Berkshire Starts Out 2012 on More Solid Footing

See our complete coverage of the 2012 Berkshire Hathaway annual meeting.

Ahead of its annual meeting this weekend,  Berkshire Hathaway (BRK.A) (BRK.B) released results for the first quarter of 2012 that were much stronger than the results the firm reported in the year-ago period.

For those that may not recall, Berkshire's insurance operations were negatively affected during the first quarter of 2011, with the firm booking an underwriting loss in excess of $800 million following a cornucopia of natural disasters: massive flooding in Australia (compounded by Cyclone Yasi), an earthquake in New Zealand, and an even bigger earthquake and tsunami in Japan. According to Warren Buffett, the first quarter of 2011 was the second-highest period of losses for the reinsurance industry (with Berkshire Hathaway Reinsurance Group booking a $1.4 billion loss, and General Re recording a $300 million loss)--trailing only the third quarter of 2005, which included a number of large hurricanes, including Katrina. Although underwriting profitability was on much better footing in 2011, it remains below historical norms (which was a bit disappointing, in our view, given the milder winter and almost complete lack of catastrophe losses during the quarter). Even so, strong overall results from Burlington Northern Santa Fe, Marmon, and McLane, as well as the inclusion of Lubrizol's results in this year's first quarter, combined to drive a 67% increase in operating earnings during the quarter. 

Berkshire also benefited from higher gains on its derivatives portfolio year over year. As a result, net earnings attributable to Berkshire during the fourth quarter of 2011 were $3.2 billion (up 115% from $1.5 billion during the first quarter of 2011). The company's book value per Class A share was $106,588 at the end of the first quarter, a 10% gain year over year and a 7% increase from the fourth quarter of 2011.

Results improved significantly in Berkshire's insurance operations during the first quarter, but they were still short of what we were expecting. Premium growth continues to be muted, given the softness of the market. The earned premium growth the company generated was almost completely attributable to GEICO, where premiums were up 9%, driven mostly by policy growth. Berkshire's competitors in the insurance industry have become increasingly bullish on insurance pricing, with many reporting low- to mid-single-digit price increases, which have boosted premium levels. Berkshire does not seem to be joining this growth to the same extent, as evidenced by its non-GEICO premium levels. We will be interested to hear Warren Buffett's commentary on the pricing market during the annual meeting this weekend.

On the bottom line, aggregate underwriting profits were slightly lower than we had expected, having believed we'd see more robust results given the mild winter and almost complete lack of catastrophe losses during the quarter. Underwriting profits were lower at GEICO, despite higher premium levels, but this was because of a change in accounting practices (with the firm needing to expense more of its advertising costs upfront rather than defer them as it has done in the past). The company also posted a loss at Berkshire Hathaway Reinsurance Group, though it was of a much smaller magnitude than last year's. Investment income also continues to be pressured. With many of the lucrative investments that were made during the financial crisis being put back to Berkshire, the firm is having to reinvest in much lower-yielding investments. We believe this will have an impact as more of the company's book is rolled into new, lower-yielding securities--especially if the interest-rate environment remains depressed.

 

 

Unlike its insurance operations, Berkshire's noninsurance businesses were a source of strength during the quarter, reporting a nearly 30% increase in operating earnings year over year. Although these results were distorted somewhat by the timing of the Lubrizol acquisition (which closed in September of last year), that should not detract from the positive things going on in these operations.

Burlington Northern Santa Fe, one of the largest contributors to earnings at Berkshire outside of its insurance operations, saw a more than 15% increase in operating earnings year over year, as increased rail volumes and fuel surcharges led to a more than 10% increase in unadjusted revenues. BNSF's operating expenses also increased at a slower rate than revenues. Despite the sluggish pace of the economic recovery, Marmon, McLane, and Berkshire's other manufacturing, service, and retail operations continue to post solid results. Marmon, in particular, recorded a 7% increase in revenue and a 21% increase in pretax earnings, while McLane posted a 4% increase in its top line year over year, with a 24% increase in pretax earnings. MidAmerican Energy and Berkshire's financial products division remain the only weak links in the firm's noninsurance businesses, with the energy and utility posting flat revenue growth and 7% pretax earnings growth, while the financial products division posted mid-single-digit revenue and pretax earnings growth.

 

 

On a separate note, the company closed out the quarter with more than $37 billion in cash on its books (not much higher than what it was carrying at the end of the fourth quarter). We continue to believe this cash hoard will be a point of contention for many shareholders, some of which would like to see the firm institute a dividend (or, at the very least, pay out a special one-time dividend) if more lucrative investment opportunities are not available.

Besides hearing more about Berkshire's plan for a potential dividend longer term, we're interested to see if the topic of share repurchases comes up during the annual meeting this weekend. For those who may not recall, Berkshire announced in late September of last year that it had authorized a share-repurchase program to buy back Class A and B shares at prices no higher than a 10% premium to the firm's book value per share. Although Buffett has been vague about how much cash he would be willing to spend buying back stock, he has noted that repurchases would not be made if they reduced Berkshire's consolidated cash balance below $20 billion. Our take on the whole announcement has been that it has effectively created a floor under Berkshire's stock price, as investors now believe he will buy back shares at prices below 110% of the firm's book value. Based on Friday's closing price of $123,495 for Berkshire's Class A shares, Buffett could potentially think about buying back stock at prices below $117,246.

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