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Berkshire Hathaway: Repurchase Limit to $125 Per Share

A review of Berkshire Hathaway's 2015 results

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Mar 01, 2016
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In addition to the release of the shareholder’s letter this past weekend, Berkshire Hathaway (BRK.A) BRK.B) reported fourth-quarter financial results as well – so let’s dive in.

Berkshire ended the year with nearly $72 billion in cash, well above Warren Buffett’s stated minimum of $20 billion. As we know, the company announced a deal to purchase Precision Castparts (

PCP, Financial) for $32.7 billion in cash; that deal closed after year end on Jan. 29.

Fixed income totaled $26 billion at year end, with more than three-quarters due within the next five years. As we’ve seen for some time, Buffett has essentially no interest in long-term bonds.

At year end, Berkshire’s equities were worth ~$110 billion; roughly 60% of the total was held in Wells Fargo (WFC) ($27.2 billion), Coca-Cola (KO) ($17.2 billion), IBM (IBM) ($11.2 billion) and American Express (AXP) ($10.5 billion). In 2015, the undistributed share of earnings attributable to Berkshire from these holdings exceeded paid dividends (which show up in the income statement) by nearly $3 billion. That number is likely to keep climbing higher over time.

During 2015, Buffett bought additional shares of IBM and Wells Fargo. At year end, the unrealized loss on IBM was $2.6 billion. As Buffett noted on CNBC, Berkshire has not sold a single share of IBM. Commentary in the annual report suggests that won’t change any time soon:

We currently do not intend to dispose our IBM common stock. We expect that the fair value of our investment in IBM common stock will recover and ultimately exceed our cost.

Business summary

For the full year, Berkshire generated $24.1 billion in net earnings, an increase of 21% from 2014. As always, the headline figure is of little value: the 2015 results include $6.7 billion in investment and derivative gains, compared to $3.3 billion in 2014. If we back these out, the net increase in earnings from 2014 was roughly 5%. I wrote an article in January that attempted to estimate Berkshire’s earnings power (here); those figures are comparable to the actual results.

Cash flow from operations was nearly $32 billion. Between capex ($16.1 billion), incremental investments in Kraft Heinz (KHC) ($5.3 billion), net equity investments ($1.5 billion) and acquisitions ($4.9 billion), Berkshire found ways to intelligently deploy most of the generated cash. Even with all those uses, it’s likely Berkshire will need to find a BNSF or Precision Castparts every few years to keep the cash pile from growing too quickly. This is a good problem to have.

Segment results

Looking at the segments, “Insurance-Underwriting” was a headwind of ~$530 million to the bottom line in 2015. The first driver was higher claim costs at GEICO: loss and loss adjustment expense was ~82% of earned premiums in 2015, roughly 500 basis points higher than 2014 (driven by both frequency and severity). This offset another improvement in underwriting expenses, which were less than 16% of earned premiums (most of the other large auto insurers are well above 20%). Overall, GEICO reported 11% earned premium growth in 2015, roughly split between higher rates and policies in force. The gecko continues to take market share (now up to 11.4%).

The other headwind in “Insurance-Underwriting” was in the reinsurance business (~$330 million), at Gen Re and Berkshire Hathaway Reinsurance Group (BHRG). For Gen Re (with a similar explanation for BHRG), the annual report included the following commentary:

Insurance industry capacity remains high and price competition in most property/casualty reinsurance markets persists. We continue to decline business when we believe prices are inadequate. However, we remain prepared to write substantially more business when more appropriate prices can be attained relative to the risks assumed.

While the underwriting results took a step back from 2014, the long-term performance of Berkshire’s insurance businesses remains stellar. The insurance businesses reported their 13th consecutive year of underwriting profits in 2015, with an average pretax gain of $2 billion a year over that period. Over that same period, float has more than doubled to $88 billion.

As we look to the rest of Berkshire, profits increased in every other segment/business activity.

The 10% increase in net earnings at BNSF is largely due to service issues in early 2014 that made for a relatively easy comparison (resulting in a nearly 500 basis point improvement in the operating ratio). These improvements were not free: BNSF spent $5.8 billion on capex last year, nearly three times the depreciation charge taken by the railroad (while maintenance capex exceeds current depreciation expense, the gap isn’t that wide). Due to the headwinds caused by low oil and natural gas prices, gains in 2015 will prove short lived: as Buffett noted in the shareholder letter, he expects lower earnings at BNSF in 2016. Guidance from the other Class I rails – most notably Union Pacific (UNP) – suggests similar thinking.

Earnings from the collection of companies under the Berkshire Hathaway Energy (BH Energy) umbrella increased 13% to $2.1 billion in 2015. The vast majority of this increase was attributable to the inclusion of AltaLink, which Berkshire acquired in December 2014.

Manufacturing, Service & Retailing profits increased 5% in 2015 to $4.7 billion. Again, the inclusion of acquired businesses was the primary driver of the year-over-year improvement (in this case, automotive dealership group Van Tuyl and German motorcycle accessories retailer Detlev Louis Motorrad). With the inclusion of Duracell and Precision Castparts in 2016, we’re going to see a substantial increase in Manufacturing, Service & Retailing profits over the next year.

Finally, Finance & Financial Products profits increased 10% in 2015 to $1.4 billion. Clayton Homes had another solid year with strong growth in unit sales (+9%) and improved loan results. Clayton has roughly tripled its market share since being acquired by Berkshire in 2003.

Conclusion

For the full year, book value per share increased 6.4%. For the class “B” shares, book value was roughly $104 at year end; at 1.2x book, Berkshire’s board has authorized share repurchases up to ~$125 per share (the stock closed at ~$134 per share on Monday). Buffett has said he would be “delighted” to repurchase shares at a price that’s ~7% below the current stock price.

Looking at it slightly differently, the stock trades at a low double-digit multiple of normalized after-tax earnings (by my math). As noted in this year’s shareholder letter, Warren and Charlie expect Berkshire’s per share normalized earnings power to increase every year going forward.

Berkshire shares continue to be quite attractive near current levels.

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