On Friday November 1, Berkshire Hathaway (BRK.B) reported quarterly results that were a bit weaker than analysts were looking for. In this article, I will go over the results and look at Berkshire's valuation.
The company reported operating income (which ignores gains and losses on derivatives and investments) of $2,228 per class A share (BRK.A), missing estimates of $2,400 while revenue beat by about $1 billion at $46.54 billion. The main weakness came at Berkshire's insurance unit where its underwriting profits fell from $392 million last year to $170 million this year. Insurance companies, including the likes of AIG (AIG) and Metlife (MET) in general have reported disappointing third quarter results.
With the rush of hedge funds into the reinsurance sector, there have been reports that pricing has deteriorated significantly, making the business less profitable. Berkshire's results appear to have been hit by this with reinsurance premiums dropping by 20% and an underwriting loss of $206 million from $102 million last year. GEICO also saw a decline in underwriting profits from $435 million to $307 million. Last year, Berkshire reported extremely strong underwriting results that were close to being unsustainable, making this an extremely difficult comp. However, I would continue to watch reinsurance results as underwriting profits may be depressed for a prolonged period thanks to the rash of new money. There likely needs to be a catastrophe that wipes out some of this fast money to restore the market to equilibrium.
Its non-insurance units performed exceptionally well, growing operating income by 12.5% to $2.78 billion. Burlington Northern profit growth did decelerate to 3% but margins remained strong. MidAmerican continues to perform well, growing 8% while Berkshire's consumer businesses continue to benefit from a generally stronger U.S. economy, growing double-digits. Berkshire's operating companies continue to perform well.
Turning to its balance sheet, equity Investments grew by roughly $3 billion in the quarter to $105 billion, which would suggest that Buffett has not initiated any major positions in the quarter (unless he was concurrently selling another) and follows his comments that the market is not nearly as attractive as it has been in the past few years. Shareholders' equity has grown $20 billion to $211 billion or $85 per class B share. Buffett also remains awash in cash with $43 billion, well above his target of $25 billion, giving him ample ammunition to make an acquisition or major investment.
Based on these results, Berkshire looks poised to deliver strong results at its operating companies so long as the economy remains decent. I expect growth above 10% through next year as they've shown no sign of deteriorating. I do believe investors should watch insurance results carefully. GEICO's results really broke trend and are out of step with other auto insurers who reported fine numbers. Auto figures can be especially fickle and transitory. Premium revenue was strong, and I expect underwriting profits to rebound in line with revenues. Reinsurance is more of a concern as profits could be stressed for the foreseeable future due to weak pricing. I do not expect much of a rebound in this unit given market fundamentals. I expect Berkshire's non-insurance units to outperform its insurance units over the next year. Together with insurance close to flat and operating units up 10%, I would look for EPS of roughly $6.50 in 2014.
Given the strength of these units, I would assign a forward multiple of 15x, giving Berkshire's operating business a value of $97. Berkshire has notes payable and insurance losses liable of $130 billion, against cash of $43 billion and investments of $166 billion. This gives Berkshire a net cash and investment position of $79 billion. Buffett has stated he likes $25 billion on hand in case of catastrophe losses, giving a net cash position for shareholders of $54 billion or $22 per share. Combined, Berkshire Hathaway is worth $119 per share, or 3% above current levels. I do not add the $25 billion in cash to the share price because it is necessary to operations, functioning like PP&E, and is included in the operating value of $97.
Berkshire remains marginally below its intrinsic value. Given the strong fundamentals of the company, I would be comfortable owning shares but would not initiate or add to a position here. The fact that this quarter "missed" expectations could overhang shares. Berkshire bulls should hope the results drag down shares so they could be bought cheaper when there is more margin of safety as the quarter does not undermine the bullish thesis underpinning this behemoth. Its operating units continue to perform exceptionally and it remains awash in cash and investment. This quarter confirms all is fine at Berkshire, though investors should watch the reinsurance unit, and I would look to add or initiate a position at $110 or lower.