Even Amid Difficulties, Berkshire Book Value Increases
The firm's fourth-quarter and full-year results were mixed but don't alter our long-term view, fair value estimate, or moat rating.
There was little in wide-moat rated Berkshire Hathaway's (BRK.A) (BRK.B) fourth-quarter and full-year results, which were relatively mixed, that would alter our long-term view of the firm. We do not expect to make any changes to our $255,000 ($170) per Class A (B) share fair value estimate, nor to our moat rating. Fourth-quarter pretax operating earnings increased 26.4% compared with the prior year's period, as investment and derivative gains/losses increased from $1.1 billion in the fourth quarter of 2014 to $2.1 billion in the current year's period. This contributed to a 24.3% increase in pretax operating earnings for the full year. Excluding the impact of the investment and derivative gains/losses (as well as other eliminations and adjustments), the company's pretax operating earnings increased 3.3% during the fourth quarter, with the same measure up 2.8% for the full year.
We remain impressed with Berkshire's ability to continue to increase its book value per Class A equivalent share--which rose 6.4% year over year to $155,501--even when faced with difficulties. In fact, the firm's end-of-year book value per share was higher than our expectations of $154,105, with much of the difference attributed to changes in Berkshire's equity investment portfolio during the fourth quarter. The company closed out 2015 with $61.8 billion in cash on its books, down from $66.3 billion at the end of September, but up from $58.0 billion at the end of 2014. With the company spending $22.4 billion on the Precision Castparts deal at the end of January, and committing another billion dollars to stock purchases (like Phillips 66) since the start of the year, Berkshire should have more than $15 billion in dry powder that can be allocated to deals or share repurchases in the near term. CEO Warren Buffett likes to keep at least $20 billion in cash on hand as a backstop for the insurance business, so that capital must be excluded from any cash deemed usable for investments or buybacks.
Fourth-quarter revenue increased 7.4% to $51.8 billion, which left full-year revenue growth at 8.3% (with full-year revenue at $210.8 billion). This was slightly below our forecast of $209.6 billion for all of 2015. Excluding the impact of investments, derivatives, and eliminations, fourth-quarter and full-year revenue increased 5.0% and 5.3%, respectively. As we note above, fourth-quarter and full-year pretax operating earnings increased 26.4% and 24.3%, respectively, when compared with the prior year's period, but were up just 3.3% and 2.8%, respectively, when excluding the impact of investments, derivatives, and eliminations. Reported net earnings per Class A equivalent share were $3,333 during the fourth quarter, which represented a 31.8% increase year over year. Full-year earnings of $14,656 per Class A equivalent share represented an increase of 21.2% compared with 2014. Excluding the impact of investments, derivatives, and eliminations, fourth-quarter and full-year earnings per Class A equivalent share increased 17.9% and 4.9%, respectively.
Looking more closely at Berkshire's insurance operations, all of the firm's four insurance segments--Geico, General Re, Berkshire Hathaway Reinsurance Group, and Berkshire Hathaway Primary Group--posted earned premium growth during the fourth quarter, but only Geico and BHPG had positive growth for the full year. From an underwriting profitability perspective, everyone but Geico posted positive results during the fourth quarter, but all four insurance segments posted positive results for the full year, with combined ratios ranging from a high of 84.7% at BHPG to a low of 98.0% at Geico (which has struggled with an elevated loss ratio for much of the year). On a combined basis, Berkshire's insurance operations were once again profitable on an underwriting perspective during 2015, but its firmwide combined ratio of 95.2% was a let-down from the 93.5% level posted during 2014 (with both Geico and General Re contributing to the underperformance).
Geico's earned premium growth of 11.2% was on par with what we saw from the firm during the third quarter, and not necessarily the sign of a firm that is paring back underwriting to get its loss ratio under control. After seeing a marked improvement in its loss ratio during the third quarter (with the auto insurer's loss ratio of 80.5% reflecting a 310 basis-point improvement over the second quarter of 2015, which was one of the highest quarterly loss ratios we can remember seeing from the firm), Geico slipped again in the fourth quarter, with its loss ratio expanding out to 83.9%.
With claim expenses remaining high relative to historical levels due to an increase in claims frequencies and severity in several of its major coverages, we had hoped that a tightening of underwriting standards, as well as selective price increases, would have started to have an impact. That said, it has paid to be a bit cautious on the recovery at Geico, as a slowly improving U.S. economy, fueled by lower gas prices, has left more drivers on the road and increased the potential for accidents. On top of that, the problem of distracted drivers using smartphones to talk, text, or even watch videos while driving is not going away any time soon, so we had expected to see a fair amount of lumpiness in Geico's return to a more normalized level of profitability when we adjusted our overall value for Berkshire earlier this month.
As for General Re, the reinsurer reported a rare quarter of earned premium growth, driven by its life/health product lines, but we don't expect this to turn into a longer-term trend. Both General Re and BHRG (which also posted a rare quarter of earned premium growth on the property/casualty side of things) continue to constrain the volume of reinsurance that they are underwriting, given the excess capacity that exists in the reinsurance market and the fact that neither firm feels that the pricing in the marketplace is now attractive enough to profitably underwrite additional business. While we have earned premium growth in negative territory for both firms over the next five years, we've always been quick to point out that there could be some lumpiness in reported results, as both firms have shown a knack for finding profitable business, even in times like we're facing now where reinsurance pricing is unattractive. General Re and BHRG are also competitively advantaged from their positions within Berkshire's overall business empire, having the luxury of walking away from reinsurance underwriting when an appropriate premium cannot be obtained, which is something that cannot be said for their peers.
Even with this headwind, Berkshire's insurance float increased during 2015 to $87.7 billion, up 4.5% from $83.9 billion at the end of 2014. We expect further gains in float to be much harder to come by as we move forward, though, with Berkshire limiting the amount of reinsurance business it underwrites (much of the growth in the firm's float over the past decade has come from its two reinsurance arms). We continue to believe that Geico will be an important contributor to earned premium growth, as well as to the growth of float, with underwriting profitability likely to improve in the coming quarters. 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. In fact, we expect that much of the additional $1 billion in earned premiums that BHPG underwrote during 2015 came from BHSI, even though Berkshire noted that National Indemnity's primary group, Berkshire Hathaway Homestate Companies, and GUARD were contributors. We still expect BHPG to be underwriting $2-$3 billion in earned premiums annually by the end of our five-year forecast period. Even so, we 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 two reinsurance arms.
Berkshire's non-insurance operations typically offer a more diversified stream of revenue and pretax earnings for the firm, helping to offset weakness in any one area, but 2015 was a challenging year. Having recently lowered our near- to medium-term expectations for BNSF, given what we're seeing in the railroad industry overall, we were not too surprised by the results we saw during the fourth quarter and the full year. Revenue declined 12.6% during the fourth quarter, with the firm seeing a marked decline in demand for shipments of coal and industrial products categories (read: crude oil). Management went so far as to note that if these conditions persist (which we believe they will), then volumes, revenue, and earnings in 2016 may be lower than in 2015 (which is our current forecast). While full-year revenue was down 5.5% during 2015, BNSF was able to post a 9.8% increase in pretax earnings, much of which was due to the benefits of lower fuel costs and the lag time in fuel surcharges. The one positive bit of good news for BNSF is that it's unlikely to see a repeat of last year's difficult first quarter, as most of the adverse weather that we've seen so far during 2016 has been east of the company's main territory.
Berkshire has made up for some of the weakness at BNSF this past year with stronger results from Berkshire Hathaway Energy, which increased revenue 3.5% during 2015, with pretax earnings increasing 5.2% as a result. We continue to believe that BHE's U.S. regulated utilities--PacifiCorp, MidAmerican Energy, and NV Energy--will receive constructive rate case outcomes and earn somewhere close to their current allowable returns on equity in the near to medium term. This would put annual revenue growth in the 2%-3% range over the next five years. For Northern Powergrid, we've incorporated the U.K.'s most recent price review into our model, assuming the division generates mid-single-digit revenue growth going forward. As for BHE's pipeline and renewables businesses, we see revenue growing at a low- to mid-single-digit rate through 2019. On a consolidated basis, we expect annual EBITDA growth of 6.5% for BHE through 2019, with EBITDA margins at around 40%. Our assumptions about revenue and profitability for the subsidiary's regulated utilities put our value for these operations at 5.4 times our 2016 EBITDA estimate, which is basically in line with our valuations for similar high-quality utilities with favorable regulatory structures and above-average growth opportunities. Our valuation also implies that BHE's pipeline group is worth 10 times EBITDA (on an EV-to-EBITDA basis), in line with peer multiples and indicative of the higher earned returns that the pipelines are able to realize on average compared with returns for the regulated utilities.
Berkshire's manufacturing, service, and retail operations overall recorded a 7.9% increase in fourth-quarter revenue, which translated into 10.4% top-line growth for the year as a whole. Mixed sales performance across the spectrum of companies--McLane (up 3.4% during 2015), Manufacturing (down 1.7%), and Service and Retailing (up 64.4% as the segment benefitted from both organic growth and the inclusion of the Van Tuyl and Detlev Louis Motorrad acquisitions in quarterly results this past year)--contributed to the group's top-line growth. This had a positive impact on fourth-quarter and full-year pretax earnings, which were up 3.3% and 4.8%, respectively. While we expect reported operating results to see a significant lift from the inclusion of Precision Castparts (and to a lesser extent Duracell) during 2016, we think that the core businesses should still be able to generate revenue growth in the mid-range of our mid- to high-single-digit top-line growth targets, with operating margins (excluding Precision Castparts and Duracell) remaining around 7.0% over the course of our five-year forecast period.
Results for Berkshire's finance and financial products division--which includes Clayton Homes (manufactured housing and finance), CORT Business Services (furniture rental), Marmon (rail car and other transportation equipment manufacturing, repair, and leasing), and XTRA (over-the-road trailer leasing)--were also up year over year, with full-year revenue increasing 6.7% and pretax earnings expanding 13.4% during 2015. Pretax operating margins hit 30.0% on a full-year basis (which is a record level for the group) as profitability improved in all three divisions--manufacturing housing and finance, transportation equipment leasing, and other leasing and financing activities. We continue to expect revenue to grow 5% per year on average during the remainder of our five-year forecast, with pretax margins declining below current levels, due primarily to the potential that exists for near-term weakness in each of the businesses that are represented in this segment.
As we noted above, book value per Class A equivalent share at the end of the fourth quarter of 2015 was $155,501--up 6.4% year over year (and 2.9% sequentially). The company also closed out the period with $61.8 billion in cash on its books. With Buffett liking to keep around $20 billion on hand as a backstop for the insurance business, and Berkshire committing $22.4 billion as part of the Precision Castparts deal, as well as spending another billion on stocks since the start of the year, we believe that the firm has an excess cash balance of more than $15 billion. We view this as dry powder for future acquisitions or share repurchases. While Berkshire did not buy back any shares during 2015 (or over the last three years for that matter), we were surprised to not see any activity in the early part of 2016, as the company's share prices did dip below its 1.2 times book value threshold during both January and February (based on its book value per share at the end of 2015). It could be that the shares did not fall far enough below that particular threshold, and had they gotten closer to passing the buyback threshold established by the firm's book value at the end of the third quarter, we might have seen the firm come out and announce that they were buying back stock. That said, the new threshold for share repurchases stands at $186,601 ($124.40) per Class A (B) share, which is less than 6% away from current trading levels.
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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.