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Is Berkshire a Good Buy Today?

Jeremy Glaser
Greggory Warren, CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Ahead of the Berkshire Hathaway annual meeting, I'm here with Gregg Warren, our senior stock analyst who covers Berkshire for us, to look at Berkshire's shares to see if they are attractive at today's prices.

Gregg, thanks for joining me.

Gregg Warren: Thanks for having me.

Glaser: So, before we do kind of a deep dive into valuation, let's talk a little bit about how the business is actually performing. I know we can slice and dice this in a bunch of different ways. But when you look at kind of the coinsurance operations, what does that look like for Berkshire right now?

Warren: Last year was a more difficult year overall. GEICO struggled through the year with an uptick in loss ratios. This wasn't necessarily emblematic of just GEICO. We saw it within the industry overall. As you know, gas prices have dropped considerably over the last two, three years. And what happens when gas prices go down is there's more drivers on the road, which increases the incidence of accidents, which increases claims. We've also seen an uptick in the amount of distracted drivers getting involved in accidents. So, I think that those two things combined impacted the firm from a perspective on the loss ratio.

And in some part, a little bit of it is GEICO's fault because you go back three, four years ago they were really looking to sort of overtake Allstate as the number-two provider of auto insurance and they were relatively close. And in some ways they did lessen standards a bit when it came down to underwriting and potentially on the pricing front. And they are paying for some of that right now. Now, when I talked to Tony Nicely last year at the meeting, he noted that they are definitely putting in plans to increase pricing where they can, improve sort of the underwriting standards that they have. That hasn't really flowed down through the system yet, but we're expecting by the end of this year to see things looking a lot better.

One of the other trouble areas has been the reinsurance business. It's just a terrible pricing environment right now for reinsurance, and it's been that way for a few years. Buffett has actually been out there saying this is going to be a difficult market for them possibly for the next decade. So, when we look at the reinsurance business, we're not really expecting much in the way of earned premium growth and not much in the way of insurance flow growth. I know a lot of people put a lot of value on the insurance float, but I'm not really necessarily concerned with them sort of slowing down the growth in float because quite honestly, you're not really earning that much on it right now. Interest rates are still at historically low levels and they still need to maintain a fair amount of that in fixed-income investments.

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Glaser: How about some of the other businesses? The energy, the railroads, have those also been having some challenging times?

Warren: Well, as you know, the railroads had a difficult time last year. There was a West Coast port strike during the first part of the year and then coal shipments really kind of fell off a cliff starting in the fourth quarter of last year, and then it's accelerated through the first quarter of this year. Part of that's driven by the fact that natural gas prices are at historic lows, and you've also had regulation come through that's sort of accelerating the closures of coal-fired plants.

Berkshire's railroad BNSF operates primarily in the western part of the U.S. and is a bit more advantaged say than those railroads on the eastern side of the coast, mainly because they are pulling about 90% plus of their coal out of the Powder River Basin, which is in Wyoming and Montana. That's very low-sulfur coal. So, if you're looking at coal-fired plants, those that are still operating if they are trying to meet emissions regulations and whatnot, it's probably going to be that coal that's going to be more in demand than say, Appalachian coal. So, from that perspective, they are probably not going to get hit as bad as the rest of the industry, but they are still going to see a sharp falloff in volumes this year, which is kind of annoying because this is kind of now the third year that they have had sort of a troubled front going in.

As far as the positives coming through this year, I mean, lower input prices are better for Berkshire Hathaway Energy. The company continues to invest heavily in renewables. We saw this past week that they are going to dump more money into wind power in Iowa. This is going to bring their renewable generation up to about 85% for that particular piece of the business. They are still targeting 100%, which is great, because if they can get to that then they are not really sort of at the beck and call of energy prices. You've got Precision Castparts, which was acquired in full at the end of January. That's going to be additive to the top and bottom line throughout this year. I think that's going to help from a headline perspective for them because results on a quarter-by-quarter basis are going to look better overall, at least from the headline perspective. But that's not to say they are not facing headwinds. I mean, energy definitely is sort of disrupting things, not just for them but for a lot of businesses.

Glaser: So, maybe more of a mixed year for Berkshire than we've been used to recently. How does that translate into your thinking about valuation? I know--again, there's a lot of ways to think about Berkshire as a business--what do you think the right way is, and what does that show us?

Warren: Yeah, I mean, we're still looking through now sort of what the potential impact might be of what we're seeing from the railroad volumes because they are a bit weaker than we were expecting going in. But I can't really see it having too big of an impact on our overall valuation. We did lower things back in early February based somewhat on what we were seeing with BNSF and somewhat on what our expectations were sort of on global growth.

The business itself is well-diversified and things do sort of trade off of each other. So, when you have weakness in one part of the business, you tend to have some other part that's actually doing better to kind of offset that. We came into this year; the stock was trading, January and February, sort of at the weaker parts of the market at about 25%-30% discount to our fair value estimate. We are really excited about it then. It was at one point only about 3% away from the 1.2 times book value price that Buffett had put out there for buying back stock. So, we were really excited to sort of recommend it there. It's had a good run, though. It's up 10% year to date. The S&P 500 Total Return Index is only up about 3%. So, it's outperformed the market by a fairly wide margin here. And it's just hard to get excited at sort of 15% discount to our fair value estimate. But again, for longer-term investors we still think it's a good entry point.

Glaser: Gregg, thanks for your thoughts on valuation today.

Warren: Happy to help.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.