Berkshire Hathaway (BRK.A) (BRK.B) reported third-quarter results after the close on Friday (here). The company ended the first quarter with nearly $85 billion in cash and equivalents.
Through the first nine months of the year, Berkshire has reported more than $25 billion in cash flow from operations. In addition, Berkshire has been a net seller of both fixed income ($1.8 billion) and equity ($14.8 billion) securities through the first nine months of the year (the latter includes the redemption of $4.6 billion in Wrigley preferreds in the third quarter, as well as the redemption of $8.3 billion in Kraft Heinz [KHC] preferreds earlier in the year). Finally, Berkshire has added an incremental $11 billion in long-term debt. These sources of cash total more than $50 billion, compared to $9.4 billion for capital expenditures and $30.8 billion for M&A.
The equity portfolio has struggled, with the value at end of the second quarter nearly $10 billion lower than at the start of the year. The four largest positions – Wells Fargo (WFC), Coca-Cola (KO), IBM (IBM) and American Express (AXP) – accounted for 60% of the equity portfolio at quarter end. The market value of Berkshire’s position in Wells Fargo has fallen by more than $5 billion since the first of the year.
As always, remember that Berkshire’s investment in Kraft Heinz common isn’t included in this bucket. The 26.8% of Kraft Heinz owned by Berkshire is held on the books at $15.7 billion – compared to a fair value at quarter end of $29 billion. By my math, Berkshire’s net investment in Kraft Heinz has been less than $10 billion.
Business summary
Berkshire reported $7.2 billion in net income in the quarter, down 24% from a year ago. Through the first nine months of the year, net income declined by 4% to $17.8 billion.
As always, one-time items are impacting the comparative results. In this year’s third quarter, “Investment and Derivative Gains” were a $2.5 billion headwind (relative to the third quarter of 2015). Adjusted for this line item, earnings increased 3% in the current period. Digging into the segment results will provide a more telling picture of what has happened so far this year.
Segment results
The insurance businesses reported $270 million in underwriting income in the first quarter, down by one-third from a year ago; year to date, underwriting income from Berkshire's insurance operations has declined by roughly 4%.
Earned premiums at GEICO increased by double digits in the quarter and through the first nine months of the year, suggesting continued market share gains. Just over half of the increase in earned premiums is attributable to higher average premiums per policy, driven by rate increases taken in 2015 to account for higher frequency and severity across all major coverages.
As noted in the 10-Q, auto new business sales were up double digits in the quarter, with GEICO adding 276,000 voluntary auto policies-in-force (PIF). This shouldn’t be too surprising. With auto insurers raising rates to cover rising costs, customers have an incentive to shop around. Those seemingly endless GEICO ads drive rate quotes – and ultimately new business.
Loss and LAE expenses remain high relative to historic results (at 82.4% of earned premiums) but improved sequentially. With a bit of work, we can see that the rate increases taken in 2015 are having an impact. Adjusted for storm-related losses in both periods, the loss ratio in the first nine months of the year was roughly 100 basis points lower than in the comparable period of 2015.
After accounting for underwriting expenses (15.5% of earned premiums), GEICO reported an underwriting margin of roughly two points in the quarter (98% combined ratio). Compared to a year ago, the underwriting margin was more than cut in half, driving a 47% decline in GEICO’s pretax underwriting gain (year to date, GECIO’s underwriting gain has increased 17%).
Revenues at Burlington Northern declined 8% in the quarter, improving the year to date decline in revenues to -12% (roughly split between lower volumes and average revenue per car). Coal continues to be a major headwind for BNSF with volumes and revenues down 27% and 33% through the first three quarters of the year. Despite the substantial dropoff in the Coal business, it has still accounted for roughly 17% of BNSF’s revenues in 2016.
Operating expenses continue to decline at a slower pace than revenues with the operating ratio (the inverse of operating margin) increasing 100 hundred basis points year to date (to 66.4%). The combination of lower revenues and tightened margins has driven a nearly 20% decline in BNSF’s net income through the first nine months of the year. Based on the forward looking statements from Union Pacific's (UNP) third quarter conference call, don’t expect much of a turnaround by year end.
At Berkshire Hathaway Energy (BH Energy), revenues have declined 3% through the first nine months of 2016 to $13.6 billion (increased 1% in the third quarter). The largest driver of the year-to-date decline was a $350 million headwind at NV Energy (SRQ, Financial), attributable to lower retail rates resulting from lower input costs. Interestingly, net earnings at BH Energy have increased 8.5% through the first nine months of the year, compared to pretax earnings growth at less than half that rate. The growing difference between pretax and after-tax earnings growth is attributable to production tax credits from wind-powered electricity generation within BH Energy.
The Manufacturing, Service and Retailing segment reported another quarter of double-digit growth in revenues and earnings, largely attributable to the inclusion of Precision Castparts (PCP, Financial). The inorganic growth more than offset ongoing end market weakness for IMC, Lubrizol and Marmon.
Finally, Finance & Financial Products profits increased 11% in the quarter, slightly faster than the high single-digit growth through the first nine months of the year. Solid results continued at Clayton Homes, with revenues and units sold both up more than 20% over the first nine months.
Conclusion
At quarter end, book value was $109 per “B” share – an increase of 5.3% since the start of the year and an increase of 8.4% over the past 12 months. With the buyback limit currently at 120% of book value, the board has authorized repurchases up to $131 per “B” share. With the stock currently at $146 per “B” share, Berkshire Hathaway trades at roughly 1.35x book value.
Berkshire offers attractive risk-adjusted returns for long-term investors.
Disclosure: Long Berkshire (BRK.B, Financial), IBM and Union Pacific.
Start a free seven-day trial of Premium Membership to GuruFocus.
