Berkshire Starts 2015 on a More Solid Note
Quarterly results were an improvement on prior-year earnings, though book value per share came in lower than we expected.
Ahead of its annual meeting this weekend, wide-moat-rated Berkshire Hathaway (BRK.B) released results for the first quarter of 2015 that were an improvement on prior-year earnings, but resulted in a rather lackluster improvement in book value per share. We do not expect to make any changes to our $168 per Class B share fair value estimate for the firm.
First-quarter revenue increased 7% year over year to $48.6 billion, with the biggest contribution coming from Berkshire's manufacturing, sales, and retail operations, which benefited from both organic growth and acquisitions during the period. Stripping out the impact of gains and losses on investments and derivatives had little impact on the growth rate, with the firm recording $47.2 billion in revenue (compared with $44.1 billion in the year-ago period).
Pretax operating earnings increased 15.9% year over year to $7.6 billion during the first quarter, and were up 18.4% (to $6.3 billion) after excluding the impact of gains and losses on investments and derivatives. BNSF saw the biggest improvement in profitability among Berkshire's major segments, as the railroad lapped higher costs for equipment, materials, and compensation because of adverse weather conditions during the first quarter of 2014.
Book value per Class A equivalent share at the end of the first quarter was $146,963--up 6% year over year and basically flat when compared with the fourth quarter of 2014. This was lower than our forecast, which had book value per share increasing to $149,841 at the end of the first quarter. The company closed out the first quarter of 2015 with $63.7 billion in cash on its books, up marginally from $63.3 billion at the end of last year, even though the firm spent $4.1 billion to close out the Van Tuyl deal in early March. Berkshire did not buy back any shares during the first quarter of 2015.
Looking more closely at Berkshire's insurance operations, only two of the firm's four insurance lines--Geico and Berkshire Hathaway Primary Group--posted earned premium growth during the quarter, with General Re and Berkshire Hathaway Reinsurance Group reporting another quarterly decline. This was not unexpected, as both reinsurers have shied away from underwriting unprofitable reinsurance deals, given the unfavorable pricing environment that has existed due to excess capacity in the market. For BHRG specifically, the runoff of its Swiss Re quota-share contract continues to have an impact on premium growth. Even so, earned premium growth overall was around 1%, with pretax underwriting earnings increasing 5% year over year. Weaker profitability at both Geico and General Re offset positive results from BHRG and BHPG. Geico, in particular, posted an uncharacteristic decline in underwriting profits, as a sharp increase in losses across many of its coverage lines led to a 430-basis-point increase in its loss ratio (to 80.1%). This left its combined ratio at 97.0%, the highest level we've seen in quite some time. Having grown concerned that Geico was getting too lax with some of its underwriting, we think that the time has come for the firm to tighten its standards and perhaps take some pricing actions to get its loss ratio back to more normalized levels.
Berkshire's insurance float increased to $83.5 billion from $73.0 billion in the year-ago period, reflective of a 14% increase year over year. Float was down modestly, though, when compared with the end of 2014, when Berkshire had $83.9 billion on hand. However, further gains in float are likely to be much harder to come by, especially with Berkshire limiting the amount of reinsurance business it underwrites (with much of the growth in the firm's float over the past decade coming from its reinsurance operations). Going forward, we expect Geico to be an important contributor to earned premium growth, as well as the growth of float, with underwriting profitability likely to return to more stable levels over the long run. BHPG should also continue to be an important contributor, especially considering the growth potential that exists for the newly formed Berkshire Hathaway Specialty Insurance unit. Even so, we continue to project more meager results from the insurance operations overall for the next couple of years, as we expect results to be far less robust in its reinsurance arms.
Berkshire's noninsurance operations continue to offer a more diversified stream of revenue and pretax earnings for the firm. BNSF, which had a miserable first quarter in 2014 as poor weather conditions in much of the firm's territory affected rail car volumes and drove up costs, recovered somewhat during this year's March quarter. A 3% increase in overall revenue was built on a more than 1% increase in cars/units handled, a greater than 1% increase in average revenue per car/unit, affected somewhat by a decline in fuel surcharges during the period due to lower fuel prices. Absent the higher costs incurred for equipment, materials, and compensation (to cope with the adverse weather conditions) in the prior year's period, BNSF saw a marked improvement in pretax profitability, which increased 43% to $1.7 billion. We continue to envision BNSF's operating ratio moving from 69.8% during 2014 to 61.0% by the end of our five-year forecast period. This is more or less in line with our forecast for BNSF's most comparable peer, Union Pacific (UNP), where we have projected the operating ratio to reach 61.0% by 2017.
Berkshire Hathaway Energy came into 2015 with slightly higher hurdles, having benefited from the addition of NV Energy last year, as well as solid results from its other regulated utilities--PacifiCorp, MidAmerican Energy, and Northern Powergrid. As such, it was no surprise to see first-quarter revenue increased less than 1% during the period, with pretax earnings actually declining 4% when compared with the prior year's period. Some of the decline at the regulated utilities was also due to lower demand as most of BHE's regions experienced milder winter weather during the first three months of 2015. Going forward, we continue to envision BHE's U.S. regulated utilities receiving constructive rate-case outcomes, which would put annual revenue growth in the 2%-3% range over the next five years. For Northern Powergrid, we assume the division generates mid-single-digit revenue growth. As for the firm's pipeline and renewables businesses, we see revenue growing at a low- to mid-single-digit rate during 2015-19. This should all contribute to consolidated annual EBITDA growth of 6.7% over the next five years, with EBITDA margins hovering around 40%.
Berkshire's manufacturing, service, and retail operations group overall recorded a 12% increase in revenue. Better performance from McLane and the firm's service and retailing (which benefited from organic growth and the inclusion of the Van Tuyl acquisition in quarterly results) more than offset somewhat weaker results from its manufacturing segment. McLane, in particular, posted an 11% increase in revenue, a 14% increase in pretax earnings, and stronger results from its grocery and foodservice operations. While revenue increased just 3% in Berkshire's manufacturing operations--which include Marmon, Lubrizol, Iscar, Forest River, CTB International, and Scott Fetzer--the segment posted a 13% increase in pretax earnings primarily due to the favorable impact of lower average raw material costs. With the Van Tuyl deal closing in early March, Berkshire's service and retailing operations saw a 35% increase in revenue and a 34% increase in pretax earnings. Of note, though, was the fact that both TTI and Berkshire's home furnishings retailers generated strong revenue growth (of 12% and 9%, respectively) during the quarter, while NetJets posted a 4% top-line decline. As for the company's finance and financial products division, revenue expanded at an 8% rate when compared with the prior year's period, with pretax earnings up 19% year over year.
As we noted above, book value per Class A equivalent share at the end of the first quarter was $146,963--up 6% year over year and basically flat when compared with the fourth quarter of 2014. The company also closed out the period with $63.7 billion in cash on its books. With Buffett liking to keep around $20 billion on hand as a backstop for the insurance business, and the company committing $5.2 billion to the Heinz-Kraft Foods deal, and an undisclosed amount for the purchase of Detlev Louis Motorradvertriebs GmbH, Berkshire now has an excess cash balance of around $38 billion.
The company did not buy back any shares during the first quarter. Given Berkshire's current book value per share, and the company's ongoing share repurchase authorization, which allows the firm to buy back stock at prices no higher than a 20% premium over book value, Buffett should be willing to buy back stock at prices up to $118 per Class B share, implying a floor on the company's common stock that is about 18% below where shares are trading right now.
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Note: This article was revised following original publication. The last paragraph was corrected to indicate Buffett should be willing to buy back stock at prices up to $118 per Class B share (not $98, as originally written), implying a floor on the company's common stock that is about 18% below where shares are trading right now.
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Greggory Warren does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.