Berkshire Hathaway Inc. (BRK.A, Financial) is one of the world's largest investing conglomerates. The company is a diversified giant which owns major businesses across insurance, railroads, energy, manufacturing and more. Warren Buffett (Trades, Portfolio), now 91 years old, has executed his strategy of buying “wonderful companies at fair prices'' down to a T. Berkshire has generated tremendous returns for investors of approximately 20% compounded over the past 57 years and seems to show no signs of slowing down.
Despite this strong performance, the share price corrected down by 25% between March and June 2021, which seems to have been mainly caused by macroeconomic headwinds and a decline in Berkshire's equity portfolio. Over the past couple of months, the stock has gained traction and increased by around 9%, which has likely been driven by strong buybacks.
Berkshire posted solid financial results for the second quarter of 2022 on Aug. 6. In this discussion, I will break down the results and take a closer look at the company's valuation.
Strong second-quarter earnings
Berkshire Hathaway generated strong financial results for the second quarter of 2022. Its revenue popped 10% year over year to a staggering $76 billion, but was down slightly from the $78.8 billion produced in the prior quarter. Operating expenses increased by roughtly 6.6% year over year to $64.5 billion. This was driven by an increase in expenses across all business segments from insurance losses (up 4% year over year) to rail, energy and utilities costs, which increased by around 14% year over year. The increase in operating expenses across the board represents Berkshire's exposure to the high inflation environment. Berkshire's management noted that, overall, pandemic lockdowns in various parts of the world and the Russia-Ukraine conflict resulted in continued supply chain disruptions and inflationary pressures.
Despite the headwinds, operating earnings in the second quarter actually rose to $9.2 billion, up a substantial 31% year over year from the $7.04 billion generated in the year-ago quarter. This was driven by strength across all its operating segments.
However, the company did record a net earnings loss from many public stock investments due to depressed stock market prices.
Investment and derivative losses ballooned to $53 billion versus just $5.43 billion in the prior quarter and $21.4 billion a year ago. The good news is the majority of these losses are "paper" balance sheet adjustments and since Buffett’s favorite holding period is “forever,” I do not imagine he will be selling anytime soon.
The overall net loss for the second quarter was $43.8 billion, much worse than the $5.46 billion loss in the first quarter and the $28.1 billion loss in the prior-year period. Berkshire's equity portfolio had a fair value of $327.7 billion as of the end of June, which was down approximately 16% year over year. Approximately 69% of this fair value is divided across just five main companies, which include:
- Apple Inc. (AAPL, Financial) ($125 billion)
- Bank of America Corp. (BAC, Financial) ($32.2 billion)
- Coca-Cola Co. (KO, Financial) ($25.2 billion)
- Chevron Corp. ($23.7 billion)
- American Express Co. (AXP, Financial) ($21 billion).
As illustrated in the chart below, the share price of the majority of these companies boomed in 2020-21, but has since dipped slightly along with the general market.
Often criticized for holding too much cash, Buffett has been on a shopping spree over the past several quarters, loading up on shares of Occidental Petroleum (OXY, Financial). Berkshire is now the largest shareholder of Occidental, owning roughtly 19.39% of its shares outstanding. Berkshire's management alluded to the fact the company also has “warrants to purchase up to 83.86 million shares of Occidental common stock at an exercise price of $59.62 per share,” which is close to where the stock traded at the time of writing. Its preferred stock includes a healthy dividend of about 8% per year, which would ensure a strong inflation hedge for Berkshire.
Berkshire Hathaway’s railroad segment includes Burlington Northern Santa Fe, which operates one of the largest railroad systems in North America with over 32,500 route miles of track. Buffett calls this the “the number one artery of American commerce” as its lines are commonly used to transport coal as well as industrial and agricultural products. The guru also highlighted in his past shareholder letter that despite rail being a legacy transportation method, it offers significant carbon emission savings over trucks.
Railroad operating revenue was $6.5 billion for the second quarter, which increased 15.1% year over year. This was primarily driven by an increase in average revenue per car, but was partially offset by higher fuel costs and slightly lower freight volumes compared to the prior year. Overall railroad earnings increased 9.76% to $1.66 billion.
Moving to the insurance segment, underwriting of $581 million increased 55% from $376 million a year ago. With a substantial jump occurring during the second quarter, insurance investment income also generated strong growth of 56% year over year to $1.91 billion.
The GEICO insurance unit had a decline in earnings due to "increased claims frequencies and severities and lower reductions of ultimate claim estimates for prior years' losses.”
But reinsurance underwriting increased due to favorable foreign currency exchange rates.
Berkshire owns 92% of Berkshire Hathaway Energy Co., which operates a global energy business. Its utility and energy segment produced $766 million in earnings, up approximately 3.5% year over year. This was driven by tax equity investments from its natural gas pipeline business, but earnings were offset partially by lower U.S. regulated utility earnings.
Manufacturing, service and retailing earnings popped by 8.2%, driven by good consumer demand. However, the segment did feel the negative effects of material, freight and labor inflation, which increased costs.
Buybacks
Buffett has been aggressively buying back stock over the past several quarters, but gradually scaling down purchase size. In the fourth quarter of 2021, buybacks were approximately $6.9 billion. In the first quarter of 2022, the company scaled buybacks down to $3.2 billion and then to around $1 billion in the second quarter.
Berkshire had a substantial cash balance of $85.3 billion as of the end of the fourth quarter of 2021. Buffett has gradually deployed the cash into various investments and buybacks to leave a healthy position of $26.5 billion, which should keep investors happy.
Is the stock undervalued?
Berkshire Hathaway is trading at a price-earnings ratio of 7.87, which is 61.5% cheaper than its five-year average.
The GF Value calculator indicates a fair value of $432,570 per share. Thus, the stock is fairly valued at the time of writing.
Final Thoughts
Berkshire Hathaway is a fantastic company and a manifestation of Buffett’s timeless investment strategy. The guru has been investing heavily into equities over the past two quarters, which could be an indication of value in the market.
