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Berkshire Coverage

Berkshire Starts Out 2014 on a Weaker Note

Just about every segment at Berkshire was dealing with elevated costs during the first quarter.

Ahead of its annual meeting this weekend, wide-moat-rated Berkshire Hathaway (BRK.A) (BRK.B) released results for the first quarter of 2014 that were slightly disappointing when compared with the prior-year period, but basically in line with our own projections.

First-quarter revenue increased 4% year over year to $45.5 billion, with the biggest contribution coming from Berkshire's railroad, utilities, and energy segment. Stripping out the impact of investments and derivatives, first-quarter revenue actually rose closer to 5% year over year.

Just about every segment at Berkshire was dealing with elevated costs during the first quarter. As a result, pretax earnings declined 10% year over year and after-tax operating earnings were down 7% when compared with the prior-year period. Accounting for the impact of investments and derivatives, which tend to fall straight down to the bottom line, Berkshire reported only a 4% decline in operating earnings. Net earnings per Class A equivalent share were $2,862 for the quarter (down from $2,977 during the first quarter of 2013).

Book value per Class A equivalent share at the end of the first quarter was $138,426--up 15% year over year and less than 3% over the fourth quarter of 2013. This was in line with our expectations, which had called for Berkshire's book value per share to increase to $138,347 per Class A share during the period. The company closed out the first quarter of 2014 with $48.9 billion in cash on its books, up slightly from $48.2 billion at the end of last year.

Berkshire did not buy back any shares during the first quarter of 2014. With the company's book value at $138,426 per Class A share (or $92 per Class B share), Buffett should now be willing to step in and buy back stock at prices up to $166,111 per Class A share (or $111 per Class B share), implying a floor on the company's shares that is about 15% below current prices.

Looking more closely at Berkshire's insurance operations, three of the firm's four insurance lines--Geico, General Re, and Berkshire Hathaway Primary Group--posted earned premium growth during the quarter, with Berkshire Hathaway Reinsurance Group seeing another decline in earned premiums as the runoff of its Swiss Re quota-share contract continues to have an impact on it. The firm also continues to constrain the volume of reinsurance that it is underwriting, given the excess capacity that exists in the market and the fact that pricing is not attractive enough to underwrite additional business. From a profitability perspective, pretax earnings for the insurance business declined 30% overall, as underwriting profit declines at both Gen Re and BHRG offset positive results from Geico and BHPG.
Berkshire’s insurance float increased to $78 billion from $73 billion last year, reflective of a 7% increase year over year. Further gains in float are likely to be much harder to come by, though, especially with Berkshire limiting the amount of reinsurance business it underwrites (with much of the growth in the firm's float over the past decade coming from its reinsurance operations). Going forward, we continue to expect Geico to be an important contributor to earned premium growth, as well as to the growth of float, with underwriting profitability likely to be among the most stable of Berkshire's insurance operations. BHPG should also continue to be an important contributor, especially considering the growth potential that exists for the newly formed Berkshire Hathaway Specialty Insurance unit. We do, however, continue to project more meager results from the company's insurance operations overall during the next couple of years, as we expect results to be far less robust in its reinsurance arms.
Much as they have the past several years, Berkshire's noninsurance operations continue to be a source of stability for the firm. BNSF, which contributes about half of the pretax earnings of the company's so-called "Powerhouse Five"--Burlington Northern Santa Fe, MidAmerican, Iscar, Lubrizol, and Marmon--reported a 3% increase in first-quarter revenue and a 9% decline in pretax profits. The overall increase in revenue reflected a 1% increase in cars/units handled and a 2% increase in average revenue per car/unit. Both figures were lower than what we've seen from BNSF in past periods, but were to be expected given the above-average results that the railroad reported in the first quarter of 2013, and the impact that poor weather conditions in much of the firm's territory had on its operations during the most recent period. The latter issue had a negative impact on operating income as well, as costs for equipment, materials, and other expenses increased 18% year over year on higher crew transportation and travel expenses, and increased utilities and locomotive materials costs. Compensation also increased 7% year over year, because of increased employment levels, and to a lesser extent, wage inflation and higher overtime. We view much of the negative revenue and profitability impact during the first quarter to be one-time in nature, and expect BNSF to get back on track in the remaining three quarters of the year.
Berkshire more than made up for the weakness at BNSF with stronger results from MidAmerican, which not only benefited from the NV Energy acquisition, but also saw stronger results from MEC, MidAmerican Energy Pipeline Group, and the firm's real estate brokerage unit. First-quarter revenue increased 38% when including the NV Energy deal and was up 18% when looking at results on a comparable basis. Pretax earnings were up 16% on a reported basis, but when excluding the NV Energy deal were actually up 9% year over year, as increased energy costs and higher renewable energy generation expenses more than offset the increase in first-quarter revenue. The other big news out of MidAmerican this week was the announcement that the firm has made a $2.9 billion bid for AltaLink, a regulated transmission-only business in western Canada. With Berkshire likely to make some cash contribution to the bid, it is unlikely to make too big of a dent in the insurer's large cash balances, as MidAmerican has announced it will fund some of the purchase price with debt. On a separate note, MidAmerican also announced that its name has been changed to Berkshire Hathaway Energy Company.
With regards to Berkshire's manufacturing, service and retail operations, which include McLane, Iscar, and Lubrizol, the group overall recorded only a 2% increase in revenue, as better performance from the segments' manufacturing and service divisions were more than offset by weak top-line growth at McLane and the company's retail division. Pretax earnings increased 8% overall, though, when compared with the first quarter of 2013, as the higher-margin manufacturing and service divisions more than compensated for the drag caused by the lower-margin businesses at McLane and within Berkshire's retail division. That said, much of the poorer results from McLane and Berkshire's retail division were due to the timing of holidays, as well as the number of days during the period, some of which should work its way out as we move through the second quarter.

Meanwhile, the company's finance and financial products division expanded during the first quarter with the inclusion of Marmon in the segment, which has traditionally been centered on Clayton Homes (manufactured housing and finance) and Cort Business Services (furniture rental). Pretax earnings for the segment increased 26% year over year, with Clayton Homes making the biggest contribution to overall earnings.

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