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3 Undervalued Stocks in Berkshire's Portfolio

We think these holdings are bargains.

Last week, Berkshire Hathaway (BRK.A) (BRK.B) released its third-quarter 13-F. Morningstar's resident Berkshire specialist, Gregg Warren, noted that there were a few surprises. Most notably, the firm scooped up four healthcare names--AbbVie (ABBV), Merck (MRK), Bristol-Myers Squibb (BMY), and Pfizer (PFE)--during the quarter. It also initiated new money positions in T-Mobile (TMUS), participated in the Snowflake (SNOW) IPO, and added to stakes in Kroger (KR), Liberty Latin America, and General Motors (GM).

As for sales, Berkshire haircut several positions in its banking stake, including JPMorgan Chase (JPM), PNC Financial (PNC), Wells Fargo (WFC), and M&T Bank (MTB). It also scaled back some in Barrick Gold (GOLD), Liberty Global (LBTYK), DaVita (DVA), and Axalta (AXTA).

Apple (AAPL) remains Berkshire's top holding by a significant margin.

Here’s a look at three stocks in Berkshire Hathaway's portfolio that are among the most undervalued by our standards.

General Motors (GM)
Morningstar Rating (as of Nov. 20, 2020): 4 Stars
Morningstar Economic Moat Rating: None

“We think General Motors' car models are of the best quality and design in decades. The company is already a leader in trucks, so a competitive lineup in all segments, combined with a much smaller cost base, says to us that GM is starting to realize the scale to match its size. The head of Consumer Reports automotive testing even said Toyota and Honda could learn from the Chevrolet Malibu. Tariff risk is a concern but seems to be abating compared with a couple of years ago.

"We think GM's earnings potential is excellent because the company finally has a healthy North American unit and a nearly mature finance arm with GM Financial. Moving hourly workers' retiree healthcare to a separate fund and closing plants have drastically lowered GM North America's break-even point to U.S. industry sales of about 10 million-11 million vehicles, assuming 18%-19% share. We expect more scale to come from GM moving its production to more global platforms and eventually onto vehicle sets over the next few years for even more flexibility and scale. Exiting most U.S. sedan segments also helps.

"GM makes products that consumers are willing to pay more for than in the past. It no longer has to overproduce in an attempt to cover high labor costs and then dump cars into rental fleets (which hurts residual values). GM now operates in a demand-pull model where it can produce only to meet demand and is structured to do no worse than break even at the bottom of an economic cycle when plants can be open. The result is higher profits than under old GM despite lower U.S. share.

"We like GM embracing the opportunity of ride-sharing and ride-hailing and selling Opel/Vauxhall. We think actions such as buying Cruise, along with GM’s connectivity and data-gathering via OnStar, position GM well for this new era. Cruise intends to offer autonomous ride-hailing with its Origin vehicle but needs more time to ensure safety and quality of service. GM is investing $20 billion in battery electric vehicles for 2020-25 and believes in an all-electric future, though not soon. It is selling access to its Ultium battery technology to Honda and talking to other possible customers such as Nikola.”

David Whiston, strategist

Pfizer (PFE)
Morningstar Rating (as of Nov. 20, 2020): 4 Stars
Morningstar Economic Moat Rating: Wide

“Pfizer's foundation remains solid, based on strong cash flows generated from a basket of diverse drugs. The company's large size confers significant competitive advantages in developing new drugs. This unmatched heft, combined with a broad portfolio of patent-protected drugs, has helped Pfizer build a wide economic moat around its business.

"Pfizer's size establishes one of the largest economies of scale in the pharmaceutical industry. In a business where drug development needs a lot of shots on goal to be successful, Pfizer has the financial resources and the established research power to support the development of more new drugs. Also, after many years of struggling to bring out important new drugs, Pfizer is now launching several potential blockbusters in cancer, heart disease, and immunology.

"Pfizer's vast financial resources support a leading salesforce. Pfizer's commitment to postapproval studies provides its salespeople with an armamentarium of data for their marketing campaigns. Further, Pfizer's leading salesforces in emerging countries position the company to benefit from the dramatically increasing wealth in nations such as Brazil, Russia, India, China, and Turkey.

"Pfizer's recent decision to divest its off-patent division Upjohn to create a new company (Viatris) in combination with Mylan should drive accelerating growth at the remaining innovative business at Pfizer. With limited patent losses and much less older drugs, the firm is poised for steady growth.

"Further, we believe Pfizer's operations can withstand the eventual generic competition, and the firm's diverse portfolio of drugs help insulate Pfizer from any one particular patent loss. Following the merger with Wyeth several years ago, Pfizer has a much stronger position in the vaccine industry with pneumococcal vaccine Prevnar. Vaccines tend to be more resistant to generic competition because of the manufacturing complexity and relatively lower prices.”

Damien Conover, director

Merck (MRK)
Morningstar Rating (as of Nov. 20, 2020): 4 Stars
Morningstar Economic Moat Rating: Wide

“Merck's combination of a wide lineup of high-margin drugs and a pipeline of new drugs should ensure strong returns on invested capital over the long term. Further, Merck is through the worst of its patent cliff, which should remove the heightened generic competition the company has experienced over the past years. And after several years of only moderate research and development productivity, Merck's drug development strategy is yielding important new drugs.

"Merck's new products have mitigated the generic competition, offsetting the recent major patent losses. In particular, Keytruda for cancer represents a key blockbuster with multi-billion-dollar potential: It holds a first-mover advantage in one of the largest cancer indications of non-small cell lung cancer. Also, we expect new cancer drug combinations will further propel Merck's overall drug sales. However, we expect intense competition in the cancer market with several competitive drugs likely to report important clinical data between 2020 and 2021 in earlier stage cancer settings. Other headwinds include generic competition, notably to diabetes drug Januvia, likely to start as early as 2022.

"After several years of mixed results, Merck's R&D productivity is improving as the company shifts more toward areas of unmet medical need. Owing to side effects or lack of compelling efficacy, Merck experienced major setbacks with cardiovascular disease drugs anacetrapib, Tredaptive, Rolofylline, and TRA along with Telcagepant for migraines. Safety questions ended the development of osteoporosis drug odanacatib. Despite these setbacks, Merck has some solid successes, including a successful launch for its PD-1 drug Keytruda in oncology. Following on this success, Merck is shifting its focus toward areas of unmet medical need in specialty-care areas, and Keytruda is leading this new direction. We expect Keytruda's leadership in non-small cell lung cancer will be a key driver of growth for the company over the next several years.”

Damien Conover, director

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.