Berkshire Hathaway (BRK.B) (BRK.A) is unlikely to repeat the 19.8% returns it enjoyed from 1964-2011 due to its size and because it has already bought up many of the most desirable investment opportunities in the marketplace. However, Berkshire should continue to generate solid growth and performance due to its mix of high quality businesses that it owns as well as its well-regarded portfolio of marketable securities. Berkshire's share price is now trading at a 36% premium to its Q3 2013 book value and 33% if investors assume that it will earn the same $2,757 in EPS for Q4 2013 that it did in Q4 2012. As Berkshire's share price is well over the 1.2X book value that Buffett has targeted for share repurchases, investors should not expect that Berkshire will be buying back shares unless its P/B drops by ~10%.
- Tilson valued Berkshire's pre-tax earnings stream (excluding investment income) at a P/E multiple of 8X.
- Tilson excluded 50% of the earnings from Berkshire's insurance businesses for purposes of conservatism.
- Tilson added up all of Berkshire Hathaway's gross cash and investments per share (excluding the impact of manufactured housing and other real estate loans originated or purchased).
- Tilson then divided that sum by Berkshire's weighted average outstanding Class A share equivalents.
Sources: Whitney Tilson and Our Estimates
Based on this model, I arrived at an annualized pre-tax adjusted EPS of $9,858, which represents a value of $78,861.50 per share to account for Berkshire's adjusted earnings power. Tilson arrived at $125,045 in gross cash and investments per share as of Q3 2013. After adding up these two valuation parts, this analyst arrived at an intrinsic value of $203,906.50 for Berkshire's Class A shares ($136/share for Class B shares). Berkshire's Class A shares traded at $173,000 recently and its Class B shares traded at $115 recently. This represents an implied fair value price to book of 1.61X, which shows that my valuation of Berkshire Hathaway is relatively within line of Whitney Tilson's intrinsic value and validates my thesis that Berkshire's share price is 15%-17% undervalued. Berkshire has also put some of its low-yielding cash to work based on the following deals that it struck this year:
- Berkshire teamed up with 3G in its recent acquisition of Heinz. 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.
- Berkshire's MidAmerican Energy Holdings division is also spending $5.6B in cash to acquire Nevada's largest utility company NV Energy (NVE). This deal will close in Q1 2014 and we discussed Berkshire's utility operations in a separate report.
- Berkshire's Marmon division announced it would acquire the beverage dispensing and merchandising operations of British engineering company, IMI plc for $1.1B and this deal will close in early 2014.
- Berkshire acquired the remaining 20% non-controlling interests in IMC Metalworking Companies (Iscar Metalworks) for $2.05B in April 2013
- Berkshire acquired 16% of the non-controlling interests in Marmon for $238M in June 2013 and will acquire the remaining 8.3% minority interest in Marmon in Q1 2014 based on Marmon's FY 2013 operating results.
Burlington Northern Santa Fe
BNSF continues to generate solid performance. BNSF's revenues in Q3 2013 increased by 5.76% in comparison to Q3 2012's revenues and reflected higher average revenues per car/unit of approximately 1% as well as a 4% increase in cars/units handled ("volume"). Q3 2013 revenue growth was due to increased volume for consumer products (6% volume growth) and industrial products (12% growth), and coal volume (7% growth) which were partially offset by declines in agricultural products (5% decline).
- Industrial products volume increased primarily because of significantly increased shipments of petroleum products.
- Agricultural product volumes declined due to decreases in grain exports as a result of the drought conditions in the U.S. in 2012 and strong global competition
- Coal volume growth was a result of higher natural gas prices and reduced utility stockpiles, partially offset by the impacts of weather, including flooding on the network.
Opposition to the Keystone Pipeline by Buffett's cronies Dickie Holland and Former Senator Ben Nelson (D-Nebraska) helped ensure that BNSF would be able to benefit from the fracking activity in the Bakken formation. BNSF increased its railroad car volume by 4% year-over-year in YTD 2013 and its revenue per car by 1% even when taking into account a 4% increase in fuel surcharges. BNSF endured incrementally negative operating leverage as its operating costs increased by 6.41% in Q3 2013. This was due to reductions in accruals for environmental and personal injury costs in 2012 and to higher property taxes and material expenses in 2013. The division's net earnings increased by 5.55% year-over-year in Q3 2013 versus Q3 2012 as BNSF's higher interest expenses ended up offsetting its lower effective tax rate.
Source: BNSF's SEC Filings
Berkshire Manufacturing, Service and Retailing
Berkshire's Manufacturing, Service and Retailing businesses' revenue grew by $3B in Q3 2013 versus Q3 2012 and reached a total of $24B. This was driven by the August 2012 acquisition of Meadowbrook Meat Company by McLean Company. Berkshire's collection of manufacturing businesses grew by 10.8% and its operating income increased by 13.6%. Forest River RVs generated strong revenue growth on the strength of higher prices and sales volumes. Berkshire's apparel businesses generated 15% pre-tax earnings growth while Iscar and Lubrizol registered 5% pre-tax profit growth.
Berkshire Finance and Financial Products
Manufactured Housing and Finance earnings were $119M for Q3 2013, an increase of $64 million (116%) compared to Q3 2012. Q3 2013 earnings benefited from lower loan loss provisions and an increase in net interest income. The reduction in interest income on Clayton Homes' loan portfolio was more than offset by lower interest expense due to a decline in average borrowings and lower interest rates. Clayton Homes' results in 2013 benefited from a year-to-date 9% increase in units sold.
Furniture/transportation equipment leasing's pre-tax earnings increased $20M (20%) in YTD 2013 versus YTD 2012. The increases primarily reflected increased lease revenues and earnings of XTRA, which benefited from increases in working units and average rental rates, relatively stable operating expenses and foreign currency related income in Q2 2013.
Investment and Derivative Pre-Tax Gains/Losses were $$2.14B in gains for Q3 2013 versus $799M of gains in Q3 2012. The sharp year-over-year increase in investment gains primarily relates to its investment in GE and Goldman Sachs common stock warrants and Wrigley subordinated notes.
Berkshire's Insurance Operations
GEICO had mixed performance during the quarter. GEICO generated solid high single-digit revenue growth during 2012 and enjoyed 11.55% revenue growth in Q3 2013. Although GEICO's underwriting expenses increased at a narrower rate (87bp) versus its 11.55% revenue growth, its losses and loss adjustment expenses increased by 20.3% ($611M) due to increased claim frequencies for property damage and collision coverage(s). This resulted in GEICO's pre-tax underwriting gain declining by $128M year-over-year.
General Re's revenues grew by 62bp but its underwriting profit declined by 59% as improved underwriting from its life and health insurance operations was not enough to offset $124M in catastrophe losses from Europe hailstorms.
Berkshire Hathaway Reinsurance Group's Q3 2013 revenue declined by 14% year-over-year as all of its units saw double digit revenue declines during the quarter except for its life and annuity unit (up 46%). This resulted in its Q3 2013 underwriting losses widening by 102% ($104M) year-over-year. However, its YTD 2013 underwriting profit of $1.16B greatly exceeds its YTD 2012 underwriting profit of $320M.
Berkshire Hathaway Primary Group is the smallest division of Berkshire Hathaway's insurance operations. Premiums earned in the first quarter by BH Primary aggregated $867M in Q3 2013 and $588M in Q3 2012. The increase was primarily due to the inclusion of GUARD and increased workers' compensation insurance volume from the Berkshire Hathaway Homestate Companies and increased premium volume from several other primary group business units. BHPG's primary insurers produced underwriting gains of $99M in Q3 2013 versus $121M in Q3 2012.
Berkshire Hathaway Insurance's Net Investment Income increased by 17.5% during Q3 2013 as higher dividends earned and received were amplified by higher income taxes. Partially offsetting these tailwinds were lower interest rates on cash balances and fixed income holdings. Unfortunately for Berkshire, Q4 2013 investment income will not include interest from the Wrigley 11.45% subordinated notes ($4.4 billion par), because of the repurchase of those notes and because future investment opportunities will generate considerably lower yields.
In conclusion, Berkshire Hathaway's share price is undervalued by 15% relative to its fair intrinsic value and its business units continue to generate steady profit growth. Investors should view Berkshire Hathaway as diversification away from traditional stocks and bonds as well as 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". Berkshire Hathaway's continued ability to increase its book value on a recurring basis is impressive and as it continues to do so, the investment community with recognize the value of Berkshire's shares. Berkshire has set an implicit floor price for its shares through its December 2012 buyback and that it is adapt at sheltering its income from the taxman. Even though Buffett has slowed down a step relative to his younger and that Berkshire will not be able to enjoy the 19.8% compounded annual growth it enjoyed from 1964-2011, Berkshire's future total return should be able to exceed that of the S&P due to its strong portfolio of diversified businesses.
Source: Berkshire Q3 2013 10-Q