Because the Covid-19 pandemic negatively impacted most businesses, including Berkshire, in early 2020, comparing current results to pre-pandemic 2019 results is helpful. Operating earnings for the second quarter of 2022 are 51% above 2019. And thanks to share repurchases, operating earnings per share are a whopping 68% above 2019.
A further look into the different operating segments in 2022 shows strong earnings growth across most segments versus 2021. Notably, the operating income for all segments is significantly above the pre-pandemic levels of 2019.
Insurance: Second quarter investment income was 56% higher than 2021 and 27% better than 2019, primarily due to higher interest income from short-term investments. Investment income was depressed by ultra-low interest rates implemented in response to Covid, but the Federal Reserve has raised rates aggressively in the second quarter to fight inflation. Investment income should continue to see improvement as the Federal Reserve is likely to be in hiking mode for the remainder of the year. While underwriting results were positive overall, Geico had an underwriting loss. Geico continues to suffer from more frequent auto claims and rising claims severity due to the higher valuation of used vehicles. Geico has posted an underwriting loss year-to-date, which drove the 53% decline in Berkshire’s year-to-date underwriting profit relative to 2021. During the annual meeting earlier in the year, there was a question about the strength of Berkshire’s Geico car insurance business relative to Progressive
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. An underwriting profit means the insurance premium exceeds all insurance claims and expenses. Berkshire had an underwriting profit for the second quarter of 2022, year-to-date 2022, and calendar years 2021, 2020, and 2019. Berkshire’s float was flat at approximately $147 billion versus the level on December 31, 2021, and above the $138 billion on December 31, 2020. Though float is not as valuable in a low interest rate environment, its value increases as yields rise. Float per share has increased to $99,961 from $98,960, aided by share repurchases.
Railroad: Berkshire owns the Burlington Northern Santa Fe (BNSF) railroad operating in the U.S. and Canada. Net operating earnings rose 10% over the same quarter in 2021 and 24% over pre-covid 2019. Revenue was higher due to higher pricing and a fuel surcharge driven by higher fuel prices, while volume was slightly lower.
Utilities and Energy: This business generally provides steady and growing earnings, which one would expect from what primarily consists of regulated utilities and pipeline companies. In June 2022, Berkshire bought the Berkshire Hathaway Energy Company (BHE) common stock owned by Greg Abel, Berkshire’s Vice Chairman – non-insurance operations, for $870 million, and Berkshire now owns 92% of BHE. A question about a possible conflict of interest stemming from Abel’s partial direct ownership of a Berkshire subsidiary was asked at the annual meeting, so this transaction ends any concern in that area. Interestingly, this group also operates Berkshire Hathaway HomeServices (BHHS), the largest residential real estate brokerage firm in the country. The slowdown in housing activity is evident in the results. The 2022 earnings suffered from lower mortgage and refinance activity thanks to higher interest rates and a decline in closed brokerage transactions.
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 (PCC) business due to its exposure to the COVID-disrupted aerospace industry. PCC’s pre-tax earnings rose in the second quarter relative to 2021, primarily due to higher demand for aerospace products. Berkshire sounded more optimistic about the outlook of PCC with a rebound in domestic flight and the need for narrow-body aircraft. Management suggested that future growth is predicated on the ability to increase production since the company has suffered from worker shortages and a restart in Boeing 787 production. Berkshire’s FlightSafety and NetJets continued to see a sharp rebound, with training hours up 29% and customer flight hours rising 25% year-to-date versus 2021. Unfortunately, the earnings of aviation services were dented by increased costs, including those for subcontracted aircraft, due to the sharp jump in customer flight hours.
Housing-related businesses like Clayton Homes, Shaw, Johns Manville, Acme Building Products, Benjamin Moore, and MiTek posted sharply higher earnings relative to 2021. Berkshire continues to note that prices were increased to offset cost pressures, and supply chain disruptions remain an issue. Perhaps the early signs of a slowing housing market are showing up in the group, with higher selling prices due to higher costs being the primary driver of revenue growth rather than unit volume and product mix. The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had lower quarterly revenues despite a higher average unit sale price. Unit sales were lower, reflecting significant new vehicle supply shortages attributable to the global computer chip shortages and other supply chain disruptions. Berkshire noted that second-quarter apparel and footwear revenues plunged relative to 2021. In addition, earnings were lower for their furniture retailers, including Nebraska Furniture Mart, with prices higher due to increased costs but lower transaction volumes. This weakness in some of the retailing exposed businesses is not a surprise, given similar statements from others in the industry. Berkshire’s McLane unit had lower profits in 2022 versus 2021. McLane is a wholesale distributor to retailers and restaurants. The decline in earnings was primarily due to supply chain constraints, labor shortages, truck driver shortages, and higher inventory costs. Berkshire continues to expect the challenging environment for McClane to continue through 2022.
Other: The segment has a significant profit for the second quarter and year-to-date 2022 primarily due to foreign currency gains and an increase in equity method earnings at Kraft Heinz (KHC) and Pilot. The foreign currency exchange rate gains were generated from bonds issued by Berkshire Hathaway and denominated in British Pounds, euros, and Japanese Yen. Investment losses from non-U.S. dollar investments generally offset these gains. These foreign currency liabilities are not a concern as Berkshire has significant assets and earnings denominated in these foreign currencies. 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), Pilot, Berkadia, Electric Transmission of Texas, and Iroquois Gas Transmission Systems.
Berkshire bought back $1 billion of its stock in the second quarter. Until an announcement in mid-2018, Berkshire had only made repurchases when the stock was trading 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 P/B ratio was between 1.2 times to above 1.5 times during the quarter, so it makes sense that the pace of repurchases slowed. Berkshire only intends to repurchase shares when the “repurchase price is below Berkshire’s intrinsic value, conservatively determined.” The P/B ratio remains a reasonable proxy for gauging Berkshire’s intrinsic value. It worked well this quarter since Berkshire only acquired shares in June, and the price-to-book didn’t fall below 1.2 times until then. Still, Warren Buffett and Charlie Munger’s judgment about its intrinsic value versus other available uses of capital could differ from that simple measure in the future.
In addition, Berkshire made other purchases. Berkshire made $6.2 billion in stock purchases for its portfolio while selling $2.3 billion in stocks for a net additional investment of $3.9 billion in publicly traded equities. One purchase was additional shares of Occidental Petroleum
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 2022 grew by 39% over 2021. In addition, 2022 operating earnings are 51% above pre-pandemic 2019 levels. 2022 year-to-date operating earnings growth is similarly impressive at 51% and 40% above 2021 and 2019, respectively. 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. If they are correct (and there is no reason to doubt them), the purchases are a value-creator for the remaining shareholders. Operating earnings per share for 2022 are now 68% above 2019, benefiting from the share repurchases! The slowing repurchases in the second quarter reflect the higher valuation of Berkshire until June and the ability of the duo to find some other opportunities with an attractive risk versus reward for investing capital.
One of Berkshire’s crown jewels in insurance businesses, GEICO, continues to be challenged by the impact of the pandemic. The underwriting loss at GEICO was disappointing, but results should improve as auto claims normalize with auto pricing. The performance differential versus Progressive (PGR) will also be part of the equation to get the business back on track. The better news was the investment income from the insurance business continued to rebound sharply as the Federal Reserve aggressively raised short-term interest rates. Excluding the insurance business and consistent with the S&P 500 data, cost pressures have caused profit margins to decline relative to second quarter 2021 levels. Even though non-insurance margins are lower than 2021, margins remain higher than the pre-pandemic second quarter of 2019.
Berkshire’s stock price trailed the S&P 500 in the second quarter, declining by almost 23% versus a total return of -16% from the S&P 500. Year-to-date through the end of June, Berkshire’s price is almost -9%, while the S&P 500 has a total return of nearly -20%. Despite additional investment purchases, cash levels were above last quarter. Berkshire retains a fortress balance sheet with cash and equivalents of over $101 billion, which provides flexibility to take advantage of opportunities, including repurchasing its own stock. Berkshire has stated that there would be no stock repurchases if it would cause cash levels to fall below $30 billion.
Despite the headline loss in the second quarter, Berkshire’s businesses are performing exceptionally well, aside from woes at GEICO and some slowing due to macroeconomic headwinds. Shareholders should take comfort in knowing that the firm continues to be managed to survive and emerge stronger from any economic or market downturn. Berkshire retains its Fort Knox balance sheet and a diversified mix of businesses. The firm maintains the unique ability to take advantage of significant opportunities when disruptions or crises provide them.