In addition to the release of the shareholder’s letter this past weekend, Berkshire Hathaway (BRK.A, BRK.B) reported fourth quarter financial results as well – so let’s dive in.
Berkshire ended the quarter with more than $63 billion in cash, plus another $27 billion in fixed income securities; cash & equivalents at year end were more than $15 billion higher than at the end of 2013, largely due to the gap between operating and investing activities (financing added another $2.7 billion). As expected, the duration on the bond portfolio remains quite low: more than 75% of the book (at fair value) comes due within the next five years. Warren and Charlie continue to hold significant dry powder; hopefully they have an opportunity to use some of it in the not too distant future.
At year end, Berkshire’s equities were worth $117.5 billion – which was actually a slight decline from the value of the equities from a year ago. The “Big Four” positions – American Express (AXP), Coca-Cola (KO), International Business Machines (IBM), and Wells Fargo (WFC) – accounted for nearly 60% of the total. The only one that showed any change in the share count from a year ago was IBM, with Warren boosting the stake 13% to 77 million shares; at year end, the position had a market value of $12.35 billion – more than $800 million below Berkshire’s cost basis. Another position, Berkshire’s 700 million Bank of America (BAC) warrants, would’ve pushed IBM out of the top four if exercised at year end; with another six and a half years to go, there’s a good chance the market value on the warrants alone could ultimately exceed $20 billion when that time comes.
For the full year, Berkshire generated more than $32 billion in cash flow from operations, with nearly half of the funds reinvested as capital expenditures ($15.2 billion); the CapEx spent in 2014 was more than 50% higher than two years earlier, with Warren suggesting the shareholder letter we could see another large increase in 2015. The pace of equity purchases picked up in the back half of the year, but still fell slightly short of the amount spent in 2012 or 2013.
While the books show $8.9 billion in equity sales / redemptions for the year, I think that includes the Phillips 66 (PSX) and Graham Holdings (GHC) transactions; assuming that’s accurate, it’s a bit disingenuous to say Berkshire was a net seller of equities in 2014. The “Other Investments” line jumped by a few billion dollars from 2013 due to the Restaurant Brands International financing deal – Berkshire’s second tie-up with 3G Capital. As Warren noted in the shareholder letter, shareholders should expect to see more here in the future: “We expect to partner with 3G in more activities.”
Spending on business acquisitions was just shy of $5 billion for the full year. As we know from Warren’s letter, these came from 30 bolt-on acquisitions at Berkshire’s wholly-owned subsidiaries (with the largest being AltaLink late in December); that’s quite a bit different than last year, when the M&A spend was primarily for one big deal – NV Energy.
2014 pre-tax earnings of $28.1 billion were a few hundred million dollars short of last year – but included just $500 million in gains on derivatives, compared to $2.6 billion in 2013. The 2014 number don’t include the ~$900 million in “non-real” amortization charges Warren called out in the annual letter. With the help of a lower effective rate, net earnings increased 2% year over year to $19.9 billion – more than $12,000 per “A” share and more than $8 per “B” share.
Operating Segments
GEICO reported more than $20 billion in premiums earned for the year, after crossing $15 billion just three years ago; GEICO’s growth continues to outpace the industry by a wide margin, resulting in continued share gains. The float attributable to GEICO, at more than $13 billion, has more than quadrupled over the past fifteen years – just like GEICO’s market share.
While the underwriting gain for the year increased as well (+3%), it didn’t keep pace with the gains in premiums earned; continued improvement on the expense ratio at GEICO (to less than 17% of premiums earned) was offset by an outsized increase in the loss and loss adjustment expense as a percentage of premiums earned, resulting in a 40 basis point increase in the combined ratio (to 94.3%). All-in, especially in comparison to the other players in the private passenger auto insurance industry, that’s hardly a result to lose sleep over.
The remaining insurance businesses collectively reported premiums that increased low double digits from 2013, driven by gains at Berkshire Hathaway Primary Group (+30%) and Berkshire Hathaway Reinsurance Group (+15%); the year over year underwriting gain attributable to the other insurance businesses fell by $300 million due to a large drop-off from BH Reinsurance Group. Lower interest income on fixed income securities resulted in a 5% decline in investment income for the insurance businesses as well, with the underwriting gain and investment income for the insurance operations in aggregate falling by nearly half a billion dollars from 2013.
Float reached $84 billion at the end of the year, up 9% from the end of 2013. Berkshire reported its 12th consecutive year of operating at an underwriting profit in 2014, with the average gain over that period at $2 billion a year. Since 2000, float has tripled from a starting $28 billion – a fourteen year compounded annual growth rate of more than 8%. Over the past twenty years, float has increased more than 25x - at a compounded annual growth rate of eighteen percent. It’s pretty astounding when you stop to consider just how successful Berkshire Hathaway has been in the insurance business over the past few decades.
One of the weak spots for Berkshire in 2014 was Burlington Northern: revenues increased by 5.5% for the year, compared to a 9% increase for rival Union Pacific (UNP) in 2014. In addition, BNSF saw operating expenses outpace revenue growth, with pretax earnings increasing 4%, to $6.2 billion; this compares to an 18% increase at UNP, to more than $8 billion.
In his letter to shareholders, Warren was clear that this needed to change going forward:
“Clearly, we have a lot of work to do. We are wasting no time: As I also mentioned earlier, we will spend $6 billion in 2015 on improving our railroad’s operation. That will amount to about 26% of estimated revenues (a calculation that serves as the industry’s yardstick). Outlays of this magnitude are largely unheard of among railroads. For us, this percentage compares to our average of 18% in 2009-2013 and to U.P.’s projection for the near future of 16-17%. Our huge investments will soon lead to a system with greater capacity and much better service. Improved profits should follow.”
Berkshire Hathaway Energy reported more than $3 billion in operating income in 2014, an increase of nearly 50% from the prior year; roughly half of the gain was attributable to the inclusion of NV Energy in 2014, with the remainder coming from year over year improvements on both the top and the bottom line in the other businesses reported within BH Energy. As BHE continues to retain all of its earnings for reinvestment, we should see strong growth here in the coming years.
Berkshire’s manufacturing and services businesses have pulled their weight as well, with combined pre-tax earnings increasing low double digits to more than $6 billion in 2014; the gains were largely driven by the Manufacturing businesses, with bolt-on acquisitions and organic growth at Lubrizol (LSPI) and Marmon (IMI early in the year), as well as strong unit sales growth at Forest River, pushing revenue and profits higher from the year ago period.
Finally, let’s close with an update on book value: for 2014, Berkshire Hathaway’s reported shareholders’ equity increased by more than $18 billion (+8.2%) to $240 billion, with book value per “A” share up to $146,186 ($97.46 per “B” share). At 120% of book, the repurchase limit is now $117 per B share; the stock currently trades at roughly 1.5x book (~$147).
Conclusion
Looking across the company’s collection of operating businesses – most notably GEICO, Burlington Northern, and BH Energy – I think it’s difficult to argue with Warren’s proclamation about the future of Berkshire Hathaway:
Despite our conservatism, I think we will be able every year to build the underlying per-share earning power of Berkshire.
As an investor, that’s a strong starting point for considering Berkshire shares for the long term. While I’m not allocating new money to BRK.B at current levels, I’m even further from selling a single share; if we moved back to the low $120’s, I’d be adding further to my position.
