Berkshire Hathaway (BRK/A, BRK/B) reported earnings of $35.9 billion in the second quarter versus a loss of $43.6 billion in the same quarter of 2022. Since results are heavily impacted by gains or losses from the investment portfolio, with unrealized losses from their portfolio included in earnings, the rally in the stock market made earnings soar. Operating earnings, which remove the distortion from market changes and better reflect the firm’s earnings power, rose 7% for the quarter versus 2022. Providing an illustration of the value from share repurchases, per-share operating income for the quarter increased by 8% compared to 2022.
Because the Covid-19 pandemic negatively impacted most businesses, including Berkshire, beginning in early 2020, comparing current results to pre-pandemic 2019 results is helpful. Year-to-date operating earnings for the second quarter of 2023 are 55% above 2019. Operating earnings increased over 2019 across all primary business segments except railroad and energy. Thanks to share repurchases, operating earnings per share for year-to-date 2023 were a massive 75% above 2019.
A further look into the different operating segments for the second quarter of 2023 shows weaker results than in 2022, aside from the insurance business, despite overall operating income increasing by 7% year-over-year. In a distinct change from 2022, the insurance segment has been the growth driver year-to-date, as operating income rose 9% but, excluding insurance fell by 8%.
Insurance: Second quarter 2023 investment income was 24% higher than in 2022, primarily due to higher interest income from short-term investments. As yields have rebounded from the ultra-low interest rates implemented in response to Covid, investment income has jumped from depressed levels. Investment income should continue improving in 2023 even though the Federal Reserve has paused its rate increases. Underwriting results were poor for 2022, with the real culprit being significant underwriting losses at GEICO. Berkshire Hathaway Primary Group and Berkshire Hathaway Reinsurance Group had underwriting gains for 2022 and continued that trend in the most recent quarter. In the second quarter, Berkshire’s insurance underwriting suffered no significant catastrophe events, defined as losses exceeding $150 million. GEICO had a solid second quarter thanks to increased premiums per auto policy and lower claims frequency. Geico continues to suffer from rising claims severity due in part to the higher valuation of used vehicles. Despite the better results, all is not well with GEICO as the policies in force have declined, and a considerable reduction in advertising expenses bolstered profits. At the annual meeting earlier in the year, Ajit Jain, who manages Berkshire’s insurance businesses, stated that GEICO had made “rapid strides” in telematics which should help bolster underwriting profits over time. However, the company was still a ”work in progress.” Previously GEICO was a growth engine for both profits and float, so the possible turnaround here is worth monitoring closely.
The two most essential concepts in insurance investing are “float” and underwriting profit. In simple terms, float is created for insurance companies because insurance premiums are paid before any claims are made by the insured. Insurance companies can invest the float, sometimes for years, before insurance losses are reimbursed. Berkshire has a history, unlike many insurance companies, of earning an underwriting profit, meaning that their float costs them nothing and makes them money in addition to allowing them to earn a profit off of investing the float. As seen in the second quarter of 2023, an underwriting profit means the insurance premium exceeds all insurance claims and expenses. Despite Berkshire’s underwriting loss for 2022, it posted underwriting profits year-to-date in 2023 and for calendar years 2021, 2020, and 2019. Berkshire’s float was higher at approximately $166 billion versus the $165 billion level at the end of the first quarter and above the $164 billion on December 31, 2022. In general, the value of float increases as yields rise. Float per share has increased to $114,519 from $113,290 and $112,066 at the end of the first quarter and 2022, respectively. Share repurchases also aided this growth in float per share.
Railroad: Berkshire owns one of the largest railroads in North America, the Burlington Northern Santa Fe (BNSF) railroad, operating in the U.S. and Canada. Second-quarter operating earnings fell 24% and declined 17% year-to-date versus 2022. According to Berkshire, “the decreases were primarily attributable to lower overall freight volumes and higher non-fuel operating costs, offset by lower fuel costs.” Along with GEICO, the railroad was a relative underperformer in 2022, which merits closer monitoring. Earnings declines were also seen across other railroads, so most of the earnings weakness stems from economic rather than company-specific factors in 2023.
Utilities and Energy: Berkshire owns 92% of Berkshire Hathaway Energy Company (BHE) which generally provides steady and growing earnings, as one would expect from what primarily consists of regulated utilities and pipeline companies. In addition, BHE typically produces significant tax credits due to its wind-powered electricity generation. Second-quarter operating earnings fell 1% and declined 23% year-to-date versus 2022. Year-to-date, the U.S. utilities segment was hampered by a $359 million loss from the 2020 wildfires. In addition, a part of BHE was hit by a new Energy Profits Levy income tax in the U.K., costing the firm $82 million in the first quarter. This group also operates Berkshire Hathaway HomeServices (BHHS), the largest residential real estate brokerage firm in the country. The results show that the slowdown in housing activity remains evident, posting a 59.5% decline in second-quarter net earnings versus 2022. The 2023 BHHS earnings suffered from lower transaction volume, mortgage, and refinance activity due to “the impact of rising interest rates, including lower existing home sales and mortgage refinancing demand.”
Manufacturing, Service and Retailing: This segment consists of many diverse businesses, so this analysis will focus on a few significant themes when looking at this segment. Berkshire’s aerospace exposure remains substantial despite selling its publicly traded airline holdings earlier in 2020. Berkshire previously took a $10 billion impairment charge on the Precision Castparts
PCP
After a 2022 boom year, housing-related businesses like Clayton Homes, Shaw, Johns Manville, Acme Building Products, Benjamin Moore, and MiTek posted lower quarterly and year-to-date earnings, at 6.1% and 13.4% decreases in pre-tax profits, respectively. The impact of higher interest rates on home construction means that “some of our businesses will experience comparative declines in revenues and earnings over the remainder of 2023.”
The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had 21.1% higher earnings for year-to-date 2023 compared to 2022, driven by higher service, repair, and finance operations. Vehicle sales margins peaked in the first half of 2022 and have declined since. In addition, year-to-date and second-quarter 2023 earnings were lower for the other retailing businesses, which include Pampered Chef, See’s Candies, and their furniture retailers, including Nebraska Furniture Mart. This weakness in some of the retailing exposed companies is not surprising, given the more challenging operating environment also reflected by others in the industry. The primary difficulty was the home furnishing businesses which experienced a 33.8% decline in earnings through June relative to 2022.
Berkshire’s McLane unit had 69.7% higher profits for the second quarter and year-to-date pre-tax earnings 53.2% above 2022. The improvement in earnings “reflects increases in the gross margin rates and lower fuel expenses, partly offset by higher personnel expenses.” McLane is a wholesale distributor to retailers and restaurants.
In another sign of a more challenging economic backdrop, Berkshire warned that its TTI
TTI
Pilot Travel Centers: Pilot is the largest operator of travel centers in North America, under the names Pilot and Flying J. In January 2023, Berkshire acquired an additional 41.4% ownership of Pilot for roughly $8.2 billion. As Berkshire’s ownership increased to 80% of the entity, it is now shown as a segment within the financials for the operating companies. According to management, “Pilot’s revenues and earnings are highly dependent on fuel volumes, prices and margins.” Pre-tax earnings fell by 22.8% for the second quarter and 24.2% year-to-date compared with 2022, “primarily due to significantly lower fuel prices, as well as from lower fuel sales volumes.”
Non-Controlled Businesses: This segment includes companies’ profits that must be accounted for under the equity method due to the size of ownership and influence on management. The after-tax equity method earnings have Berkshire’s proportionate share of profits attributable to its investments in Kraft Heinz (KHC), Occidental Petroleum (OXY), and Berkadia. The equity method earnings include Occidental beginning in the fourth quarter of 2022, so part of the significant earnings increase in this segment was that Occidental was not included in the second quarter of 2022 data. According to management, the increase in after-tax earnings was “primarily due to earnings from Occidental Petroleum and increases in earnings attributable to Kraft Heinz.” According to Bloomberg, Berkshire is Occidental Petroleum’s largest shareholder, with a 25.3% stake. More about the reasons for the Occidental investment is here.
Other: The segment had a gain in the quarter primarily due to foreign currency exchange rate gains generated from bonds issued by Berkshire Hathaway and denominated in British Pounds, euros, and Japanese Yen. These foreign currency liabilities are not a concern as Berkshire has significant assets and earnings denominated in these foreign currencies. Investment gains from non-U.S. dollar investments generally offset these losses and vice versa depending on currency exchange rates. Though overwhelmed by the currency gains, there were losses in the segment created by amortizing intangible assets connected to companies purchased by Berkshire. Finally, other earnings include “Berkshire parent company investment income and corporate expenses.”
Berkshire bought back almost $1.4 billion of its stock in the second quarter, down from $4.45 billion in the first quarter. Until an announcement in mid-2018, Berkshire had only made repurchases when the stock traded at less than 1.2 times the price-to-book (P/B) ratio. While that constraint is now relaxed, it is still a good indicator of the general range when aggressive repurchases will likely be seen. Berkshire’s price-to-book ratio was between 1.3 and almost 1.5 times during the quarter. Berkshire only intends to repurchase shares when the “repurchase price is below Berkshire’s intrinsic value, conservatively determined.” The price-to-book ratio remains a reasonable proxy for gauging Berkshire’s intrinsic value. Still, Warren Buffett and Charlie Munger’s judgment about its intrinsic value versus other available uses of capital can differ from that simple price-to-book measure.
In addition, Berkshire made other purchases but was a net seller of publicly traded stocks in the first quarter. Berkshire bought $4.6 billion of stocks while selling $12.6 billion for a net decreased investment of $8 billion in publicly traded equities. A close review of the firm’s 10Q filing revealed that approximately $1.4 billion of Berkshire’s Chevron (CVX) holding was sold during the quarter while adding to its Occidental stake. More details will be found in the 13F filing with the SEC, released on August 14.
Berkshire Hathaway initially announced the acquisition of about 5% of five Japanese trading companies at the end of August 2020. These holdings are Itochu Corp., Marubeni Corp., Mitsubishi Corp., Mitsui & Co. Ltd., and Sumitomo Corp. Buffett revealed in April 2023 that Berkshire increased its stakes in these companies to 7.4%. Buffett indicated that these were intended to be long-term holdings, and Berkshire may still increase its stake to 9.9%. The 13F does not include international stocks.
Summary: Quarterly results are generally not meaningful for Berkshire since it is managed with a focus on increasing long-term value and not meeting quarterly hurdles. This ability to take advantage of time arbitrage has served the company and shareholders well over the years. The goal in looking at the results is to see if the segments are generally operating as expected and consider the capital allocation decisions made by Warren Buffett and Charlie Munger.
Operating earnings for the second quarter of 2023 rose by 7% over 2022 and are 64% above pre-pandemic 2019 levels. In recent years, a significant capital allocation decision was made to increase share repurchases. This activity signals that Buffett and Munger believe Berkshire Hathaway’s price is below their intrinsic value estimate, which should be a value-creator for the remaining shareholders. Operating earnings per share were 8% above 2022 and 85% above 2019, with the additional benefit from share repurchases.
Despite the strong headline operating earnings growth, Berkshire was not immune to the general earnings slowdown experienced by other S&P 500 companies. Berkshire’s second-quarter operating earnings, excluding the insurance segment, declined by 5% compared to the same quarter in 2022. According to FactSet data, this is consistent with the 5.2% decline in second-quarter earnings reported by the S&P 500 constituents. In addition, profit margins, excluding the insurance business, were down almost three percentage points versus last year. Buffett’s prediction at the annual meeting that most of Berkshire’s businesses will likely have lower earnings in 2023 than the previous year has proven correct so far.
Despite the expectation that most Berkshire’s businesses would do worse, Buffett forecasted higher 2023 overall operating earnings at the annual meeting. Buffett noted that insurance underwriting does not “correlate with economic activity.” Higher bond yields will provide significantly higher investment income for Berkshire’s insurance business in 2023. With the tailwind from the insurance segment, Berkshire’s second quarter and year-to-date operating earnings diverged from the rest of the S&P 500 and were 7% and 9% higher than in 2022, respectively.
Berkshire’s stock price outperformed the S&P 500 in the second quarter, rising by 11.2% versus a total return of 8.7% from the S&P 500. For 2023 through the end of July, Berkshire’s price is 14.2% higher, while the S&P 500 had a total return of 20.6%. Cash levels were significantly above last quarter. Berkshire retains a fortress balance sheet with cash and equivalents of almost $142 billion, providing flexibility to take advantage of opportunities, including repurchasing its stock. Berkshire has stated that there would be no stock repurchases if it would cause cash levels to fall below $30 billion.
Despite the advanced age of its two top leaders, Warren Buffett, CEO and Chairman, and Charlie Munger, Vice Chairman, Berkshire has a solid bench to continue managing the firm. Greg Abel manages the non-insurance business and is the architect of Berkshire Hathway Energy. Ajit Jain manages the insurance businesses and will continue to do so. Ted Weschler and Todd Combs already manage a portion of Berkshire’s publicly traded stock portfolio. Berkshire is managed to survive and emerge stronger from any economic or market downturn, and that philosophy is not likely to change, given the culture. Buffett’s statement that Berkshire “will buy $50 billion of our stock if it makes sense” should comfort those worried about the stock dropping precipitously when Buffett and Munger can no longer control the firm.
Berkshire’s robust second-quarter results again illustrated the value of its diversified business mix. The insurance business was a strong performer, while many other business units saw earnings declines. Berkshire retained and expanded the cash hoard on its Fort Knox balance sheet, allowing the unique ability to take advantage of opportunities in any downturn while virtually eliminating the risk of ruin.
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