 per “A” share and $98 per “B” share. The ceiling for repurchase activity (at 120% of book value) is approaching $120 per “B” share. As Warren noted in his 2013 letter, he believes intrinsic value exceeds that percentage book value by a “meaningful amount”.
One final note: in the quarter, Berkshire Hathaway (the parent company) issued €3 billion in debt in the quarter, with the longest duration at twenty years. The interest rate on the 20-year notes was a meager 1.625%, which doesn’t sound too good to my ears – though it’s better than the 1.2% that you can currently receive for lending the Germany government money for thirty years!
If anybody needs a place to park a few million (or billion) dollars for the next two decades, I’ll happily borrow from you at the sky-high rate of 2% per annum; don’t be shy if you’re interested!
