Berkshire's 4Q Transactions Have Ted Weschler's Fingerprints All Over Them
The company made a number of significant purchases in the quarter while selling off small amounts of long-held legacy positions.
While Berkshire Hathaway is best known for the near celebrity status of Warren Buffett, the firm's chairman, CEO, and primary investor, a changing of the guards is looming over the horizon.
Lou Simpson stepped down from his position of running GEICO's portfolio at the end of 2010 and both Buffett and his partner, Charlie Munger, are octogenarians. Although both are in reasonably good health--as Buffett's stage-1 prostate cancer is said to be non-life-threatening--and they could theoretically run the portfolio for many more years, succession plans have begun in order to keep the portfolio running in the event that Buffett or Munger passes away unexpectedly.
Two years ago Buffett made one of the first steps in this process by selecting Todd Combs, a little-known hedge fund manager, to handle a "significant portion" of the firm's investment portfolio. More recently, in September, Buffett announced the hire of a second investment manager: Ted Weschler. The Weschler hire is notable for a number of reasons. Most interesting was the fact that twice he had been the high bidder for a charity auction whose prize was a lunch with the Oracle of Omaha. Prior to being hired by Berkshire, Weschler ran a $2 billion hedge fund in Virginia which, it seems, followed investing methodologies similar to those preached by Buffett. Buffett has not provided explicit details about the responsibilities of each of his lieutenants, but we expect that Weschler will manage a similar proportion of the portfolio as Combs (around $2 billion-3 billion of the more than $65 billion invested in equities). Buffett has mentioned that the smaller investments that would be appearing in the portfolio (around the $200 million level), would be the work of Weschler or Combs.
Berkshire Hathaway's Top Stock Holdings (as of Dec. 31, 2011)
Stock price and Morningstar Rating data as of 5-2-12. Figures do not include foreign investments that are held abroad, such as BYD Corporation, Tesco PLC, and POSCO.
When we looked at Berkshire's 2011 fourth-quarter 13-F filing, which details the company's holdings at the end of that quarter as well as the changes made since its previous report, a couple of things stood out to us. The first transaction of note was the firm's purchase of another 22.3 million shares of Wells Fargo (WFC), which brings Berkshire's stake in the bank up to 383.7 million shares (worth $10.6 million at the end of the fourth quarter). After touting Wells in his annual review to shareholders in 2011 as a major holding that could see a meaningful increase in its dividend, Buffett put his money where his mouth was and snatched up another 41.1 million shares of the bank last year, increasing Berkshire's holdings in the firm by 12%. Morningstar analyst Jim Sinegal is positive on the name, as well, giving it a narrow economic moat rating. Furthermore, the stock trades at more than a 25% discount to Sinegal's fair value estimate and carries a Morningstar Rating for stocks of 4 stars. About the only other transactions we can ascribe to Buffett were the purchase of 6.6 million additional shares of International Business Machines (IBM) (which we already knew about previously), as well as the sale of 8.4 million shares of Johnson & Johnson (JNJ) and 2.7 million shares of Kraft Foods (KFT). Berkshire has many reasons to sell securities, but the quarter's major sales might simply reflect Buffett's desire to free cash for Weschler and Combs to invest. That said, he has expressed a negative opinion on Kraft recently, especially regarding the firm's handling of the merger with Cadbury.
Although the purchase of another 16.1 million shares of DirecTV might have looked like a Buffett move, given that the size of the stock position was worth more than $870 million at the end of the fourth quarter, it is more likely a purchase from one (or both) of Berkshire's two new hires. As noted in the table below, DirecTV was among Weschler's largest holdings in his Peninsula Capital fund at the end of the second quarter of 2011 (before he began liquidating the fund). Looking at the rest of Weschler's holdings at the end of the June quarter, it looks like he was also the driving force behind Berkshire's new money purchases of 2.7 million of DaVita (DVA) and 1.7 million shares of Liberty Media , as both firms were top-five holdings in his fund. What's interesting to note, though, is the absence of W.R. Grace from the portfolio, given that it was Weschler's top holding at the end of the second quarter.
Ted Weschler's Top Stock Holdings at Peninsula Capital (as of June 30, 2011)
Stock price and Morningstar Rating data as of 5-2-12.
Morningstar analysts, in general, view the stocks of some of the companies that Weschler purchased favorably. Both DaVita and DirecTV receive narrow economic moat ratings from our analyst team. Morningstar analyst Mike Hodel believes that DirecTV's scale advantages and the low cost of each incremental customer gives it an advantage over its peers. In contrast to some of the recent market entrants, the firm can add new customers at relatively modest capital expenses, allowing it to meet demand fairly easily. Furthermore, in many rural areas, customers don't have an option for fixed-line pay-television service, leaving DirecTV as one of the only choices. That said, at current prices the company's stock does not seem attractive from a valuation perspective. DirecTV trades at more than a 20% premium to Hodel's fair value estimate, and therefore we would recommend investors wait for a better opportunity before following Berkshire's footsteps in this transaction.
With regard to DaVita, which is a leading provider of dialysis services for patients with chronic kidney failure in the United States, our analysts believe that the firm continues to sport a narrow economic moat. The pure-play dialysis firm has the second-leading market position in services, which is essentially an oligopoly with market leader Fresenius Medical Care (FMS). Our analysts believe that even though both firms have dug narrow economic moats in this business, there's not much separating them in terms of market share and returns on invested capital. They note that in recent quarters DaVita has been stealing market share from Fresenius in the post-bundling U.S. reimbursement environment, believing that DaVita's position as a key endorser of home-based service (where patients self-administer the therapy) might be a reason for some of that share shift. Furthermore, DaVita's contract with Amgen (AMGN) for its anemia drug Epogen has been extended through 2018. With several alternative drugs potentially coming to market, our analysts suspect that DaVita was able to obtain a significant discount on the drug, which might contribute to expanding future cash flows even as it deals with the new bundled payment system.
As for the remaining transactions, which we assume were handled by Todd Combs, Berkshire picked up another 573,000 shares of Visa (V) to go with the 2.3 million shares that had been picked up with new money during the third quarter. Combs also bought another 1.4 million shares of CVS Caremark (CVS) in the fourth quarter, adding to the 5.7 million share stake that he had initiated in the previous quarter. The same sort of activity occurred with General Dynamics (GD) and
Intel (INTC), each of which were new money purchases during the third quarter. With Intel, it was the addition of 2.2 million shares that brought Berkshire's stake in the semiconductor firm to 11.5 million shares at the end of the quarter.
Buffett Pans Bonds and Gold, Sticks With Stocks
While not directly related to these equity purchases, this quarter also saw Warren Buffett penning an adaptation of his shareholder letter which served as an op-ed in Fortune. The main arguments expressed in the article have been heard by Berkshire followers many times in the past, but the underlying mood seems to indicate that Buffett is in a buying mood which may give hints about his plans for future purchases. He devotes a decent portion of the article to his feelings on gold, especially given the recent increase in popularity of the asset class among certain investors. In general, he echoed the statements he made at last year's annual meeting. Buffett believes that gold is unproductive and its value is only determined by the price the next buyer is willing to pay. Gold is not used for any industrial or product purposes and, in his opinion, the only thing you can do with it is look at it, or, as he mentions specifically, "fondle it." Furthermore, Buffett makes allusions to the fact that gold may be experiencing a bubble.
For people concerned about inflation, which seems to be the common theme to the article, he recommends investors focus on companies that do not require much capital reinvestment in order to maintain pricing power during an inflationary period. In general, we agree with his opinion and have a similar view here at Morningstar: that investors should consider buying shares in companies with competitive advantages first, as these firms often tend to have the pricing power that Buffett mentions. In the op-ed, he specifically singles out Coca-Cola (KO) and IBM, which the company hold's in its investment portfolio, as well as See's Candies, a company Berkshire fully owns, as examples of companies that benefit from this pricing power. The conclusions are nearly the same as the previous, "Buy American," op-ed that he wrote during the financial crisis.
His investment strategy does not change much with the times, but rather he believes you should look for high-quality companies that are trading at a temporary discount to their underlying value. Unfortunately, this does not help us much in terms of anticipating future purchases for the company, but we could look specifically to companies that require little capital reinvestment as likely targets. The world may be entering a more inflationary period, which would indicate that the more capital-heavy businesses that have been his more recent targets (Lubrizol, Burlington Northern, and so on) might be shunned in favor of lower-capital companies.
What to Expect Next
Looking forward to what we might see when Berkshire releases its next 13-F filing, which details the firm's first-quarter purchases, we do not expect the company to be nearly as active as it was during preceding period. For one, the more notable purchase that was detailed in the fourth quarter was the purchase of IBM, which was in fact an acquisition which Berkshire accumulated throughout the course of the year. Given the time constraints, we do not expect the company to be able to build such a position in a single quarter alone. Furthermore, given the strong performance of the equity markets, it doesn't look like there would likely be as many opportunities attractive to a value investor such as Berkshire. That said, Buffett's new investment lieutenants might surprise us by purchasing shares of companies we would not expect. We look forward to analyzing their respective strategies as they evolve and develop in order to get a preview of what Berkshire Hathaway's investment portfolio of might look like in the distant future.
Disclosure: Drew Woodbury owns bullish derivatives positions in the following companies mentioned above: Wells Fargo.
A version of this article appeared Feb. 21.
Drew Woodbury does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.