Description

Berkshire Hathaway is certainly one of the best-known companies by the value investing community, so this investment idea is certainly not original in the sense of a newly discovered company. Nevertheless, I feel that when it comes to the private businesses owned by Berkshire, some aspects are often underappreciated.

This writeup will focus solely on the non-insurance, privately held businesses of Berkshire Hathaway, and its relation to the overall valuation of the company. At the current share price, I find Berkshire, a good investment candidate. This is especially the case when considering the value of these privately held businesses which are not fully reflected in the book value of the company.  

A.    Non-insurance Businesses: 

1. BNSF

The largest single private non-insurance business under Berkshire is Burlington Northern Santa Fe, which was acquired between 2009-2010 (first roughly 20% and then the rest of the company).

For BNSF, the Berkshire annual report reports their figures. In 2019, BNSF had $23.5 billion in revenues and $ 5.5 billion net earnings. This compares in 2010 (when it was acquired) of $16.6 billion revenues and $2.6 billion in net earnings. So earnings more than doubled. So how much is this business worth?

One way to assess this, is to compare it to their still listed peer: Union Pacific. If you just use Union Pacific's PER of 19x (that business earned $ 5.9 billion in 2019 and trades at an market cap of $ 107 billion and an EV of $ 137 billion), the calculation for BNSF’s  valuation comes to $ 105 billion.

By revenue, BNSF is the largest railroad company in the United States (neck and neck with Union Pacific) and a similar valuation seems roughly sensible. With a gross margin of approximately 30% and with a return on tangible capital of > 20%, BNSF is a good compounder and I would think a 19x PER multiple is fair.

2. Berkshire Hathaway Energy (BHE)

Berkshire Hathaway Energy is comprised of the acquired Mid American Energy (acquired in 2000) business as well as several other energy businesses including PacifiCorp (acquired in 2005) and Northern power grid. All in all, this group of businesses earned (net earnings attributable to BHE) $ 3.1 billion in 2019 and which has consistently grown over the years at mid-single digit percentage terms.

If we take a similar multiple as Berkshire paid for Mid American Energy for this business (17x PER), then a reasonable value attributable to BHE may be $53 billion.

As background, Berkshire Hathaway announced the acquisition of Mid American Energy in 1999, which was then completed in 2000. The purchase price of the shares bought out was $ 35.50 and the EPS in 1998 of the listed company was $ 2.01, hence roughly 17x PER. The EV calculation would be different as Mid American had significant net debt, but this is a back of the envelope calculation above.

3. Precision Castparts & Other manufacturing

Precision Castparts, before they became private were growing double digits for many years. From what I could put together, Buffett paid $ 235 per share in 2015 for each share of Precision. In 2015, the company had a net income of roughly $ 1.5 billion, which was about $ 11/share. So Buffett acquired PCC at a valuation just north of 20x PER. In total BH paid $ 37 billion for PCC.

Also included in this section is Lubrizol for which BH paid $ 9.7 billion for it in 2011. In total PCC and other manufacturing businesses (includes also Marmon, CTB, IMC) generated a pre-tax earning of $ 9.5 billion. If we assume that the whole group has a bit lower quality than PCC, and a fair valuation maybe 10x EBIT, we come to roughly another $ 95 billion for these businesses. Please note this is a very rough estimate. 

4. Service & Retail

This group of businesses includes See’s Candies, RC Willey, Flight Safety, BHA, Nebraska Furniture Mart, McLane, Pampered Chef etc. 

I won’t go into details for these businesses, but in aggregate as per the 2019 BH annual report, these businesses generated a pre-tax earnings of just under $ 3.0 billion. Maybe in total we can attribute a value of around $ 25 billion for these.

B. Valuation

All in all, my purpose is not to exactly pinpoint the value of all Berkshire Hathaway’s private non-insurance businesses. Rather it is to show that many of these have significantly grown over the years and it is clear that the underlying book value reflecting these assets far understates their real value. This is the case even when considering a discount investors may want to take for the illiquidity of these positions.

Taking the balance sheet figures from Berkshire Hathaway’s 2019 annual report, the book value reflected of these private non-insurance businesses is just around $ 100 billion. From the above analysis, I would conclude that the real intrinsic value of these businesses has grown to perhaps a bit above $ 250 billion.

Ultimately, what this means is that when we referenced a 1.10x book value valuation figure in 2010 or 2012, this is not the same as a 1.10x book value today. Today the gap between the book value and the intrinsic value of the private non-insurance businesses is significantly more.

In this light, looking at the valuation of Berkshire Hathaway, which is currently trading at roughly 1.2x book value (green line), seems to be a very fair valuation for a still high-quality compounder. In the last 20 years, only during 2000 and 2008-2011 did the shares trade at a similar or slightly greater discount, and I would argue that at the time the intrinsic value was closer to the book value than now. 

Catalyst

Continued compounding and multiple expansion to 1.5x P/B.