Berkshire Posts Mixed 2Q Results

Wide-moat-rated

Second-quarter revenue increased 3% year over year to $51.4 billion on mixed operating results from the company's main operating segments. Excluding the impact of investments and derivatives, revenue increased 9% year over year. Berkshire posted $2.5 billion in investment and derivative gains on its top line for the second quarter of 2014, compared with less than $200 million in this year's period. Through the first six months of the year, unadjusted revenue was up 5%, putting top-line growth at the lower end of our full-year forecast of mid-to-high-single-digit revenue growth.

With expenses rising at a higher rate than revenue, the company reported a 34% decrease in pretax earnings (to $5.8 billion) and a 37% decrease in net earnings (to $4.1 billion). Stripping out the impact of investments and derivatives, operating earnings decreased 10% to $3.9 billion. Net earnings per Class A equivalent share were $2,442 (down from $3,889 during the second quarter of 2014). For the first six months of 2015, net earnings per Class A equivalent share were $5,585, which is about $400 less than we expected the firm to have generated by this point in the year.

Book value per Class A equivalent share at the end of the second quarter was $149,735--up 5% year over year (and 2% when compared with the first quarter of 2015). This was lower than our forecast, which called for book value per share to increase to $151,004. The company closed out the June quarter with $60.4 billion in cash on its books, up 20% year over year, and reflective of a 5% sequential increase.

Looking more closely at Berkshire's insurance operations, three of the firm's four insurance lines--Geico, Berkshire Hathaway Reinsurance Group, and Berkshire Hathaway Primary Group--posted earned premium growth during the quarter. Meanwhile, General Re reported its first decline in earned premiums in two years primarily due to pricing pressure within the property and casualty markets. In particular, the firm continues to constrain the volume of reinsurance it is underwriting, given the excess capacity that exists in the market and the fact that pricing is not attractive enough to profitably underwrite additional business. From a profitability perspective, Berkshire's insurance operations incurred a pretax underwriting loss of $48 million, compared with an underwriting gain of $637 million during the second quarter of 2014, as underwriting losses of $411 million at BHRG more than offset the more positive results generated by Geico, General Re, and BHPG. While Geico posted another quarter of consistent growth on the top line, claim expenses remained at elevated levels. The auto insurer's loss ratio climbed to 83.6% from 76.4% in the year-ago quarter, as the company continued to experience increases in claims frequencies and severity in several of its major coverages. That said, premium growth was relatively strong, with written premiums growing 12% over last year's levels, reflecting an increase in premium volume and pricing. Geico's growth trends were healthy and more or less in line with our expectations, and should improve once the firm gets its underwriting standards tightened up and takes pricing actions aimed at getting its loss ratio back to more normalized levels in the near to medium term. Berkshire's insurance float increased to $85.1 billion from $83.9 billion at the end of 2014, reflective of a 1% increase during the six-month period. We expect further gains in float to be much harder to come by as we move forward, especially with Berkshire limiting the amount of reinsurance business it underwrites (noting that much of the growth in the firm's float over the past decade coming 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. 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. Berkshire's noninsurance operations typically offer a more diversified stream of revenue and pretax earnings for the firm, helping to offset weakness in any one area. After posting stronger results during the first quarter, BNSF took a step back during the second quarter, with revenue declining 6% year over year and pretax earnings increasing just 4% as a result. On a year-to-date basis, revenue was down 2%, but pretax earnings were up 21%. This increase was primarily due to a significantly better first quarter in 2015 compared with the same period a year ago, when poor weather conditions plagued much of BNSF's territory, had an impact on rail car volumes, and drove up costs meaningfully. Lower average revenue per car/unit (on which lower fuel surcharges had an impact year over year) and relatively flat volumes were responsible for the decline in year-to-date revenue. As for volumes, so far in 2015 softening demand for energy-related products (read: oil and coal) has had a negative impact on freight. We view this volume glut as a temporary glitch in BNSF's performance, and one that is affecting most of its peers as well. We continue to expect the railroad's operating ratio to resume the path that would put its profitability more in line with Union Pacific longer term. Berkshire Hathaway Energy came into 2015 with slightly higher hurdles, having benefited from the addition of NV Energy last year, as well as solid results from its other regulated utilities--PacifiCorp, MidAmerican Energy, and Northern Powergrid. That said, the firm did benefit this time around from both the AltaLink purchase (which closed in December 2014), as well as continued acquisitions and better operating performance from its real estate arm Berkshire Hathaway HomeServices. Second-quarter revenue increased 9%, lifting year-to-date top-line growth to 5%. Pretax earnings increased 12% when compared with the second quarter of 2014, with year-to-date pretax profits increasing 4% as a result. Going forward, we continue to envision BHE's U.S. regulated utilities receiving constructive rate-case outcomes, which would put annual revenue growth in the 2%-3% range over the next five years. For Northern Powergrid, we assume the division generates mid-single-digit revenue growth. As for the firm's pipeline and renewables businesses, we see revenue growing at a low- to mid-single-digit rate during 2015-19. This should all contribute to consolidated annual EBITDA growth of 6.7% over the next five years, with EBITDA margins hovering around 40%. With regards to Berkshire's manufacturing, service, and retail operations, the group overall recorded a 13% increase in second-quarter revenue (which translated into 12% top-line growth on a year-to-date basis), as better performance from McLane and the firm's service and retailing division (which benefited from organic growth and the inclusion of the Van Tuyl acquisition in quarterly results) more than offset somewhat weaker results from its manufacturing segment. McLane, in particular, posted a 5% increase in second-quarter revenue (and 8% increase in year-to-date revenue), and a 17% increase in second-quarter pretax earnings (and 15% increase in year-to-date profits) as stronger results from its grocery and foodservice operations contributed to better results overall. While revenue decreased 1% during the second quarter in Berkshire's manufacturing operations--which include Marmon, Lubrizol, Iscar, Forest River, CTB International, and Scott Fetzer--the segment continues to post positive growth in pretax earnings, primarily due to the favorable impact of lower average raw material costs. As for the company's finance and financial products division, revenue expanded at a 10% rate when compared with the prior year's period (with year-to-date top-line growth at 9%), and pretax earnings rose 30% (25%). As we noted above, book value per Class A equivalent share at the end of the second quarter was $149,735--up 5% year over year (and 2% when compared with the first quarter of 2015). The company also closed out the period with $60.4 billion in cash on its books. Buffett likes to keep around $20 billion on hand as a backstop for the insurance business. Assuming that the rest of the businesses need at least 2% of revenue as operating cash, and with Berkshire committing $5.26 billion to the Heinz-Kraft Foods deal (which closed in early July), we believe that the firm has an excess cash balance of around $32 billion. The company did not buy back any shares during the first half of 2015. Given Berkshire's current book value per share, and the company's ongoing share repurchase authorization, which allows the firm to buy back stock at prices no higher than a 20% premium over book value, Buffett should be willing to buy back stock at prices up to $179,682 per Class A share (or $120 per Class B share), implying a floor on the company's common stock that is about 17% below where Berkshire's shares are trading right now.

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