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By Jeremy Glaser and Greggory Warren, CFA | 04-28-2014 03:00 PM

Berkshire's Moat Not Eroding

Management's ability to continuously reinvest earnings into Berkshire subsidiaries, which mostly have their own moats, will keep the firm's competitive advantages solid over time.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Gregg Warren; he's our analyst who covers Berkshire Hathaway. Ahead of the annual meeting, we're going to look at how their competitive advantage has evolved over time.

Gregg, thanks for joining me.

Gregg Warren: Thanks for having me.

Glaser: Let's talk about Berkshire's competitive advantage, their economic moat first. This has been a wide-moat company for some time. Could you talk to us about what underlies that wide economic moat?

Warren: When you think about Berkshire, you got to remember that the company itself is a conglomerate, in fact, it's probably the purest form of conglomerate that still exists today. The company's run on a completely decentralized basis. [Chairman Warren] Buffett owns all these different companies through Berkshire, but each of them is run independently by their managers, in most cases, that have run them prior to selling them to Berkshire. Overall, you're looking at a conglomerate structure.

When we look at the economic moat, we're looking at the individual businesses that make up the whole. The biggest businesses within Berkshire are their insurance operations, MidAmerican Energy Holdings, Burlington Northern Santa Fe--the railroad operation--and then they've got a combination of other businesses in manufacturing services, retail, financial-products divisions.

But when we think about the moat itself, we're really looking primarily at insurance. It's the biggest contributor to our fair value estimate for Berkshire. It also accounts for about a third of their pretax profits. Within there, you've got GEICO, which is a good solid narrow-moat firm, similar to Progressive on the auto insurance side of the business.

Within reinsurance, you've got General Re and Berkshire Reinsurance. Overall, we're not really fond of their reinsurance business. We think that from a moat perspective, it tends to be a no-moat business. In Berkshire's case, there are little bit of an exception because they can afford to not underwrite business when pricing conditions are poor, which happens to be the case right now, and for these guys here they're probably about as close to a narrow moat within the reinsurance business as we've ever seen.

They also run a primary group collection of insurers, probably one of the more profitable insurance businesses on a consistent basis within Berkshire. And those businesses are also sort of a narrow moat. So, when we look at insurance overall, it is collectively about a narrow moat.

Burlington Northern is interesting because over the last year, the company itself has moved from a narrow moat rating to a wide moat. Our railroad analyst over the last year took a deep dive look at the Class One North American railroad operators, and they moved their rating for those firms to wide. BNSF is a large player within that market, so it also benefits from a wide economic moat. That's the one significant change we've seen in the moat overall over the past year.

MidAmerican; regulated utilities tend to be pretty much narrow-moat firms. They've got a lot of wide-moat characteristics, but since their pricing structures and longer-term returns are really capped by state and local governments, it's really difficult for them to kind of move out of that box.

Then, when we look at the rest of the businesses, there tends not to be a whole lot of information about what's in there. We know there is Dairy Queen, there is Acme, there is Shaw industries, a lot of other different companies within there. But actually having the real operating metrics of those firms is difficult to come by.

So, when we look at them, we believe that based on the acquisition metrics that Buffett has laid out historically, based on what he looks for in firms that he acquires, that they're all probably in sort of a narrow-moat range on a collective basis. Now there is always going to be instances where an industry falls off, one or two of them underperform, or things change. But when you look at it as a whole, it's basically sort of a narrow-moat area.

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