We don't see Warren Buffett, Todd Combs and Ted Wechsler repeating the 19.8% returns that Berkshire Hathaway (BRK.B) enjoyed from 1964-2011 due to its size and the fact that it has already bought up many of the most desirable investment opportunities out there. However, we think that Berkshire will continue to chug along to solid growth and performance as if it was one of its Burlington Northern Santa Fe railcars. We were particularly impressed with the performance of BNSF, which generated the best combination of revenue and profit growth during the year of any of Berkshire's business units. However, investors will want to keep their eye on BNSF as two of its competitors (CSX Corp. (CSX) and Norfolk Southern (NSC)) had put up soft sales and profit performance recently. Berkshire generated nearly $22.8B in increased book value during 2012 even after buying back $1.3B worth of stock and after accounting for acquisition of minority interests in Berkshire's subsidiaries. This resulted in a 14.6% increase in book value during the year. Berkshire's share price is now trading at a 39% premium to its Q4 2012 book value.
If we project that Berkshire will earn at least $3.5B in net income in Q1 2013 and another $3.5B from net other comprehensive income (unrealized gains on its investment securities), then BRK.B is trading at a 34% premium to its estimated Q1 2013 book value. We're not expecting Berkshire to buy back any shares in FY 2013 as its share price is well over the 1.2X book value that Buffett has targeted for share repurchases. At the same time, we agree with Morningstar analyst Greggory Warren and hedge fund manager Whitney Tilson that Berkshire is worth between 1.6X and 1.8X book value and that there is at least 20% upside remaining in Berkshire, especially with its recent alliance with 3G in acquiring Heinz (HNZ). Heinz shareholders overwhelmingly approved its acquisition by Warren Buffett's Berkshire Hathaway and 3G Capital recently. At the closing of the transaction, Heinz shareholders will receive $72.50 in cash for each share of common stock they own, in a transaction valued at $28 billion, including the assumption of Heinz's outstanding debt. Berkshire put up $4.4B in common equity and $8B in preferred stock that will yield 9% in dividends and should give Berkshire's net investment income a boost by cashing in low-yield cash and fixed income securities to buy the Heinz 9% preferred stock.
Burlington Northern Santa Fe
BNSF saw solid performance during the quarter and year to date. BNSF's revenues in 2012 increased by 6.58% in comparison to 2011's revenues and reflected higher average revenues per car/unit of approximately 4% as well as a 2% increase in cars/units handled ("volume"). 2012 revenue growth was due to increased volume for consumer products (4% volume growth) and industrial products (13% growth), which were partially offset by declines in coal volume (4% decline) and agricultural products (3% decline). Industrial products volume increased primarily as a result of increased shipments of petroleum products, as well as increased sand shipments. We maintain that Buffett's opposition to the Keystone Pipeline helped ensure that BNSF would be able to benefit from the fracking activity in the Bakken formation. BNSF increased its railroad car volume by 2% year-over-year in Q3 and its revenue per car by 4% even when taking into account a 6% increase in fuel surcharges. BNSF enjoyed positive operating leverage, which resulted in operating costs only increasing by 4.12% in 2012. This positive operating leverage enabled the division to generate 13.5% profit growth in 2012 versus 2011 even though interest expenses increased at a faster rate (11.25%) than revenues (6.58%).
Source: Berkshire FY 2012 10-K
Berkshire Manufacturing, Service and Retailing
Berkshire's Manufacturing, Service and Retailing businesses' revenue grew by $10.85B in 2012 versus 2011 and reached a total of $83.255B. This was driven by the August acquisition of Meadowbrook Meat Company by McLean Company and the inclusion of Lubrizol revenues in this quarter versus last year. The Lubrizol acquisition was announced on March 14th, 2011 and completed on September 16th, 2011. Berkshire's collection of manufacturing businesses grew by 26% year over year, but 6% if we exclude the impact of the Lubrizol acquisition. Forest River RVs generated 27% revenue growth on the strength of higher prices while BRK's building products operations and apparel operations registered 4% and 5% revenue growth respectively. However, revenue declines were posted at CTB, Scott Fetzer and ISCAR Metalworking. The good news was that this division's pre-tax profit grew by $1.1B (21.8%) however it should be noted that this was primarily due to acquisitions.
MidAmerican Energy Holdings Company
Berkshire owns an 89.8% ownership interest in MidAmerican Energy Holdings Company. MidAmerican's revenues and operating income saw a slight growth in the quarter and in the year-to-date periods versus last year's levels. Real estate brokerage revenues are also included in this segment and saw strong 32% revenue growth due to a 16% increase in sales transactions closed as well as inclusion of newly acquired businesses. Berkshire's HomeServices of America subsidiary had also acquired the Prudential and Real Living real estate brokerage franchises from Brookfield Asset Management (BAM).
Source: Berkshire 2012 Annual Report
Revenue growth at the PacifiCorp regulated utility operations was offset by revenue declines from MidAmerican Energy Holding's non-regulated businesses due to the declines in natural gas prices. PacifiCorp's revenue growth was primarily due to higher retail revenues of $244M, which were due to higher prices approved by regulators across most of PacifiCorp's jurisdictions of $222 million, as well as to increased revenues from renewable energy credits. In 2012, PacifiCorp also experienced higher customer load in Utah due to the impacts of hot weather, partially offset by lower industrial customer load in Wyoming and Oregon as certain large customers elected to self-generate their own power. We can see why Berkshire bought PacifiCorp from Scottish Power in 2006 as all the states it operates in have population growth rates over the last decade, which exceeded the US average national population growth rate over that time period.
Source: U.S. Census 2010
Berkshire Finance and Financial Products
Manufactured Housing and Finance revenues inched upward by 2.8% in 2012 as higher unit sales volumes have been offset by lower average selling prices. Pre-tax earnings from the division have shown strong growth rates exceeding 66% in 2012 due to increased manufacturing operations efficiencies, lower insurance claims and reduced credit losses
Furniture/transportation equipment leasing revenues grew by 2% and pre-tax income declined by 5% as strength in its CORT furniture leasing business was offset by weakness in its XTRA transportation equipment leasing operations. CORT's growth was due to increased rental income and higher operating margins. XTRA's weakness was due to flat revenues, higher depreciation expenses and lower foreign currency gains.
Investment and Derivative Gains/Losses were positive in 2012 versus the losses in 2011. The company benefited from the absence of $2.1B in derivative losses from last year and booked $3.4B in pre-tax investment securities gains this year.
Berkshire's Insurance Operations
GEICO's performance continues to be the stabilizing force for Berkshire's insurance operations. GEICO generated solid high single-digit revenue growth during 2012. GEICO's revenue growth was coupled with losses growing at a much lower rate than revenues and this enabled GEICO to generate strong double digit underwriting profit growth during the year.
General Re's revenues inched upward by 2.85% but saw reduced catastrophe losses and this enabled the division to generate a 46.5% growth in pre-tax underwriting profit for 2012 ($355M in 2012 versus $144M in 2011).
Berkshire Hathaway Reinsurance Group's performance during 2012 was better than 2011. BHRG enjoyed 5.75% revenue growth good news and the combination of reduced losses and higher revenues helped the business go from recording a $714M pre-tax underwriting loss in 2011 to generating a $304M pre-tax underwriting gain.
Berkshire Hathaway Primary Group is the smallest division of Berkshire Hathaway's insurance operations. It saw strong revenue and underwriting profit growth on the strength of increased volume of workers' compensation insurance from the Berkshire Hathaway Homestate Companies and premiums from Princeton Insurance Company.
Berkshire Hathaway Insurance's Investment Income sagged by 4.44% during 2012 due to the redemptions of Berkshire's preferred stock holdings in Goldman Sachs and General Electric, as well as low interest rates on its liquidity holdings.
In conclusion we are satisfied with the performance from Berkshire Hathaway. We see our investment in the company as not only a diversification away from traditional stocks and bonds, but also being able to utilize a high-quality asset manager to gain access to private equity businesses that are not leveraged to the hill in order to pay dividends to some self-styled "Master of the Universe." We were impressed that Berkshire has been able to increase its book value by $22.8B in 2012 and we believe that as it continues to do so, we will see the value in Berkshire realized by the investment community on behalf of Berkshire's investors. We are also pleased that Berkshire has set an implicit floor price for its shares through its December buyback and that it is adapt at sheltering its income from the taxman. We believe that even though Buffett has slowed down a step relative to his younger self and that Berkshire will not be able to enjoy the 19.8% compounded annual growth it enjoyed from 1964-2011, we expect that it will be able to exceed that of the S&P due to its strong portfolio of diversified businesses.
Source: Berkshire 2012 Annual Report
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.