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Succession, Wells, Cash Hot Topics for Berkshire Meeting

Greggory Warren, CFA
Jeremy Glaser

Jeremy Glaser: From Morningstar, I'm Jeremy Glaser. The Berkshire Hathaway Annual Meeting is this weekend. I'm here with Gregg Warren, he's a senior analyst at Morningstar who covers Berkshire. He will be on a panel asking questions of Warren Buffett and Charlie Munger.

Gregg, thanks for joining me.

Gregg Warren: Thanks for having me.

Glaser: I want to talk about some of what you think are going to be the big topics at the meeting. There aren't really any burning issues that there has been in some previous years. One that always comes up is succession planning, but there has been some movement there. Do you think that question has really finally been put to rest?

Warren: I think the easy answer to that is probably no. We still don't have complete clarity yet on what's going to happen with succession planning. I think for Berkshire overall, for the shareholders, here you've had two guys running the show for 50 plus years now. To have this lack of clarity this close to what would be expected to be retirement, is an uncertainty I think for everybody. That said we did get some sort of hint to where things may be going we had Ajit Jain and Greg Abel named to the board of directors earlier this year.

Ajit has run Berkshire Hathaway Reinsurance for many, many years, and in his new role he'll basically be overseeing all of the insurance business, which I think is something he has always wanted to do. With Greg Abel who's run Berkshire Energy for many, many years, and he's done a lot of deal-making during that time, a lot of M&A activity, we still view him as being the next CEO or the next capital allocator in chief, which is something that Buffett sort of put out there. He'll be overseeing in his new role all of the businesses that are noninsurance. I think from that perspective we still feel like he's the next guy to run the show. You've also got Todd Combs, Ted Weschler there from an investment perspective to help back him up there. I think Ajit's not necessarily going to fall out of the picture I think he'll still be helping them out with risk assessment and other stuff.

Glaser: Do you think that they'll address Wells Fargo and the scandals involving Wells Fargo directly? They are obviously a major shareholder there.

Warren: The interesting thing with Warren is he tries not to talk up or talk down stock holdings, especially in situations where they are major stakeholders. I am sure there will be questions put to him during the course of the meeting, and I'm sure he'll answer things in his way. He likes to deflect a lot and not necessarily get to the point of answering the actual question itself. I think overall it bears looking at, and it bears talking about. The question is how do you formulate the question in a way that he will actually speak to it. Just some hindsight, there was that one year where I asked a question about American Express; they were going through a lot of different issues competitively. So I was more direct, looking at the moatiness of the firm, the competitive positioning and trying to sort of get at that. He spent the next five minutes talking about the history of American Express. It's a risky proposition asking a question along those lines. He has surprised us from time to time. So I would expect to see questions coming that way.

Glaser: Let's talk about the cash hoard. Is there any way that they can actually deploy the amount of cash they have on their balance sheet right now?

Warren: It's really tough. They were at $116 billion at the end of last year. You are looking at a firm that's on pace to generate $20 billion to $25 billion in free cash flow and that's even before you roll in the tax cuts. They are going to be about $150 billion mark in two years. That was a threshold that Buffett had put out there last year as far as, if Berkshire is sitting with $150 billion a couple of years from now and have not deployed at any place, it's going to be hard for him to explain that to shareholders. If you look at sort of where market valuations are right now, there really isn't anything cheap out there to buy. It will run contrary to his wanting to get the best possible deal when he makes an acquisition. The stock's trading well above the share repurchase threshold. So unless he is willing to change his spots on how he thinks about valuations of the company he is buying or how he thinks about valuation for the shares that they are buying back themselves, they are going to be sitting on a lot of cash few years out. Our expectation has always been they are likely to put a special dividend out there. Our current forecast has a $25 billion special dividend paid out in 2020.

Glaser: Let's talk about insurance losses--in 2017 there were number of big hurricanes, some catastrophic losses there. Any questions around the insurance business how they handled those losses, or was everything about as you would have expected?

Warren: Some of the reinsurance we had thought that it'd be a little bit lighter than it was, because they have actually sat on their hands a lot the past five to 10 years on reinsurance underwriting, just because pricing environment has been really poor. To walk away with less than $3 billion in losses overall for three major hurricanes, a few earthquakes, and a couple of other catastrophes, I think it was doing pretty well. From the perspective of the business overall our expectation on reinsurance, pricing is still going to be rough and you are always going to have a catastrophe year somewhere in the cycle. We always build in one at least halfway through the cycle to make sure that we are looking at the business from a prudent basis. We're expecting a loss here going out. Overall I think they handle that well, and when we look at the business as well, Geico has been lot more aggressive the past couple of years on underwriting. Because, A, their peers have stepped back from underwriting in some parts of the market and, B, I think they are eyeing that market share that State Farm is sitting at.

Right now Geico is sitting around 13% market share, State Farm's traditionally been around 18%, 19%; they are the market leader. I think there is a bit of push to really take additional share when they can, which means you are taking on some losses because you've got to season those portfolios over time. The expectation, at least ours is over the next several years, is they are going to accept larger loss ratios on their auto insurance portfolio as they take share. I think given the fact that Geico is one insurance business within a larger portfolio of insurance businesses within a larger portfolio of overall businesses, they can afford to do this. This is some Progressive, which is Geico's prime competitor on the direct side, couldn't do. They couldn't take the kind of losses that Geico is taking just because they don't have that same sort of backstop.

Glaser: Gregg, thanks for the preview of the meeting.

Warren: Thank you.

Glaser: From Morningstar I'm Jeremy Glaser. Thanks for watching.