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Anticipating Buffett's 2013 Annual Letter To Shareholders

|Includes:Berkshire Hathaway Inc (BRK.A), BRK.B

Next Saturday, the Sage of Omaha will once again demonstrate his magic by pulling a few more rabbits out of Berkshire's seemingly bottomless hat.

Those rabbits come in two forms:

a) the timely business/investment insights he shares in his annual letter, and

b) the growing profits and equity he bestows upon partners/shareholders.

Last year, those insights included: a summary of Berkshire's diverse business activities; a look at the economics of the declining newspaper industry, and; a study of dividend policy. For those seeking a perpetual source of income from their investments, Buffett suggested systematically selling shares from a non-dividend paying company like Berkshire and showed how it was more beneficial to shareholders than simply receiving dividends (see: pages 19-21, 2012 Berkshire Annual Report).

On the numbers front, Berkshire rewarded shareholders with these impressive results:

a) Book Value (i.e. shareholder's equity) increased 14.4% from the previous year. At the end of 2012, each BRK.A share had a book value of $114,214 and each BRK.B share had a book value of $76.14. As no dividends were declared, the increase in shareholder equity was a non-taxable event - unless a shareholder chose to sell shares.

b) Earnings on Class A shares were $6,215 in 2011 and $8,977 in 2012. Similarly, Class B shares earned $4.14 in 2011 and $5.98 in 2012. Whether you owned Class A or Class B shares, earnings attributable to shareholders were up 44% in 2012 from 2011. That's a trend appreciated by any long term shareholder I know.

2012 was also a banner year for Berkshires intrinsic value. Their privately held companies produced terrific results, Mr. Buffett added the H.J. Heinz Company to their corporate honor roll in early 2013 and the Board of Directors at Berkshire re-purchased shares from a long standing shareholder. In the process, investors learned the board is willing to re-purchase shares up to 1.2 times the company's growing book value - a reasonable proxy for Berkshire's intrinsic value (why can't all boards engaging in share re-purchase programs make their re-purchase criteria public?).

As good as the news was last year, I expect this year to be even better. A review of Berkshire's component parts reveals plenty of reasons for optimism. Let's look at the four businesses segments as Buffett and Munger might, starting with insurance, Berkshire's core business.


In 2012, among other catastrophes, property and casualty insurers needed to cover claims originating from Hurricane Sandy. This destruction, courtesy of Mother Nature occurred during the final days of October 2012 and it cost Berkshire about $720 million. Writing a cheque wasn't an issue but, it was a bit unusual to witness a tropical season this late in the season (Hurricane season typically runs June 1 - Nov 1 and peaks during first two weeks of September). In spite of the carnage, Berkshire had an underwriting profit of $1.6 billion and an aggregate float of $73 billion at the end of 2012.

In 2013, damage caused by hurricanes and tornadoes was minimal. Berkshire will likely achieve an eleventh consecutive year of underwriting profit - even greater than in 2012. The Q3-2013 press release shows a "9 month" underwriting profit of $1.601 billion, up 50% year over year. The float was a reported $77 billion - up 5.3% from 2012. That's more free money for talented individuals like Buffett, Combs and Weschler to invest.

It's reasonable to expect the 2013 underwriting profit might approach $2 billion and the float may be worth over $80 billion by year's end.

The next reason for optimism stems from Berkshire's regulated capital intensive businesses: Mid-American Energy and Burlington Northern Santa Fe.

Regulated, Capital Intensive Businesses

Mid-American provides power to 2.5 million retail customers across 10 U.S. states. They provide 6% of the nation's wind power and 14% of all solar generated power in the union. The two utility companies owned in the UK - Yorkshire Electricity and Northern Electric, serve 3.7 million customers making them the third largest power supplier there. In 2012, the UK utilities provided $429 million of earnings and the US utilities earned $973 million. Combined, that's $1.402 billion added to the bottom line.

Mid-American also owns two pipeline networks: Kern River & Northern Natural Gas Pipeline. These pipelines move 8% of the country's natural gas and when a "polar vortex" grips the nation as it did this winter, demand increases and pipelines are kept busy. Pipeline revenues are typically derived from transportation of the gas rather than the price of it. Therefore, it's reasonable to expect revenues and profits from Mid-American's pipelines will be robust.

Finally, Mid-American maintains ownership in Home Services of America (soon to be Berkshire Hathaway Home Services). During 2012, some 16,000 agents sold $42 billion worth of homes, adding an additional $82 million to Mid-American's $1.5 billion bottom line ($1,323 billion applicable to BH).

Given their diverse and resilient business interests, a 10% increase in Mid-Americans earnings will translate into $1.45 billion of applicable earnings for Berkshire.

Berkshire's other non-insurance behemoth, Burlington Northern Sante Fe is a bit more difficult to assess. Accidents and derailments occurring in 2013 will likely add unexpected costs to operations. However, these need to be viewed in perspective.

Since purchasing BNSF, Buffett has emphasized that capital infusions are required to keep a rail line in ship shape. In 2011, over $1.8 billion was re-invested in BNSF to maintain their 23,000 miles of track, bridges, tunnels, locomotives and freight cars, etc. In 2013, that infusion was closer to $4 billion. It's costly to maintain a railroad but, even more so if regulators and customers aren't happy.

A fair amount of value is exchanged when you move 15% of the nation's intercity freight. From that exchange, CEO Matt Rose and COO Carl Ice typically deliver earnings representing 15-16% of revenues. In 2012, BNSF's revenues were $20.835 billion and earnings were $3.372 billion. In 2013, I suspect BNSF's revenues will be about $23 billion and earnings roughly $3.45 billion.

If my estimates are correct, the two capital intensive businesses in this category will have earned $5 billion dollars plus for Berkshire in 2013 (i.e. $1.5 billion + $3.5 billion).

Manufacturing, Service & Retailing Operations

The good news continues when reviewing Berkshire's privately owned companies. This eclectic group of 70 companies produces, manufactures, retails and services everything from dilly bars to underwear, from carpets to jet airplanes. See: .

Here's a chart indicating the growth in earnings and revenues from this sector since 2009.

* Note: 2013 numbers assume an 8% growth in revenue and 20% growth in earnings - estimates based on previous year's performance. Given the figures from September 30, 2013, these may prove conservative.

Figures in millions.



Annual $ Increase

Annual % Increase


Annual $ Increase

Annual % Increase






$ (1,170.00)







$ 1,349.00







$ 577.00







$ 660.00







$ 751.00


More detailed figures can be viewed in the Management's Discussion portion of the annual report. For simplicity's sake, they're viewed here in aggregate. These companies have produced some stellar results and it's why they're owned by Berkshire.

In the aftermath of the 2008 Financial Crisis, they still earned over $1.1 billion. Despite the sluggish economy since, these companies have grown earnings in excess of 25% per year. That's impressive.

There was a few noteworthy additions to this select group of companies in 2013. First, in December 2013, Berkshire swapped some of their shares in Phillips 66 (NYSE: PSX) for Phillips Specialty Products - a division that will be integrated with Lubrizol courtesy of James Hambrick. Second, Berkshire acquired the remaining portion of IMC International Metalworking Co. from the Wertheimer family for $2.05 billion. All surplus cash earnings will now be wired to Omaha.

Third, Berkshire and 3G Capital purchased the H.J. Heinz Company for $16 billion. 3G Capital invested $4 billion in common equity and provided management. Berkshire invested $4 billion in common equity and $8 billion in preferred shares paying a 9% annual dividend (i.e. $720 million /year).

If Heinz can grow their earnings - $1.09 billion in 2012, roughly $905 million a year will be attributable to Berkshire (i.e. $720 million in preferred dividends plus $185 million - Berkshire's share of Heinz's earnings attributable to common shareholders).

All total, I expect Berkshire's private equity holdings to produce earnings of $4.45 billion and that ought to approach or exceed $5 billion over 2014.

Finance & Financial Products

More good news can be expected from Finance and Financial Products - Berkshire's fourth source of earnings and revenue. This sector includes two rental companies - XTRA (Trailers) & CORT (Furniture), Clayton homes (they finance the homes the manufactured homes they build), a 50% interest in Berkadia - a joint commercial mortgage venture with Leucadia, derivative underwriting and all of the publicly traded securities Berkshire holds as investments.

In 2011, the pre-tax earnings from the finance companies were $774 million. In 2012, pre-tax earnings were $848 - an increase of 9.5%. A similar increase in 2013 would see Berkshire's finance sector earning $920 million. Check.

In the 2012 Annual report, Buffett reported that all derivatives sold by Berkshire providing credit protection for corporate bonds would expire in 2013. At expiration, these contracts would provide a $1 billion pre-tax profit. Add another billion to the 2013 bottom line.

Berkshire still has other outstanding derivative contracts. These include puts written on US, UK, Europe and Japanese stock indices. In exchange for premiums totaling $4.2 billion, Berkshire has guaranteed a floor price for the indices when they expire between 2018 and 2026. Until the expiry dates, no cash changes hands and Buffett is free to invest those premiums as he chooses. And, with the market's updraft in 2013, Berkshire's (accounting) liability decreases ($3.9 billion at the end of 2012). Expect a bump up.


The happy news continues where Berkshire's Stock Portfolio is concerned. The chart below reveals Berkshire's 2013 pro-rata earnings and dividend amounts from the "BIG Four" permanent holdings - assuming no shares were bought or sold over the course of the year.


# Shares Owned Dec 30, 2012

2013 Dividends

Cash Rec'd by Berkshire

Earnings per Share

2013 Pro-Rata Earnings

American Express



$ 139,481,844


$ 739,860,216

The Coca-Cola Company



$ 448,000,000


$ 760,000,000




$ 258,838,839


$ 1,017,645,331

Wells Fargo



$ 515,472,169


$ 1,774,501,537



$ 1,361,792,852


$ 4,292,007,084


  • The four companies will have delivered over $1.36 billion in dividends to Berkshire in 2013
  • Earnings at American Express were up 25% and 16% at Wells Fargo
  • Earnings were up 4% at IBM and 1% at Coca-Cola
  • Berkshire's pro-rata share of earnings from these companies was roughly $4.29 billion in 2013. Only the dividends received by Berkshire can be included in the accounting. They're posted here because Berkshire's unaccounted for earnings (or "look through earnings" as Buffett calls them) affect Berkshire's over all intrinsic value.

On December 30, 2013, the market capitalization of these four companies was $63.76 billion versus $51.85 billion on December 30, 2012. That's an increase of $11.91 billion or roughly 23%.

If the value of the entire portfolio appreciated by that much, it suggests Berkshire's Investment portfolio was worth $107.8 billion at the end of December 2013 (Note: I'm too pressed for time to calculate each holding and the investment portfolio is dynamic, like a moving target. Shares in long held companies will vary as will the companies w/ market caps in excess of $1 billion).

In a week's time, my assumptions about the Investment portfolio will be confirmed or rebuked.


As of September 30, 2013, book value had increased 11% over the first 9 months of the year and had a value of $126,766 for Class A shares or $84.51 for Class B shares. Earnings attributable to Berkshire shareholders were $14.486 billion up 41% from $10.273 billion during the same period in 2012. On a per share basis, earnings for the 9 months attributable to Class A shareholders were $8,814 or $5.88 for Class B shareholders.

If the trends hold, book value could appreciate another 3.6% to $131,330 for Class A shares and $87.55 for Class B shares. Earnings could surpass $10,000 per Class A share or $6.67 for Class B shares.

On February 21, Berkshire`s Class A shares closed at $170,120. B shares closed at $113.18. Should my calculations be in the ball park (or even inside the foul line), it means Berkshire is on sale this week for 1.3 times book value or 17 times last year`s earnings.

I believe I've erred on the conservative side with my calculations and the Oracle of Omaha will deliver even better results than what I've forecast. Next week, my assumptions will either be proven judicious or wrong. It could be that Berkshire holds tremendous value at these prices. At Berkshire, the best days are yet to come.

Buffett is fond of saying how "it's tough to teach a new dog old tricks." That's true. Very few have ever been able to get the rabbits to breed like he has, prior to pulling them out of his magic hat.


Disclosure: I am long BRK.B.

Stocks: BRK.A, BRK.B