On Saturday, Berkshire Hathaway (BRK-A) released its 2008 annual report and shareholder letter.  Not surprisingly given the economic and market downturn, Berkshire’s net worth, or book value, declined in aggregate by 9.6% to $70,530 per each class A share.  It should be noted—as Chairman Warren Buffet did—that this is the largest decline in both the S&P 500 as well as Berkshire’s net worth in the conglomerate’s 44-year history.

The majority of Berkshire’s decline in net worth was due to the decline in the value of the conglomerate’s equity holdings, which given the size of the companies that Berkshire owns, it’s not surprising that with the S&P down substantially, so were the value of Berkshire’s equity holdings.  But even with this headwind, Berkshire’s results were better than the S&P, to the tune of 27.4 percentage points better.  Berkshire’s accounting net worth was also impacted by increased accounting liabilities—non-cash for the most part—on its derivatives exposure.

Derivatives Exposure

Berkshire’s derivative exposure has, in my opinion, caused some investors to view the firm a bit differently than they had previously.  For years, Buffett referred to derivatives as “weapons of financial mass-destruction”, and he had indicated that he steered clear of them in both word and action.  On the latter, he sold Berkshire’s position in Freddie Mac (FRE) in the early 2000’s, and wound down the conglomerate’s derivative book in General Re, which Berkshire had acquired in the late 1990’s.   So, to learn that Berkshire has some new—and recently written—derivative contracts may be a bit un-nerving to some long-term shareholders.

I agree that the flip-flop on this stance has certainly impacted the perception of Berkshire in the marketplace.  But, I think there are some important differences to note as well.  One is that Berkshire has essentially no counterparty exposure in the contracts, which helps to isolate the firm from the interconnectedness that has plagued other large financial institutions in today’s vicious downward re-pricing of assets.  The other significant difference is that Buffett said Berkshire would not engage in any contracts where it was required to post collateral.  This is important because collateral postings in a time of financial stress can often be devastating to a company—think AIG (AIG).  As a result, Berkshire should be further insulated from this type of risk, and probably, I would suspect, ultimately make money on its derivative positions in the coming years, despite the impact these contracts have had on Berkshire’s present day image.

Earnings

There was nothing really that surprising in Berkshire’s earnings report.  Auto-insurer GEICO has continued to grow nicely despite the weak economy, and in fact has seen more rapid growth than I had expected, as many consumers have looked to reduce their auto insurance costs by using a low-cost player like GEICO.  Berkshire’s reinsurance operations were also profitable this past year, thanks largely to the absence of natural—not financial—disasters in 2008.  As a result, Berkshire benefited from another year of negative-cost on its float, which now approximates $58 billion.

Berkshire continued to grow its utilities earnings, which now are an even bigger and more important component of the conglomerate’s overall earnings stream.  What’s more, Buffett indicated that he is seeking to further expand Berkshire’s utility footprint if additional deals become available at the right prices.

As for the other businesses Berkshire owns, the results were a bit of a mixed bag.  Certainly the businesses that are tied to housing, construction, and the consumer suffered, particularly in the fourth quarter, with the current economic slowdown.  Other higher-end businesses such as Net Jets also saw weakness in its earnings.  On the other hand, McLane—a grocery distributor—actually saw a very modest increase in sales and a slight improvement in its operating margin.  All in all, earnings were largely down, though, and consistent with the general economic weakness we are experiencing today.

Annual Letter Tidbits

To me at least, this year’s annual letter was a little bit different than some of the more recent letters.  Part of this is likely because there is just a lot more to write about this past year than there have been in prior years.  I basically see this year’s annual letter as divided into three distinct components:  review of earnings, marketing for deals, and general economic/market commentary.

The first of these, earnings, as I’ve detailed above, was neither a great year, nor a terrible year for Berkshire, but in aggregate the conglomerate is being affected just like everyone else is by today’s economic weakness.

The second of these, marketing for deals, was significant, I thought.  As usual, Buffett indicated that he was on the prowl for large and well run family businesses that are in need of either a long-term owner, or that are facing the challenge of needing to simplify their ownership structure.  This is really no different from prior letters. 

The more interesting elements of the marketing aspect of the letter were that Buffett was basically telling regulators that Berkshire via Mid-American is looking to expand and make acquisitions in the utilities sector.  What’s more, he indicated that Mid-American has been a leader in wind power generation.  With the current government emphasis on making capital outlays for alternative energy sources—such as wind—Buffett was potentially positioning Berkshire to capture some of this investment. 

And finally, the letter also marketed Berkshire’s financial strength to municipalities and states seeking bond insurance for any new or existing debt issues.  Berkshire entered into the bond insurance industry in early 2008 via Berkshire Hathaway Assurance Corp, and so far has provided protection on bonds that were already insured by legacy players.  Berkshire is now likely to push harder into the primary market of bond insurance with its solid AAA rating.

The third element, and perhaps the most interesting to the average investor, was Buffett’s comments on the economy and the markets.  To be sure, he indicated, these are in fact challenging times.  But—and importantly—he said that we as a country have survived and prospered through much worse during the twentieth century, and that our system of unleashing human economic potential will also get us through this difficult spot and allow us to prosper again.  He also defended the government’s actions to save some beleaguered financial institutions, as they had potentially become a threat to the overall financial system due to their size and interconnectedness. 

Buffett also indicated that the world has gone from under to over pricing risk, and warned—as I’ve alluded to previously—about the potential for a bubble in the Treasury bond market.  He also warned that the current government action, while necessary, would have side effects, one of which could be inflation.

The most interesting aspect of this discussion to me, though, was that he wrote “Beware the investment activity that produces applause; the great moves are usually greeted by yawns.” (1)   Naturally, this means that to produce great investment returns, decisions shouldn’t be popular—we all know that.  What it also means, however, is that investors should avoid trying to catch a falling knife, and look for areas of the markets that are generally ignored, where people don’t have enough interest to have an opinion one way or the other.  I think of Berkshire’s investment in Anheuser-Busch a few years ago as a prime example of this, as nobody really had much to say about this investment, and Berkshire ended up almost doubling its money when Anheuser was acquired earlier this year.  Perhaps Burlington Northern (BNI) is another stock like this.

If it is, or if it isn’t, 2008 was a year that while Berkshire’s reported results were down, the conglomerate put a lot of cash to work and a number of markers on the table, as asset prices cascaded down.  Berkshire’s cash balance is down from over $40 billion to around $24 billion, and I believe that Buffett has been busy planting some great investment seeds for the future, at what appear to be varying depths. 

You might also be interested to know that buffettologist.com was featured in a recent MarketWatch article which I’ve linked here, and also mentioned in an Associated Press article which I’ve linked here.

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

(1)  http://www.berkshirehathaway.com/letters/2008ltr.pdf

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.

Berkshire Hathaway (BRK-A) indicated Monday that it plans to release its 2008 shareholder letter this Saturday.  This has undoubtedly been a year where a lot has happened at Berkshire—and in the economy—and many investors will likely be anxious to hear Chairman Warren Buffett’s thoughts on a number of topics.

Buffett has already indicated his view on some issues this year, from his Op-Ed piece in the New York Times last fall, to the myriad of appearances he has made on various television shows over the last few months.  What I’ll be looking to learn more about, though, in this year’s shareholder’s letter, is more details—or perspectives—on some of the new investments Berkshire made during 2008.  In my mind, at least, this has truly been a watershed year, as the current market panic has offered Berkshire—and other long-term investors—the opportunity to plant several investment seeds for the future, at varying depths.  In fact, Berkshire has been able to put more capital to work in one year, than I would have thought it would have been able to do over the next few years, and as a result, Buffett has probably been able to move the needle on Berkshire’s long-term valuation.  I’ll also be looking to learn more about Berkshire’s derivative positions, as they have caused a lot of uncertainty over the last few months, and have also likely impacted the share price to some extent.  While Berkshire received cash up-front in its derivatives positions--which eliminates the conglomerate’s counterparty risk--the general fear of derivatives these days has certainly affected some investors’ perception of Berkshire.  As such, I’ll be hoping to learn a little more about the details of some of these positions.  And finally, I always pay attention to any general market or economic commentaries from Berkshire, as historically these observations have tended to be very prescient.

Please be sure to check back at buffettologist.com this weekend for my analysis of Berkshire’s earnings, as well as my commentary on any investing nuggets included in the 2008 shareholder letter.  You might also be interested to know, that buffettologist.com was mentioned in a recent Associated Press article, which I have linked here.

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.

On Tuesday, Berkshire Hathaway (BRK-A) filed its most recent form 13-F, which details the investment conglomerate’s holdings at the end of the fourth quarter of 2008.  Chairman Warren Buffett, as well as his colleague at auto-insurer Geico, Lou Simpson, manage Berkshire’s stock portfolios.  It should be noted that this disclosure does not include Berkshire’s international stock holdings.  Berkshire also sometimes receives exemptions from the SEC to delay the disclosure of some of the stocks it is buying, in order to avoid other investors trying to front run the firm.  Therefore, Berkshire could still be buying some stocks that it has yet to disclose.

In general, though, this was not a quarter where Berkshire was a net buyer of stocks.  In fact, Berkshire continued to re-allocate capital during the fourth quarter, which really isn’t that surprising, given the opportunities in the markets today.  In my opinion, Berkshire sold some of its position in stocks that have held up relatively well over the past year, and that are also somewhat newer positions to the portfolio.  On the former, these stocks are generally defensive names—think Johnson & Johnson (JNJ) and Procter & Gamble (PG)—that have proven to be a flight to quality for many other investors, and as a result have held up well relative to the rest of the market.  On the latter, since Johnson & Johnson was a relatively newer position to the portfolio, by selling it, Berkshire’s tax liability would be much less than had it sold something that it had held for a very long time.  As for Procter & Gamble, Berkshire was forced to use a more recent cost basis on this name when P&G acquired long time Berkshire holding Gillette a few years ago.  As such, selling some of P&G would also result in a relatively low tax liability for Berkshire.

Given that Buffett wrote an article last fall indicating that he was bullish on American stocks over the next 3 to 5 years, many investors expected to see a bevy of new investments in Berkshire’s equity portfolio.  What has actually happened, though, is that Berkshire has become a lender of last resort to companies in need of debt, or debt refinancing.  Given that the debt markets have become essentially dysfunctional, and have all but dried up, Berkshire has been able to extract equity like returns from good companies in need of debt financing.  Two recent deals that demonstrate this are Berkshire’s financing of Harley Davidson (HOG) at a lofty 15% coupon over the next five years, as well as Berkshire’s refinancing of Tiffany (TIF) debt at a 10% coupon.  With equity-like returns like that—which are guaranteed because they are debt instruments—its no wonder Berkshire re-allocated some of its capital in this manner.

Reductions

Berkshire decreased its stake in the following companies over the fourth quarter.  The largest reduction was to Johnson & Johnson, followed by Procter & Gamble, and then by US Bancorp (USB).

•    Johnson & Johnson
•    Procter & Gamble
•    US Bancorp
•    Conoco Phillips (COP)
•    Carmax (KMX)
•    United HealthGroup (UNH)
•    Wells Fargo (WFC)

As I’ve also noted previously, Berkshire received shares in Constellation Energy (CEG), which it had received when Constellation pulled out of its deal to be acquired by Berkshire subsidiary Mid-American.  Throughout January and February, Berkshire has been aggressively selling this name.

Additions

Berkshire did add to a few positions during the fourth quarter as well.  As I’ve noted in a prior article, Berkshire has continued to accumulate shares in Burlington Northern (BNI), and by the end of January owned more than 22% of the company.  Here are all of the companies that Berkshire added to over the last quarter:

•    Burlington Northern
•    NRG Energy (NRG)
•    Ingersoll-Rand (IR)
•    Eaton Corp. (ETN)

The last of these, Eaton, was a new addition to the portfolio during the third quarter, and it appears as though Berkshire has continued aggressively adding to the name.

New Position

Berkshire did buy one new stock during the fourth quarter, initiating a position in Nalco Holding (NLC), which is a company that offers water treatment products and services.

•    Nalco Holding

Unchanged Positions

There were a number of unchanged positions during the quarter, though, Berkshire’s stake in USG (USG), has actually increased, as Berkshire intends to convert some of its debt into additional shares of USG, which was recently approved by USG shareholders.  Here is the listing of the unchanged positions for Berkshire during the fourth quarter:

•    American Express (AXP)
•    Bank of America (BAC)
•    Coca-Cola (KO)
•    Comcast (CMCSA)
•    Comdisco (CDCO)
•    Costco (COST)
•    Gannett (GCI)
•    General Electric (GE)
•    GlaxoSmithKline (GSK)
•    Home Depot (HD)
•    Iron Mountain (IRM)
•    Kraft Foods (KFT)
•    Lowes Companies (LOW)
•    M&T Bank (MTB)
•    Moodys (MCO)
•    Nike (NKE)
•    Norfolk Southern (NSC)
•    Sanofi Aventis (SNY)
•    SunTrust Bank (STI)
•    Torchmark (TMK)
•    USG
•    Union Pacific (UNP)
•    United Parcel Service (UPS)
•    Wabco Holdings (WBC)
•    Wal-Mart (WMT)
•    Washington Post (WPO)
•    Wellpoint (WLP)
•    Wesco (WSC)

I’m often asked whether it is more advantageous to follow Berkshire’s stock picks or to just follow Berkshire.  My answer is always the same.  While one can try to game the system by “cherry-picking” Berkshire’s stock picks, I’ve always felt it is better to just follow Berkshire.  While Buffett is a great investor, he’s not perfect, so just because he buys a particular stock, does not mean it will automatically go to the moon.  By following Berkshire, on the other hand, one can benefit from Berkshire’s stock positions on a portfolio, or aggregate, basis.  More importantly, though, by following Berkshire, one can benefit from deals and terms that are only available to a company like Berkshire---think the recent Harley and Tiffany debt offerings.

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.

Just when you thought Berkshire Hathaway (BRK-A) and Chairman Warren Buffett might slow down a bit, the investment conglomerate has continued to aggressively re-allocate capital. 

Last week, Berkshire’s Mid-American subsidiary continued to sell its stake in Constellation Energy (CEG).  In December, Constellation pulled out of its deal to be acquired by Mid-American, in favor of a deal with Electricite de France (EdF).  As a result, Berkshire received 19 million shares in Constellation as well as $593 million in cash as a break-up fee.  Throughout January and February, Berkshire has sold over 5 million shares in Constellation for proceeds of about $136 million, bringing the total cash in the bank from the cancellation of this deal to about $729 million.

This has likely helped buffer Berkshire’s coffers, especially as the conglomerate has made a bevy of deals as of late.  I’ve already written about Berkshire’s participation in Harley Davidson’s (HOG) debt offering, its increased stake in Burlington Northern (BNI), and its capital injection into Swiss Re, and just last week Berkshire made a couple of additional moves.

Cement and aggregate company Vulcan Materials (VMC) announced in its earnings call last week that Berkshire was the sole investor in a $400 million debt offering that the company recently completed.  Vulcan did not, however, indicate the terms of the deal.  With the difficulty in finding and acquiring permits for new rock quarries, Vulcan is a company with selection of assets in locations that would be difficult for competitors to replicate.  What’s more, it is likely to benefit from the government’s intention to increase infrastructure spending over time.  Because of the nature of its business, though, Vulcan has a high amount of fixed costs--and therefore operating leverage--and as a result its earnings and cash flow can be somewhat volatile.

Late Friday, leading luxury brand Tiffany’s (TIF) announced that it had sold a $250 million slug of debt to Berkshire.  This paper will pay a 10% annual coupon, and half of the debt will mature in 2017, while the other $125 million will come due in 2019. Like most luxury retailers, Tiffany has struggled as of late, as consumers have refrained from making big-ticket jewelry purchases.  As such, this debt refinancing will bolster Tiffany’s balance sheet, and help it weather the current downturn in its business.  For Berkshire, Tiffany is yet another outstanding brand that Buffett has had the opportunity to invest in, at what—to me at least--appear to be somewhat attractive terms.

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.

Yesterday, Berkshire Hathaway (BRK-A) announced plans to contribute $2.6 billion to European reinsurance firm Swiss Re.  Under terms of the deal, Berkshire will receive convertible bonds in Swiss Re that carry a lofty 12% coupon, and upon conversion, could give Berkshire a 20% stake in the company.  This isn’t the first deal that Berkshire has done with Swiss Re, as last year Berkshire bought a 3% stake in the firm, and also struck a reinsurance pact, whereby Berkshire would take a pro-rata portion of Swiss Re’s European insurance exposure.

Given this existing reinsurance pact, it isn’t really surprising that Berkshire decided to add additional capital to Swiss Re at this time.  Because of recent losses, rating agencies were contemplating reducing Swiss Re’s capital strength ratings, which would have meant that Swiss Re may have had trouble maintaining both the quality of its business and its pricing.  Since a portion of this business would be passed along to Berkshire under the terms of their prior agreement, it was in Berkshire’s interest to help plug the hole in Swiss Re’s balance sheet.

In addition to this direct incentive to support Swiss Re, Berkshire also benefits from this relationship as it helps to diversify Berkshire’s own insurance portfolio at somewhat reasonable terms.  What’s more, Buffett has always mentioned that he attempts to invest within his circle of competence, and given Berkshire’s long time participation in the insurance industry, he certainly knows a thing or two about this business.

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.

On Tuesday, Berkshire Hathaway (BRK-A) agreed to purchase $300 million of new debt from Harley-Davidson (HOG), while another Berkshire-like investor, Davis Selected Advisors, purchased another $300 million slug of the same debt offering.  Terms of the deal were very attractive, as Berkshire will earn a 15% annual coupon on this paper over the next five years.  For Harley, this will provide the company with more liquidity, helping to fund its lending activities in its financial services arm.  Harley has been hit hard on two fronts recently, as not only has the current economic weakness hurt demand for Harley’s motorcycles, but the drying up of credit has hurt Harley’s ability to secure funding in the asset-backed securities market.  As such, this deal—while expensive—will give Harley a much needed shot in the arm to bolster its financial services unit.

In many ways, this deal is typical Buffett.  Harley-Davidson is a well-run company with little debt in its manufacturing operations.  What’s more, this is an investment in yet another iconic American brand for Berkshire, which has been typical of Buffett deals as of late—think Anheuser Busch, Wrigley, and General Electric.  Since Berkshire is yet again acting as a liquidity provider—or some might say a lender of last resort—it was also able to extract very favorable terms for its shareholders.

You might also be interested to know that buffettologist.com was featured in a Bloomberg article about this deal on February 4th, which I’ve also linked here.

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.

Late last night, Berkshire Hathaway (BRK-A) indicated that it bought more shares in Burlington Northern Santa Fe (BNI) last week.  Last Friday, Berkshire bought an additional 2.3 million shares for roughly $174 million, boosting its stake in the railroad to more than 76 million shares, or a 22.4% stake.  Burlington seems to be one of Berkshire's more active investments, as the conglomerate has continued to slowly add to its holdings of Burlington throughout the latter part of 2008 and the early part of 2009.  Chairman Warren Buffett has indicated in the past that the competitive positioning of the railroads has improved vis-a-vis truckers over the past several years, which could be one of the reasons he has been building a position in Burlington over the past couple years.

Many of you have asked me if it is better to follow Berkshire's stock picks or to just analyze Berkshire.  It's a good question, too.  While Buffett is a great investor, he's not perfect, so there is more risk to those that try to only cherry pick the stocks he buys.  Furthermore, it's always critical to do one's own work on these potential investments.  By analyzing the full conglomerate, on the other hand, one can get a better understanding of the full portfolio of Berkshire's public--and private--businesses, and also benefit from Buffett's stock picks on an aggregate, or portfolio, basis. 

I welcome dialogue with my readers, so please send me any questions and comments you have.  Also, if you haven’t already done so, please be sure to sign-up for my free email alerts from buffettologist.com by emailing me at Justin@buffettologist.com.

Justin

Copyright © 2009 Buffettologist.com

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business.  This content is intended solely for the entertainment of the reader, and the author.