Berkshire Hathaway BRK.A
October 18, 2007 - 6:22pm EST by
flubber926
2007 2008
Price: 129,000.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 199,600 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

We believe the discount at which Berkshire Hathaway trades today versus its intrinsic value is as large as it has been in the past and only comparable to that which briefly existed in early 2000 and prompted Mr. Buffett to publicly state his intention of repurchasing Berkshire’s stock at that time.   

Berkshire was originally written-up at this forum by nish697 a couple of years ago.   At that time nish estimated that the company’s fair value would be close to $132,000 per-share 18 to 24 months out.  We now know, with the benefit of hindsight, that thanks to Berkshire’s managers’ great execution and to Mr. Buffett’s investment skills, the company’s intrinsic value by yearend 2006 was roughly in line with that which nish predicted would be.

It is our estimate that Berkshire’s fair value, after two continuous years of stellar results from its insurance division lies somewhere between $150,000 and $160,000 per-share at this time. Using very conservative assumptions and nothing more than sixth grade math, it is our estimation that by yearend 2008, Berkshire’s intrinsic value should approximate $200,000 per-share.

Berkshire’s growth in value has far outpaced the appreciation of its shares and although this has probably been the case for the last two years, we think that the divergence between value and price has never been as wide as it is today. Berkshire trades at what we believe are depressed prices and should return close to 55% within the next 12-18 months, if it reaches its fair value, with minimal downside risk.

Because I suspect this is a very well known company for most fellow members of this club, I will not waste your time with an introduction and concentrate instead on the company’s valuation, its growth history, touch upon what we believe are some of the key concerns weighing on investors today and finally discuss possible catalysts and potential risks to our thesis.

Without further due,


 

I.                    Valuation

 

Berkshire’s valuation at current prices ($129,000 per-share)

Although we recognize that there are different ways to get to Berkshire’s intrinsic value, we prefer to take a very simplistic approach which is to value its operating units, add the per-share value of the investments in publicly traded securities owned by the company and finally add any excess cash generated.
 
As of yearend 2006, Berkshire’s investments per-share were $80,636. Let’s assume a conservative 7% appreciation and by the end of 2008, investments per-share should be somewhere around $92,300.
 
Berkshire is generating around $ 9 billion of cash every year, let’s assume $ 18 billion of excess cash in two years or roughly $12,000 per-share excess cash by the end of 2008 versus 2006.              
 
 

Berkshire's share price

                       129,000

- Investments

                         92,300

- Excess cash

                         12,000

Value of operating businesses

                         24,700

2008E after-tax op. earnings

                          6,027

after-tax implied multiple

                              4.1

 

 

 

 
 
We are adjusting 2008 underwriting earnings downward because we believe that 2006 and 2007 underwriting results are not sustainable given the absence of any large super-cat event during both years.  If this continues to be the case for some years Berkshire’s earnings will be far larger than what we predict but we just can’t count on that happening.
 
Basically, at current prices you get Berkshire’s operating divisions (insurance, utilities, manufacturing, services, retailing), for 4 times after-tax 2008 normalized earnings. Essentially you are paying 4x for a collection of businesses that have been growing pre-tax earnings at a compounded rate of 31.7% for the last 10 years and have great prospects ahead of them.

 What is the normalized earnings power of Berkshire’s op. businesses?

2006

2005

2004

Insurance – underwriting

 $           2,485

 $              27

 $          1,008

Insurance - investment income

3,120

2,412

2,045

Utilities and energy

885

523

237

Manufacturing, service and retailing

2,131

1,646

1,540

Finance and financial products

732

514

373

Other

-47

-124

-154

Investment and derivative gains/losses

1,709

3,530

2,259

Net earnings

 $          11,015

 $          8,528

 $          7,308

 

 

 

 

 

 

 

 

i)                    Insurance – Underwriting

 
The absence of super-cat’s during 2006 combined with huge premiums after the losses brought by both Rita and Katrina contributed to last year’s extraordinary underwriting results.
 
This year will likely be the second stellar year in a row thanks to a so far very benign hurricane season and the absence of large super-cat’s as well.  It wouldn’t surprise me to see underwriting profits approach $ 3 bn this year.
 
However, as Mr. Buffett has repeatedly said, we just can’t count with such stellar results repeating themselves in the future.
 
As of yearend 2006, Berkshire’s float was $ 50.9 billion and if you add the retroactive reinsurance contract written with Equitas, which adds $ 7 billion, float should be around $ 59 to $60 billion as of today. We assume that float grows modestly to around $62 billion by yearend 2008 and that underwriting profit is a modest 3% or $ 1.86 billion that year. That is a 25% haircut from 2006 underwriting results which we believe is conservative enough.

 

ii)                   Insurance -  Investment Income

Investment income has grown at an after-tax rate of 23-25% during the last three or four years putting to rest all doubts on Mr. Buffett’s ability to invest Berkshire’s large sums of cash.
 
To be conservative, let’s assume only a 5% increase in investment income year-over-year to reach $ 3.4 billion by 2008. (It is worth noting that for the first six months of the year, investment income has grown by 9.4%).
 

iii)                 Regulated Utility Business

To be conservative, we assume growth in this division’s earnings of just 2% in 2007 and another 2% in 2008 (The big jump in earnings seen from 2005 to 2006 is largely explained by the acquisition of the Western utilities in March of 2006).
 

iv)                 Manufacturing, services and retailing

This group is now firing up on all cylinders… Last year it earned 25% return on tangible net worth!
 
We expect continued growth going forward but again, in sake of being conservative we are projecting 5% growth in after-tax earnings for two years. After-tax earnings should approach $ 2.24 billion in 2007 and $ 2.35 billion by yearend 2008.
 
Again note that so far, for the first six months of 2007, this division’s earnings have increased 17 percent versus the first six months of 2006 (largely because of the inclusion of IMC and Netjets improved results), we believe Netjets will continue to deliver solid growth for the next couple of years because of improving margins in the US network and pent-up demand in Europe.
 

v)                  Finance and Financial Products

Since this division’s results are largely influenced by Mr. Buffet’s opportunistic trading results we simply take on Clayton home’s, CORT and XTRA’s results and grow them at a conservative 2% year-over-year pace.

 

                So what are Berkshire’s operating units worth?

                                              

2008E

Insurance - underwriting

 $           1,860

Insurance - investment income

3,400

Utilities and energy

921

Manufacturing, service and retailing

2,349

Finance and financial products

762

Net earnings excl. Investment gains/losses

9,292

Average common shares outstanding

1,541,807

 

Net earnings per common share

 

$            6,027

 

 
Mr. Buffett has hinted to using a 11 to 13 pre-tax multiple to value Berkshire’s operating businesses (see 1996-1999 annual reports), which roughly equates to a 15 to 18 after-tax multiple.
 
We like to be conservative and use 15x after-tax but you can play with the numbers and reach a value yourself. It is our opinion that somewhere between 14 and 16 times after-tax is reasonable.
 

After-tax multiple

14

15

16

2008 EPS

        6,027

         6,027

         6,027

Fair value op. biz.

      84,378

       90,405

       96,432

 

 

 

 

We believe that conservatively calculated, Berkshire’s operating units should be worth between $84,000 and $96,000 per-share by the end of 2008.

               

              Berkshire’s Intrinsic Value

Operating Businesses

         84,378

      90,405

       96,432

Investments per-share

         92,300

      92,300

       92,300

Excess cash generated

         12,000

      12,000

       12,000

Berkshire's Fair Value (08)

        188,678

    194,705

     200,732

               

 

 
 
We estimate that Berkshire’s intrinsic value, conservatively calculated, should lie somewhere between $188,000 and $200,000 per-share by the end of 2008.

 

II.                  The growth story

It is sometimes forgotten just how fast has Mr. Buffett and his group of managers managed to compound earnings over time…
 
As mentioned in Berkshire’s latest annual report, the company’s pre-tax earnings per share (operating companies earnings, excluding insurance), have compounded at a stunning rate of 31.7%  during the last 10 years and 17.9% since 1965!
 
In terms of value created by the investments made by Mr. Buffett, the record is much better known but stunning as well. Berkshire’s per-share investments have grown at a 27.5% rate during the last 10 years and at 12.6% since 1965.

 

III.                Some of the common concerns shared by the investment community

 
a)      Will Mr. Buffett be able to continue deploy Berkshire’s cash as he has in the past?
 
Mr. Buffett’s net purchases of equity securities during 2006 and 2005 were $5.4 and $6.3 billion respectively. During the same period, Berkshire purchased seven businesses (Forest River Inc, Medical Protective, Iscar Metalworking, Russell Corp, Applied Underwriters, PacifiCorp and Business Wire), for an aggregate of $12.6 billion. So, during the last couple of years he’s effectively deployed $24.3 billion of cash. During 2007, he’s been quite active as well as indicated by his latest railroad filings.
 
 
b)      Who will succeed Mr. Buffett and what will happen with Berkshire when he’s no longer running it?
 
In our opinion succession fears are overblown. Each of the Berkshire’s operating companies are run by very talented managers/owners that were hand-picked by Mr. Buffett and Mr. Munger for their business talent and integrity. Those businesses will continue doing well long after Mr. Buffett is gone. In terms of the performance of Berkshire’s current investments, they are all high quality, deep moat, well managed companies that should continue appreciating over time albeit a more modest pace. Furthermore, Mr. Buffett has initiated a search for capable managers that should replace him in the future.
 
Finally, Mr. Buffett’s health is excellent at his 77 years of age. A testament that we should all drink 10 cherry colas a day to stay fit!
 
 

IV.                Possible Catalysts

 

a)      Hurricane season coming to an end with no big super cat event in 2007.

b)      Berkshire’s portfolio of publicly traded securities has appreciated around 6% since its latest filing.

c)       Further disclosure of investments made by Mr. Buffett and possible trading gains realized during the recent market correction.

d)      Continued correction in the equity markets.

 

 

 

 

V.                  Risks

 

a)      Large super-cat event that would depress the insurance division’s earnings.

b)      If Mr. Buffett’s health falters Berkshire’s shares could suffer temporarily.

 

 

 

 

Catalyst

a)Hurricane season coming to an end with no big super cat event in 2007.
b)Berkshire’s portfolio of publicly traded securities has appreciated around 6% since its latest filing.
c)Further disclosure of investments made by Mr. Buffett and possible trading gains realized during the recent market correction.
d)Continued correction in the equity markets.
    sort by    

    Description

    We believe the discount at which Berkshire Hathaway trades today versus its intrinsic value is as large as it has been in the past and only comparable to that which briefly existed in early 2000 and prompted Mr. Buffett to publicly state his intention of repurchasing Berkshire’s stock at that time.   

    Berkshire was originally written-up at this forum by nish697 a couple of years ago.   At that time nish estimated that the company’s fair value would be close to $132,000 per-share 18 to 24 months out.  We now know, with the benefit of hindsight, that thanks to Berkshire’s managers’ great execution and to Mr. Buffett’s investment skills, the company’s intrinsic value by yearend 2006 was roughly in line with that which nish predicted would be.

    It is our estimate that Berkshire’s fair value, after two continuous years of stellar results from its insurance division lies somewhere between $150,000 and $160,000 per-share at this time. Using very conservative assumptions and nothing more than sixth grade math, it is our estimation that by yearend 2008, Berkshire’s intrinsic value should approximate $200,000 per-share.

    Berkshire’s growth in value has far outpaced the appreciation of its shares and although this has probably been the case for the last two years, we think that the divergence between value and price has never been as wide as it is today. Berkshire trades at what we believe are depressed prices and should return close to 55% within the next 12-18 months, if it reaches its fair value, with minimal downside risk.

    Because I suspect this is a very well known company for most fellow members of this club, I will not waste your time with an introduction and concentrate instead on the company’s valuation, its growth history, touch upon what we believe are some of the key concerns weighing on investors today and finally discuss possible catalysts and potential risks to our thesis.

    Without further due,


     

    I.                    Valuation

     

    Berkshire’s valuation at current prices ($129,000 per-share)

    Although we recognize that there are different ways to get to Berkshire’s intrinsic value, we prefer to take a very simplistic approach which is to value its operating units, add the per-share value of the investments in publicly traded securities owned by the company and finally add any excess cash generated.
     
    As of yearend 2006, Berkshire’s investments per-share were $80,636. Let’s assume a conservative 7% appreciation and by the end of 2008, investments per-share should be somewhere around $92,300.
     
    Berkshire is generating around $ 9 billion of cash every year, let’s assume $ 18 billion of excess cash in two years or roughly $12,000 per-share excess cash by the end of 2008 versus 2006.              
     
     

    Berkshire's share price

                           129,000

    - Investments

                             92,300

    - Excess cash

                             12,000

    Value of operating businesses

                             24,700

    2008E after-tax op. earnings

                              6,027

    after-tax implied multiple

                                  4.1

     

     

     

     
     
    We are adjusting 2008 underwriting earnings downward because we believe that 2006 and 2007 underwriting results are not sustainable given the absence of any large super-cat event during both years.  If this continues to be the case for some years Berkshire’s earnings will be far larger than what we predict but we just can’t count on that happening.
     
    Basically, at current prices you get Berkshire’s operating divisions (insurance, utilities, manufacturing, services, retailing), for 4 times after-tax 2008 normalized earnings. Essentially you are paying 4x for a collection of businesses that have been growing pre-tax earnings at a compounded rate of 31.7% for the last 10 years and have great prospects ahead of them.

     What is the normalized earnings power of Berkshire’s op. businesses?

    2006

    2005

    2004

    Insurance – underwriting

     $           2,485

     $              27

     $          1,008

    Insurance - investment income

    3,120

    2,412

    2,045

    Utilities and energy

    885

    523

    237

    Manufacturing, service and retailing

    2,131

    1,646

    1,540

    Finance and financial products

    732

    514

    373

    Other

    -47

    -124

    -154

    Investment and derivative gains/losses

    1,709

    3,530

    2,259

    Net earnings

     $          11,015

     $          8,528

     $          7,308

     

     

     

     

     

     

     

     

    i)                    Insurance – Underwriting

     
    The absence of super-cat’s during 2006 combined with huge premiums after the losses brought by both Rita and Katrina contributed to last year’s extraordinary underwriting results.
     
    This year will likely be the second stellar year in a row thanks to a so far very benign hurricane season and the absence of large super-cat’s as well.  It wouldn’t surprise me to see underwriting profits approach $ 3 bn this year.
     
    However, as Mr. Buffett has repeatedly said, we just can’t count with such stellar results repeating themselves in the future.
     
    As of yearend 2006, Berkshire’s float was $ 50.9 billion and if you add the retroactive reinsurance contract written with Equitas, which adds $ 7 billion, float should be around $ 59 to $60 billion as of today. We assume that float grows modestly to around $62 billion by yearend 2008 and that underwriting profit is a modest 3% or $ 1.86 billion that year. That is a 25% haircut from 2006 underwriting results which we believe is conservative enough.

     

    ii)                   Insurance -  Investment Income

    Investment income has grown at an after-tax rate of 23-25% during the last three or four years putting to rest all doubts on Mr. Buffett’s ability to invest Berkshire’s large sums of cash.
     
    To be conservative, let’s assume only a 5% increase in investment income year-over-year to reach $ 3.4 billion by 2008. (It is worth noting that for the first six months of the year, investment income has grown by 9.4%).
     

    iii)                 Regulated Utility Business

    To be conservative, we assume growth in this division’s earnings of just 2% in 2007 and another 2% in 2008 (The big jump in earnings seen from 2005 to 2006 is largely explained by the acquisition of the Western utilities in March of 2006).
     

    iv)                 Manufacturing, services and retailing

    This group is now firing up on all cylinders… Last year it earned 25% return on tangible net worth!
     
    We expect continued growth going forward but again, in sake of being conservative we are projecting 5% growth in after-tax earnings for two years. After-tax earnings should approach $ 2.24 billion in 2007 and $ 2.35 billion by yearend 2008.
     
    Again note that so far, for the first six months of 2007, this division’s earnings have increased 17 percent versus the first six months of 2006 (largely because of the inclusion of IMC and Netjets improved results), we believe Netjets will continue to deliver solid growth for the next couple of years because of improving margins in the US network and pent-up demand in Europe.
     

    v)                  Finance and Financial Products

    Since this division’s results are largely influenced by Mr. Buffet’s opportunistic trading results we simply take on Clayton home’s, CORT and XTRA’s results and grow them at a conservative 2% year-over-year pace.

     

                    So what are Berkshire’s operating units worth?

                                                  

    2008E

    Insurance - underwriting

     $           1,860

    Insurance - investment income

    3,400

    Utilities and energy

    921

    Manufacturing, service and retailing

    2,349

    Finance and financial products

    762

    Net earnings excl. Investment gains/losses

    9,292

    Average common shares outstanding

    1,541,807

     

    Net earnings per common share

     

    $            6,027

     

     
    Mr. Buffett has hinted to using a 11 to 13 pre-tax multiple to value Berkshire’s operating businesses (see 1996-1999 annual reports), which roughly equates to a 15 to 18 after-tax multiple.
     
    We like to be conservative and use 15x after-tax but you can play with the numbers and reach a value yourself. It is our opinion that somewhere between 14 and 16 times after-tax is reasonable.
     

    After-tax multiple

    14

    15

    16

    2008 EPS

            6,027

             6,027

             6,027

    Fair value op. biz.

          84,378

           90,405

           96,432

     

     

     

     

    We believe that conservatively calculated, Berkshire’s operating units should be worth between $84,000 and $96,000 per-share by the end of 2008.

                   

                  Berkshire’s Intrinsic Value

    Operating Businesses

             84,378

          90,405

           96,432

    Investments per-share

             92,300

          92,300

           92,300

    Excess cash generated

             12,000

          12,000

           12,000

    Berkshire's Fair Value (08)

            188,678

        194,705

         200,732

                   

     

     
     
    We estimate that Berkshire’s intrinsic value, conservatively calculated, should lie somewhere between $188,000 and $200,000 per-share by the end of 2008.

     

    II.                  The growth story

    It is sometimes forgotten just how fast has Mr. Buffett and his group of managers managed to compound earnings over time…
     
    As mentioned in Berkshire’s latest annual report, the company’s pre-tax earnings per share (operating companies earnings, excluding insurance), have compounded at a stunning rate of 31.7%  during the last 10 years and 17.9% since 1965!
     
    In terms of value created by the investments made by Mr. Buffett, the record is much better known but stunning as well. Berkshire’s per-share investments have grown at a 27.5% rate during the last 10 years and at 12.6% since 1965.

     

    III.                Some of the common concerns shared by the investment community

     
    a)      Will Mr. Buffett be able to continue deploy Berkshire’s cash as he has in the past?
     
    Mr. Buffett’s net purchases of equity securities during 2006 and 2005 were $5.4 and $6.3 billion respectively. During the same period, Berkshire purchased seven businesses (Forest River Inc, Medical Protective, Iscar Metalworking, Russell Corp, Applied Underwriters, PacifiCorp and Business Wire), for an aggregate of $12.6 billion. So, during the last couple of years he’s effectively deployed $24.3 billion of cash. During 2007, he’s been quite active as well as indicated by his latest railroad filings.
     
     
    b)      Who will succeed Mr. Buffett and what will happen with Berkshire when he’s no longer running it?
     
    In our opinion succession fears are overblown. Each of the Berkshire’s operating companies are run by very talented managers/owners that were hand-picked by Mr. Buffett and Mr. Munger for their business talent and integrity. Those businesses will continue doing well long after Mr. Buffett is gone. In terms of the performance of Berkshire’s current investments, they are all high quality, deep moat, well managed companies that should continue appreciating over time albeit a more modest pace. Furthermore, Mr. Buffett has initiated a search for capable managers that should replace him in the future.
     
    Finally, Mr. Buffett’s health is excellent at his 77 years of age. A testament that we should all drink 10 cherry colas a day to stay fit!
     
     

    IV.                Possible Catalysts

     

    a)      Hurricane season coming to an end with no big super cat event in 2007.

    b)      Berkshire’s portfolio of publicly traded securities has appreciated around 6% since its latest filing.

    c)       Further disclosure of investments made by Mr. Buffett and possible trading gains realized during the recent market correction.

    d)      Continued correction in the equity markets.

     

     

     

     

    V.                  Risks

     

    a)      Large super-cat event that would depress the insurance division’s earnings.

    b)      If Mr. Buffett’s health falters Berkshire’s shares could suffer temporarily.

     

     

     

     

    Catalyst

    a)Hurricane season coming to an end with no big super cat event in 2007.
    b)Berkshire’s portfolio of publicly traded securities has appreciated around 6% since its latest filing.
    c)Further disclosure of investments made by Mr. Buffett and possible trading gains realized during the recent market correction.
    d)Continued correction in the equity markets.
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