A Sum Of The Parts Analysis Shows Berkshire Fairly Valued

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About: Berkshire Hathaway A (BRK.A), BRK.B
by: Matt Hylland

Summary

Determining Berkshire's intrinsic value is important as the pressure to use Berkshire's cash for share buybacks grows.

We find Berkshire's utility, industrial, and retail companies to be worth $332.3 billion and insurance operations worth $83.5 billion.

Although Berkshire's insurance operations may very well deserve a premium valuation compared to other companies, today Berkshire is fairly valued.

Today, Berkshire Hathaway (BRK.A) (BRK.B) has a market cap of $530 billion.

Chart BRK.A Market Cap data by YCharts

The company has nearly $100 billion in cash and cash equivalents. This growing pile of cash is making some investors impatient.

Berkshire's board recently gave Warren Buffett and Charlie Munger additional freedom in buying back Berkshire shares, leading many investors to speculate that massive share buybacks may be on the horizon.

At today's price, is it a wise investment for Buffett to use Berkshire's cash to buyback shares, or should it go towards other uses?

To begin to evaluate the best use of Berkshire's cash ad the value of share buybacks, we need to know the true value, commonly called "intrinsic value" of the company.

Let's start by taking a look at what the values of some individual pieces of the Berkshire machine would be worth as stand alone companies:

Breaking Apart Berkshire

The Berkshire Hathaway empire is massive. The list on the company's website begins to list the companies that make up Buffett's sprawling empire:

Let's start to begin to value these parts of Berkshire:

Berkshire's Insurance Companies

The most famous component of Berkshire is its insurance operations. The insurance companies provide the float that Warren Buffett has invested for the last 40 years, turning Berkshire into what we know today.

First, let's start with GEICO:

What is the value of GEICO? To get an idea, let's compare how Wall Street values Progressive (PGR), GEICO's largest competitor.

For the first 9 months of the year, Progressive has written $24.67 billion in premiums, and earned $22.73 billion in premiums. Most of that are policies in its personal insurance line, in direct competition with GEICO.

Source: Progressive Investor Relations

GEICO has written $25.8 billion in premiums so far this year, and earned $24.705 billion - Just slightly more than Progressive. But, these companies appear to be very similar in size.

Progressive is seeing slightly higher growth in its written and earned premiums than GEICO.

So far this year, Progressive has had a 19% increase in written and earned premiums, compared to GEICO's 14.2% growth.

Progressive grew its policies in force by 11%, while GEICO's grew at 6%.

Today, Progressive has a market cap of $40.5 billion. I don't think that is that far off from what GEICO should be valued at since their numbers are very similar. We could give Progressive a slightly higher value since it is showing higher growth. But, we can argue that GEICO deserves a premium as well with the backing of Berkshire, Buffett investing the float, longer history of profitable underwriting, etc.

GEICO's Estimated Value: $40.5 billion

Next, Berkshire's reinsurance, property and casualty insurance, and its health and life insurance operations.

Berkshire splits its insurance operations in 3 reported segments. First let's look at what falls under the property/casualty insurance segment.

Property/casualty:

In total, Berkshire's property and casualty reinsurance operations have earned premiums of $6.479 billion so far this year.

To value Berkshire's property and casualty reinsurance segments, let's compare these numbers with RenaissanceRe Holdings (RNR). The company deals primarily in the property and casualty reinsurance markets and is valued with a market cap of $5 billion today.

For the first 9 months, RNR has earned $1.4 billion in premiums:

Berkshire has earned about 4.6x the amount of premiums as RNR. If we apply that multiple to RNR's market cap of $5 billion, that would give Berkshire's property and casualty reinsurance operations a value of $23 billion.

Calculations:

($6.479 / $1.401) = 4.6

($5 billion * 4.6) = $23 billion

Next, Berkshire's health/life insurance segment:

To value Berkshire's health reinsurance operations, let's compare Berkshire with Reinsurance Group of America (RGA), a company that deals specifically with life and health related reinsurance. The company is valued at $9 billion today.

Source: Page 47 of RGA's most recent 10-Q

RGA has net premiums almost exactly twice that of Berkshire's health and life operations. Both companies have similar underwriting profit this year. However, Berkshire's health and life reinsurance operations grew at 21% last year, while RGA's grew at 5.5%. However, let's remain conservative and say that despite the faster growth, Berkshire's health and life insurance operations deserve a similar multiple as RGA's.

Since RGA is valued at $9 billion today, I estimate that Berkshire's health and life reinsurance operations are worth $4.5 billion today.

Calculations:

($7.739 / $3.855) = 2

($9 billion / 2) = $4.5 billion

Lastly, Berkshire's "Primary group", which provides a wide variety of insurance, including healthcare malpractice, workers' compensation, general liability, and many other forms of specialty insurance products.

So far in 2018, this segment of Berkshire's primary group has earned $5.921 billion in premiums.

Finding a direct comparison here is hard since there is a wide variety of insurance products grouped into this segment. Although it is admittedly not a perfect match, I am comparing this to Chubb Ltd. (CB), a diversified insurance provider that offers property and casualty, workers' compensation insurance, medical insurance, and many other specialized lines. The company earns about 3.8x the premiums that this segment of Berkshire does, and is valued at $59 billion today:

Valuing Berkshire's primary group of insurance providers based on Chubb's market cap today gives this portion of Berkshire's insurance operations a value of $15.5 billion.

Calculations:

($22.599 / $5.921) = 3.8

($59 billion / 3.8) = $15.5 billion

In total, we have GEICO worth approximately $40.5 billion, Berkshire's property and casualty businesses worth $23 billion, Berkshire's primary group insurance businesses worth $15.5 billion, and Berkshire's health and life insurance businesses worth $4.5 billion.

Total estimated value of Berkshire's insurance business: $83.5 billion.

Next up, valuing Berkshire's railroad operations.

Berkshire's Railroad Business

Berkshire Hathaway owns BNSF, Burlington Northern Santa Fe railroad, one of the largest railroad systems in North America.

For the first 9 months of 2018, BNSF has $17.649 billion in revenue, and net earnings of $3.847 billion.

How does that compare to other publicly traded railroads out there today?

The closet competition I found was Union Pacific (UNP), which had slightly lower revenue compared to BNSF, but higher net income and has a market cap of $109 billion today:

Source: UNP's most recent 10-Q

Accounting for UNP's income that is 1.15x higher than BNSF's, we can estimate the value of BNSF at $94.7 billion today.

Calculations:

($4.412 / $3.847) = 1.15

$109 billion / 1.15 = $94.7 billion

Next up, Berkshire's growing energy empire.

Berkshire Hathaway Energy

Berkshire energy is made up of several parts: Regulated utilities (MidAmerican Energy, PacifiCorp, and NV Energy), natural gas pipelines, Great Britain electricity distributors, "other energy", and Berkshire's real estate brokerage business. Let's take a look at each of these lines of business.

First, Utilities:

In total, Berkshire's U.S. regulated utility companies generated $1.599 billion in after-tax earnings on $8.59 billion in revenue so far in 2018 (after tax income for each utility is broken down on pages 35 and 36 in the most recent 10-Q). Add in the Great Britain "Northern Powergrid" income and we get a total after tax income of $1.79 billion on $9.346 billion of revenue.

How does this compare to other publicly traded utilities today?

Dominion Energy (D) is very close to the size of Berkshire's utility operations.

So far in 2018, Dominion has $10 billion in revenue and $1.8 billion in net income. Today the company has a market cap of $45.8 billion.

Although Berkshire's utility companies have slightly higher revenue, for this we will assume that they should be valued equally since net income is almost exactly the same.

Estimated Value for Berkshire utilities: $45.8 billion

Natural Gas Pipelines:

Berkshire's total revenues from its natural gas pipelines were $889 million so far in 2018. Pre-tax earnings were $376 million. After-tax income is not provided, but assuming the pipeline business is subject to the same effective tax rate as all of Berkshire's energy companies (12.46%, as detailed on page 26 of the latest 10-Q), they should have an after-tax net income of approximately $329 million.

To see how this would be valued as a stand-alone company, I compared these numbers to Williams Companies (WMB), a natural gas pipeline operator that has $416 million in net income so far this year per their most recent 10-Q. The company has a current market cap of $31 billion.

Adjusting for the ratio of net income between WMB and Berkshire's pipeline companies, we can estimate Berkshire's pipeline companies are worth $24.6 billion

Calculations:

($416 / $329) = 1.26

($31 billion / 1.26) = $24.6 billion

Other energy:

Berkshire's "other energy" businesses are primarily involved in renewable energy. This portion of Berkshire has $1.764 billion in revenue and $318 million in pre-tax earnings so far in 2018. Once again, post-tax earnings are not provided, but assuming a tax rate of 12.46% gives us an estimated net income of $278 million.

This segment of Berkshire consists of several companies. The most recent 10-Q highlights operating results from AltaLink, L.P in its discussion of its "other energy" segment. AltaLink is is Alberta Canada's largest electric transmission company, much like larger utilities like Dominion in the United States.

For that reason, I am going to compare its value to TransAlta (TAC), a Canadian electric utility company with a market cap of $1.5 billion today.

Although this company is not profitable, it has nearly identical revenue as Berkshire's "other energy" segment:

Source: TAC's most recent quarterly report

If we assume that Berkshire's other energy bets should have a similar value as TransAlta, that would give Berkshire's other energy segment a value of $1.5 billion.

Lastly, Berkshire's real estate brokerage business:

Berkshire Hathaway Energy also owns and operates the second-largest residential real estate brokerage firm in the United States.

So far in 2018, Berkshire's real estate brokerage business has done $3.263 billion in revenue and has $180 million in pre-tax earnings. Assuming a 21% corporate tax rate, this should give the segment after-tax income of approximately $142 million.

To determine a value for Berkshire's real estate operations, let's compare it to Remax (RMAX), which has revenue of just $161 million and net income of $20.7 million according to its most recent 10-Q. Remax has a market cap of $1.04 billion today

Although it is smaller than Berkshire's operations, I thought the similarity of the business models made for the best comparison.

Berkshire's real estate operations have 7x the net income of Remax. Applying that multiple to Remax's market cap today, and we can estimate Berkshire's real estate brokerage business to be worth approximately $7.2 billion.

So in total, we found Berkshire's utility business to be worth $45.8 billion, pipelines worth $24.6 billion, "other energy" worth $1.5 billion, and Berkshire's real estate brokerage business to be worth $7.2 billion.

That gives Berkshire Hathaway Energy an estimated value of $79.1 billion.

Next up is Berkshire's manufacturing, Service, and Retail empires:

Berkshire Manufacturing, Service, and Retail

This is a huge segment of Berkshire that so far this year has done $98 billion in revenue and has a net income of $6.06 billion.

This segment of Berkshire includes Precision Cast Parts, Lubrizol, Marmon, 80 auto dealerships, newspapers, Dairy Queen, Nebraska Furniture Mart, Business Wire and much, much more.

Much of the specifics for each operating entity are not broken down in the company's 10-Q report, but there are a few large segments that we can try to value.

First, Manufacturing:

Berkshire breaks down its manufacturing companies into 3 parts; industrial products, building products, and consumer products.

We'll look at all 3 of these segments. First, the industrial products which is largely dominated by Precision Cast Parts and Lubrizol.

Precision Cast Parts (PCP):

When Berkshire purchased PCP, it had a market cap of approximately $26.7 billion. Let's assume Precision Cast Parts is worth today exactly what Buffett paid 3 years ago - $26.7 billion. I believe this is very conservative since PCP grew revenues at 6.3% last year alone (per page 37 of the most recent 10-Q).

Lubrizol:

Berkshire purchased Lubrizol for $9 billion in 2011. For its last year reporting separately from Berkshire, the company had profits of $732 million with revenue of $5.4 billion.

(Source for numbers above)

Just for comparison, Last year NewMarket Corporation (NEU) a company with a market cap today of $4.5 billion, had net income of $190 million (and income has been dropping for most of the previous 5 years):

If we assume Lubrizol's net income has grown at 3% per year since Berkshire acquired the company (conservative considering revenue was up 6% this year per the latest 10-Q), that would put Lubrizol's net income at exactly $900 million today.

Despite the fact that Lubrizol is growing and likely deserves a bigger multiple, giving it the same multiple as NewMarket would value Lubrizol at $21.3 billion.

Calculations:

($900 million / $190 million) = 4.73

4.73 * $4.5 billion = 21.3 billion

Marmon:

Berkshire purchased 60% of Mormon Holdings in 2007 for $4.5 billion, valuing 100% of the company at $7.5 billion. Berkshire now owns 100% of the company. Although total earnings attributable to Marmon are not broken down in Berkshire's 10-Q, we can make a few very basic, conservative assumptions to arrive at a value for Marmon today.

If Marmon has increased in value at 3% per year since 2007 (the latest 10-Q reports pre-tax earnings growth of 12.3% for this year so far, so this is a very conservative estimate), Marmon would be worth $10.3 billion today.

Next is Berkshire's building products:

This part of Berkshire includes Shaw flooring, Benjamin Moore paint, MiTek construction products, Acme Brick, and a few other companies.

We know that so far this year sales from the building products segment have been $9.563 billion with pre-tax income of $1.042 billion.

If we assume that this segment of Berkshire has a effective tax rate of 23.8% (as given as the effective tax rate for all of Berkshire manufacturing, retail and service related businesses on page 37 of the recent 10-Q) , this segment of Berkshire's business should be bringing in approximately $823 million in net income after the first 9 months of 2018. If we assume that business remains steady for the rest of the year, this segment of Berkshire's business should net a profit of $1.05 billion.

Since this is income from a wide variety of industrial companies, let's compare the value of this segment of the business using a multiple consistent with the industry. The companies that make up the portfolio of Vanguard's Industrial's ETF (VIS) currently trade at a 19.9 price to earnings multiple. (Source: Vanguard's fund page)

Applying that multiple to Berkshire's building products segment, we arrive at an estimated value of $21 billion.

Consumer industrial:

This segment of Berkshire Hathaway's manufacturing companies consists of apparel and footwear products, and Duracell batteries.

In total the segment has had revenue of $9.23 billion, and pre-tax earnings of $948 million so far in 2018. If we assume a tax rate of 23.8%, and assume that business remains steady for the rest of the year, this segment of Berkshire should return $963 million in profits.

Apply the same P/E multiple of 19.9 as we did for the other industrial segment, we get a value of Berkshire's manufacturing companies at about $19.1 billion.

Next, Berkshire's retailing operations.

Berkshire Retailing:

In total, Berkshire's retail businesses has done $11.4 billion in revenue this year so far, and have pre-tax earnings of $572 million.

This includes Nebraska Furniture Mart, 80 car dealerships, Helzberg Diamonds, Borsheims, See's Candies, Pampered Chef, Oriental Trading Company, and many more different companies.

If we assume that this segment of Berkshire has a effective tax rate of 23.8%, then Berkshire's retail businesses have a total net income of about $435 million for the first 9 months of 2018. If we assume that the fourth quarter sees the same portion of net income (very conservative since this is the holidays!), Berkshire's retailing operations should finish 2018 with at least $580 million in after tax income.

Since we are comparing a wide variety of retail stores, let's compare these numbers to the retail sector as a whole.

SPDR S&P Retail ETF (XRT) trades at a current price to earnings multiple of 14.7 (source: SPDR's XRT fund page).

Applying that multiple to Berkshire's retail operations, we get a value of $8.5 billion.

Berkshire Services Industries:

Berkshire's service companies include NetJets, Dairy Queen, FlightSafety, several newspapers, a television station, Business Wire, Charter Brokerage, and more.

So far this year, this segment of Berkshire has done $9.219 billion in revenue, and had $1.268 billion in pre-tax earnings. If we assume the same effective tax rate of 23.8%, so far in 2018 Berkshire's services businesses have a net income of around $966.2 million. If we assume the company generates equivalent quarterly profits in the fourth quarter as it has the first 3 quarters this year, Berkshire's services businesses should finish the year with $1.28 billion in net income.

I am not confident that these are the superior businesses of Berkshire, and don't think they deserve as high of a multiple as Berkshire's retail operations.

If we assume that these businesses should be valued at a price to earnings ratio of 8, Berkshire's services companies are worth $10.3 billion.

McLane Company:

Because of its large revenues, McLane Company is separated from the rest of the retail companies.

McLane company is a food distributor that Berkshire purchased in 2003 for $1.45 billion.

So far in 2018, McLane has done $37.4 billion in revenue. Last year, McLane Company did $50 billion in revenue - Let's assume that the company reaches $50 billion again for 2018.

That is a little more than twice the revenue that McLane's competitor US Food (USFD) did last year (source). Today, US Foods has a market cap of $6.06 billion.

If we assume that McLane is worth twice the value of US foods since it has twice the revenue, we can estimate McLane's value at $12.1 billion.

Lastly, Berkshire has a "Finance and Financial Products" segment.

Finance and Financial Products:

This segment of Berkshire consists of Clayton Homes (and its loan portfolio), transportation manufacturing companies (UTLX and XTRA), and transportation equipment leasing companies.

Clayton Homes:

So far in 2018, Clayton Homes has done revenue of $4.3 billion, with pre-tax earnings of $634 million.

This is almost exactly the net income Mohawk Industries (MHK), a company still valued at $9.48 billion after its more than 50% decline from its 52 week high, has done so far in 2018:

If we give Clayton Homes a similar value as Mohawk Industries today, (Very conservative given the fact that Clayton Homes grew revenue at 20.7% over the last year per the latest 10-Q). That would value Clayton Homes at $9.4 billion.

Transportation equipment leasing:

This segment of Berkshire has $2 billion in revenue so far in 2018, and pre-tax earnings of $624 million.

If we assume a tax rate of 23.8% and that business remains steady through the end of the year, this segment of Berkshire should produce after-tax income of $634 million this year.

To estimate a value for these companies, I am going to use the price to earnings multiple of the iShares Transportation ETF (IYT), since these equipment leasing companies operate in the same industry.

Currently, the holdings of IYT trade at a price to earnings multiple of 17.1. (source: iShare's fund page)

If we apply that same multiple to Berkshire's equipment leasing businesses, we get a value of approximately $10.8 billion.

Let's Stop And Review

So far, in our quest to value the rest of Berkshire we have:

  • GEICO: $40.5 billion
  • Property/Casualty reinsurance businesses: $23 billion
  • Health/life reinsurance business: $4.5 billion
  • Primary insurance business: $15.5 billion
  • BNSF railroad: $94.7 billion
  • Berkshire's utilities: $45.8 billion
  • Pipelines: $24.6 billion
  • Other Energy: $1.5 billion
  • Real Estate Brokerage: $7.2 billion
  • Precision Cast Parts: $26.2 billion
  • Lubrizol: $21.3 billion
  • Marmon: $10.3 billion
  • Berkshire building products: $21 billion
  • Berkshire's consumer products: $19.1 billion
  • Berkshire retail: $8.5 billion
  • Berkshire services: $10.3 billion
  • McLane: $12.1 billion
  • Clayton Homes: $9.4 billion
  • Transportation and Leasing: $10.8 billion

All that adds up is $415.8 billion.

And I believe that is a fairly conservative estimate of the value of these parts of Berkshire!

Now, we look at the infamous part of Berkshire, its massive stock holdings:

Berkshire's Equity Portfolio

Per the company's most recent 10-Q, Berkshire Hathaway has $207.3 billion in equity securities, not including $17.4 billion in Kraft Heinz shares:

69% of the value of Berkshire's equity portfolio is in 5 companies:

  • American Express (AXP) - $16.1 billion
  • Apple (AAPL) - $57.6 billion
  • Bank of America (BAC) - $26.5 billion
  • Coca-Cola (KO) - $18.5 billion
  • Well-Fargo (WFC) - $24.4 billion

In total Berkshire's equity portfolio plus its stake in Kraft Heinz is worth $224.7 billion.

Berkshire's Cash and Fixed Income Holdings

Berkshire is also building a very large cash pile.

Currently, Berkshire has $96.453 billion in cash and cash equivalents:

Additionally, Berkshire has $18.27 billion in longer dated fixed income securities.

In total, Berkshire's cash and fixed income holdings total $114.7 billion.

So, combining the equity portfolio with Berkshire's cash and fixed income portfolio totals $339.4 billion.

But of course, we have already accounted for some of that $339.4 billion since much of it is assets invested by Berkshire's insurance companies. Currently $277.2 billion of that $339.4 billion portfolio it is held by Berkshire's insurance companies:

Since those were assets of the insurance companies that we valued earlier, these $277 billion of assets were already accounted for.

That leaves Berkshire Hathaway with $62.2 billion. Add that to our estimated value of Berkshire's businesses of $415.8 billion and we get a total of $478 billion.

Lastly, there are numerous intangibles that I will leave readers to value on their own. For example:

  • What premium does Berkshire deserve for the quality of deals the company can get that no other company can? (Large reinsurance opportunities, bailouts like Bank of America, GE, and Goldman Sachs).

These deals have made Berkshire billions, and were mostly deals that you or I as an individual investor, and many other companies, would never have access to.

  • What is the financial strength of Berkshire as a whole worth? Buffett mentioned in last year's annual letter:

No company comes close to Berkshire in being financially prepared for a $400 billion mega-cat. Our share of such a loss might be $12 billion or so, an amount far below the annual earnings we expect from our non-insurance activities. Concurrently, much – indeed, perhaps most – of the p/c world would be out of business. Our unparalleled financial strength explains why other p/c insurers come to Berkshire – and only Berkshire – when they, themselves, need to purchase huge reinsurance coverages for large payments they may have to make in the far future.

As an investor who is finally learning to appreciate the value of an investment that allows you to sleep well at night and not worry about certain "what-ifs" (for example, see my recent post on TransDigm, a company with a impressive track record but growing debt), this quality undoubtedly means that Berkshire's insurance companies deserve a premium to what we valued above. Though I think this "value" is largely dependent on an investor's risk tolerance.

  • What are Warren Buffett and Charlie Munger "worth"?

These 2 iconic investors have been responsible for bringing deals, talent, and investment into Berkshire that most insurance or investment companies can only dream of.

  • Lastly, what premium is the conglomerate structure of Berkshire worth?

Berkshire benefits from huge efficiencies by being able to move excess cash from one of its company's and into another. Unlike standalone insurance or industrial companies Berkshire can send free cash flow into the highest expected return industries at the present time.

In Summary

Our conservative estimate of Berkshire's valuation was $478 billion, plus certain intangibles.

Compared to Berkshire Hathaway's current market cap of $530 billion, today's price seems fairly valued.

Lately investors are growing impatient as Berkshire's cash pile grows. Buffett himself commented in the 2017 annual meeting:

"There’s no way I can come back here three years from now and tell you that we hold $150 billion or so in cash or more, and we think we’re doing something brilliant by doing it.”

Even Buffett is feeling the pressure to put cash to work. However, at today's prices it seems best kept for a better opportunity.

Berkshire shareholders are as long-term thinkers as any. We just need to hold on a little longer, because if history is any guide, there will be a time in the future we will be ecstatic that Buffett and Berkshire have $100 billion ready to deploy.

Disclosure: I am/we are long BRK.B.

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.