We are maintaining our Outperform rating on the shares of Berkshire Hathaway Inc. (BRK.A)/(BRK.B) following the release of fourth quarter 2010 results. Berkshire’s economically sensitive non-insurance businesses – utilities & energy, manufacturing, service and retail have posted impressive results led by the gradual economic recovery.
Berkshire’s property and casualty insurance business has been the engine behind its growth. Berkshire’s insurance business (which accounted for approximately 40% of the company’s 2010 operating income) maintains capital strength at exceptionally high levels. This strength differentiates Berkshire’s insurance companies from their competitors.
Collectively, the aggregate statutory surplus of Berkshire’s U.S.-based insurers was approximately $94 billion at year-end 2010, up from $64 billion at 2009 end. Its insurance business has been able to increase float (money held between the time when policyholders submit payment and when funds are eventually paid out to settle claims) to $65 billion from $28 billion over the past decade.
Warren Buffett has effectively used this float to make profitable investments. Given Berkshire’s sound underwriting practices, we believe its insurance companies are capable of generating significant floats in future.
Berkshire’s economically sensitive non-insurance businesses – utilities & energy, and manufacturing, service & retail – eventually headed for a sharp recovery after suffering a steep earning decline in 2009 due to the weak economy.
The utilities and energy business will expectedly drive key growth, with increased revenues expected from BNSF, the railway that was acquired in February 2010. During the fourth quarter, revenues from BNSF spiked up 23% year over year.
Stating the importance of railroads in future, Buffett contends that railroads are bound to expand with growing population and GDP. He expects that this railroad will increase Berkshire’s normal earning power by nearly 40% pre-tax and well over 30% after-tax.
Also, the MidAmerican utility business is anticipated to generate modest normalized annual earnings growth driven by PacifiCorp’s rate cases and a drop in some expenses, partially offset by continued investment in the business. According to Buffet, demand for utilities will be strong in future, thereby driving significant earnings growth for the company.
Total revenue for manufacturing, service and retail inched up 4.2% in the fourth quarter, reflecting improved results across most of the units owing to better economic conditions and higher consumer demand.
Warren Buffett’s unique skills have created tremendous value for shareholders over the past 46 years, with per-share book value growing from $19 to $95,453, a rate of 20.2% compounded annually. Book Value growth, which has been significant in 2010, is expected to get a solid boost with the economy rebounding, further gains in the value of the derivatives positions and continued earnings growth in the insurance operations.
Free cash flow from operations at Berkshire increased 25% year over year to $38 billion at 2010 end. Buffett is very eager to utilize this surplus cash. To this effect, last week he announced his intention to acquire Lubizol Corp. (LZ), a specialty chemical company for $9 billion. The cash position of the company is further expected to grow as earnings and investments mature.
Buffett has not spent a dime of cash for dividends or share repurchases during the past 40 years. Instead, he has retained all of Berkshire’s earnings to strengthen the business, a reinforcement now running about $1 billion per month. The company’s net worth has thus increased from $48 million to $157 billion during the past four decades.
Berkshire Hathaway, an Omaha, Nebraska-based holding company, owns 80 operating units ranging from insurance to rail roads, utilities, manufacturing services, retail and home building. The company has four major operating sectors – Insurance, Regulated Utility Business, Manufacturing, Service & Retailing Operations, and Finance & Financial Products.
Berkshire also has stock investments in several market leading companies.
BERKSHIRE HTH-A (BRK.A): Free Stock Analysis Report
BERKSHIRE HTH-B (BRK.B): Free Stock Analysis Report
LUBRIZOL CORP (LZ): Free Stock Analysis Report
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