Berkshire Hathaway: Signs Of A Shining And Balanced Portfolio That Must Continually Rebalance

| About: Berkshire Hathaway (BRK.B)

Summary

The second quarter results rivet the underlying balance in the Portfolio that evenly counteracts the headwinds from energy & utilities while gaining tailwinds in insurance under-writing (automotive).

The acquisition of Precision Cast Parts' business clearly outweighs the down-signs in Railroad, which suffers from the upstream weaknesses in freight movement.

Moving out of non-renewable energy at the right time and moving into long-term value generating assets is a rebalancing process that must continue.

After Ben Comston's analysis, it would appear that we have all the answers on the Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) second quarter. But I will try to cover some added points.

The results have been quite stunning to say the least given the current environment. It rivets Berkshire's position as the most balanced portfolio among all the conglomerates of the world. First of all, the results by themselves stand tall as given below:

All earnings after taxes in $ Million (taken from 10-Q)

2016

2015

2016

2015

Q2

Q2

H1

H1

Operating Earnings (After Taxes)

4607

3890

8344

8134

Investment Earnings (including Derivatives)

394

123

2246

1043

Net attributable to Shareholders

5001

4013

10590

9177

Click to enlarge

The Operating Earnings can be further broken down in the following table into its constituent elements:

2016

2015

2016

2015

Q2

Q2

H1

H1

Insurance Underwriting

337

-38

550

442

Insurance Investment Income

978

977

1897

1852

Railroad Utilities & Energy

1254

1465

2479

2931

Other Businesses

1889

1679

3466

3091

Other

149

-193

-48

-182

Operating Earnings

4607

3890

8344

8134

Click to enlarge

Berkshire's continuous efforts to rebalance its portfolio led to the acquisition of Precision Cast Parts. It is one of the reasons the second quarter looks different from last year.

At the outset, it must be said that the second quarter gains from Precision Cast Parts did not appear in the second quarter of last year (acquired in January 2016). So to start with the revenue line and income line has a big boost from PCC. But my analysis shows that PCC is actually on a strong wicket.

70% of PCC revenues come from the Aerospace Industry, so it is better we see how the industry analysis stands.

PCC: An analysis of the Aerospace Industry

I will begin by looking at the three most important indicators of the aerospace industry. The first one is the order backlog and how it has been growing as is shown in this series taken from the AIA website. The backlog number has grown from $219 Billion in 2004 to a formidable $732 Billion in 2015.

Year

2005

2015

Backlog of Orders in $ Billion

219

732

Click to enlarge

The second is the capacity utilization of the important segments, of which the most important would be to look at the parts manufacturing segment as is provided in this series. If I take the period 2004 to 2015, the capacity utilization in the aircraft and parts segment has shown a capacity utilization improvement from 65% to 104%.

Year

2004

2015

Capacity Utilization (Aircraft & Parts)

65%

104%

Click to enlarge

The third and last is the trade imbalance in this segment, which is arguably the most export positive segment over imports amongst all the manufacturing industries in U.S. and this shows a whopping surplus in excess of $60.7 Billion (in constant dollars) as is evident in this series. More importantly, the strength of the dollar is itself a huge value-add for this industry. If there was one very clear element of China-proofing to be seen, then this was it.

Year

2010

2015

Balance of Trade (Surplus)

In Constant Dollars ($ Billion)

42.8

60.7

Click to enlarge

PCC financials have been quite impressive so far:

PCC Financials:

Year

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Revenue ($Million)

1913

2919

3546

5361

6852

6801

5486

6209

7202

8361

9616

Net Profit

($Million)

117

(1.7)

350

633

987

1044

922

1015

1226

1430

1784

Click to enlarge

PCC therefore remains a star acquisition. Mark Donegan, given a free hand in his business, will most likely deliver better results going forward.

Let me now turn my attention to other parts of the Berkshire portfolio.

To analyze the results further, one has to get into the segment results given in the 10-Q and separate the real winners; the obvious ones are Geico and Berkshire Hathaway Re-Insurance Group, while the results are not so good in the rest of the Insurance (including Re-insurance) and in Railroad (BNSF). The performance has been balanced by the income from investments.

Page 24 of the 10-Q provides the segment results as follows:

Revenue (in $ Million): Insurance (Underwriting):

2016

2015

2016

2015

Q2

Q2

H1

H1

Geico

6247

5619

12297

11004

General Re

1389

1494

2779

2992

Berkshire Hathaway Reinsurance Gr

1652

1978

3895

3425

Berkshire Hathaway Primary Gr

1511

1309

2952

2519

Investment Income

1236

1338

2385

2428

Total Insurance Group

12035

11738

24308

22368

Click to enlarge

The Income before Taxes for the Insurance Underwriting segments is as follows:

2016

2015

2016

2015

Q2

Q2

H1

H1

Geico

150

53

414

213

General Re

2

107

44

60

Berkshire Hathaway Reinsurance Gr

184

-411

105

48

Berkshire Hathaway Primary Gr

174

203

295

378

Investment Income

1235

1334

2377

2421

Total Insurance Group

1745

1286

3235

3120

Click to enlarge

The Statutory Surplus of the Insurance Business is given on page 26 and is $124 Billion, the investment and re-investment of even a part of this very large sum results in the change in gains and losses (including derivatives). The results of the Berkshire Hathaway Reinsurance group has seen a significant swing in the second quarter of 2016 over the same quarter in 2015.

In the same page, Geico's better performance is attributed to the loss expenses moving from 99% in Q2 2015 to 97.6% in Q2 2016 on the back of increased premiums earned. The rate of premium increase for this quarter has been significantly higher, which shows the buoyancy of the auto sector in terms of premium absorption.

One would be reminded of Mr. Buffett's letter to shareholders where he was so proud of Geico. In his letter, he was so much eager to talk about GEICO, that covers 40% of the American auto industry. How things have changed is evident in his comparison given in the letter:

"Their fledgling did $238,000 of auto insurance business in 1937, its first full year. Last year GEICO did $22.6 billion, more than double the volume of USAA. (Though the early bird gets the worm, the second mouse gets the cheese.) GEICO's underwriting expenses in 2015 were 14.7% of premiums, with USAA being the only large company to achieve a lower percentage. GEICO employs about 34,000 people to serve its 14 million policyholders."

In contrast, the Life and Health coverings premiums in the General Re-Insurance business declined for both direct and broker markets. Here again, Mr. Buffett's letter to shareholders provides some clues. Mr. Buffett did not mince words when he said that the insurance business now is quite different from what it was ten years back with more competition and with other issues now cropping up like the low interest rates, which make it less attractive.

The low interest rate environment, especially in Europe, makes it even more difficult to do justice to the huge 'float' available as fixed income returns have stayed extremely low. The matter is entirely different in the case of the Reinsurance business of Berkshire as it allowed a much higher earnings power variety due to many areas unrelated to the insurance business. No matter how much more competitive this business may have become ('supply was always far more than demand'), Berkshire remained strong in this business.

The Berkshire Hathaway Re-Insurance business, BHRG, underwrites excess-of-loss reinsurance and quota-share coverage on property and casualty risks for insurers and re-insurers worldwide, including property catastrophe insurance and reinsurance. The performance has been stellar in both Retroactive business and in Life & annuity in terms of underwriting gains over last year.

The efforts on rebalancing is evident in Re-Insurance as well as Berkshire Hathaway came out of the Swiss Re and Munich Re investments, which had lackluster performance on the back of ultra low interest rates in Europe.

The rest of Berkshire's portfolio can be seen in this table given below:

Revenue in $ Million:

2016

2015

2016

2015

Q2

Q2

H1

H1

Railroad (BNSF)

4585

5369

9352

10971

Energy

4299

4543

8417

8874

Manufacturing (PCC+Duracel)

12201

9524

22755

18387

Mclane Company

12049

12293

23850

23936

Service & Retailing

6385

6294

12276

10815

Finance & Financial Products

1989

1799

3715

3353

Total

41508

39822

80365

76336

Click to enlarge

The Operating Income before Taxes:

2016

2015

2016

2015

Q2

Q2

H1

H1

Railroad (BNSF)

4585

5369

9352

10971

Energy

4299

4543

8417

8874

Manufacturing (PCC+Duracel)

12201

9524

22755

18387

Mclane Company

12049

12293

23850

23936

Service & Retailing

6385

6294

12276

10815

Finance & Financial Products

1989

1799

3715

3353

Total

41508

39822

80365

76336

Click to enlarge

I will end with a short analysis on BNSF.

BNSF suffered from revenue losses in almost all product segments, namely, consumer products, industrial products, agricultural products and coal. Out of this, the decline in coal revenues have been significant: "Freight revenues in 2016 from coal declined 41.6% in the second quarter to $0.7 billion and 40.0% in the first six months to $1.4 billion compared to the same periods in 2015."

But the results of BNSF could be still balanced through a cost reduction effort in almost every area. The question remains how BNSF could grow in an environment where energy prices are low. While almost every segment of BNSF has seen de-growth, we have seen commensurate gains in businesses that operate in the value-added part of the delivery chain like UPS (NYSE:UPS) or FedEx (NYSE:FDX). Given that more than 80% of all movements in the U.S. do not touch the railroad, it demonstrates the shift of the downstream part of delivery (finished products) as the more dominant business than the upstream part (commodities).

In Table 2-1 in Freight Facts & Figures (from the Department of Commerce website) for the U.S. shows how small Railroad is compared to Road and other modes:

Railroad moved 1858 Million tons in 2013 while Road alone moved 13955 tons.

In Table 2-2, the value of goods shipped shows:

Railroad moved goods worth $577 Billion while Road alone moved $11444 Billion in 2013.

The projections, given in this report, for 2040 show a similar denouement on a relative basis. Maybe Mr. Buffett is already working on consolidation and alliances; that is how rebalancing continues in Berkshire Hathaway.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.