With Berkshire Hathaway’s BRK.A/BRK.B annual shareholder meeting imminent, we have compiled 10 questions on a range of subjects, including Geico’s competitive positioning and path forward, BNSF’s aversion to adopting precision scheduled railroading, Berkshire Hathaway Energy’s issues with wildfires and renewables, the path forward with Occidental Petroleum OXY and the Japanese trading houses, the dearth of acquisition activity by Berkshire’s operating subsidiaries, the possibility of a larger rotation into longer-dated fixed-income securities, and other cash-management priorities—especially as they relate to capital allocation and distributions to shareholders.
(1) What is Geico’s path forward in a difficult market?
Geico has used price increases and more-disciplined underwriting to get its loss ratio more in line with historical norms after several years of abnormally high claims costs. This has had a profound effect on the combined ratio as well as written and earned premiums. With price increases less likely going forward, Geico needs to show that it can produce better underwriting results, pushing it back into a competitive profile more on par with Progressive PGR, its largest comparable peer, and less like Allstate ALL and Travelers TRV. With Todd Combs having run the business for more than four years, what are the key things he has found that Geico was doing wrong (and right) on the underwriting side to put the company in a better position now than it was just a few years ago? What will it take for Geico to both expand its market share and keep its profitability more on par with Progressive, as well as its own historical norms?
(2) What is keeping BNSF from adopting precision scheduled railroading?
While BNSF has kept volume and revenue growth close to that of main competitor Union Pacific UNP during the past decade, it has trailed on profitability. Its operating ratio has been 450 basis points worse than Union Pacific’s on average in the past 10 years, as well as 300 basis points poorer than the average of all of the other Class I railroads.
With all of BNSF’s peers having adopted precision scheduled railroading in one form or another, the expectation is that this outperformance on the profitability line could approach 650 basis points on average annually for Union Pacific and 540 basis points on average for all of the other Class I railroads (excluding Kansas City Southern, which was acquired by Canadian Pacific CP), leading to the potential that BNSF’s competitors will get more competitive on pricing—willing to give up some of that margin differential to drive share gains.
For more than five years, BNSF and Berkshire have said that the railroad is in wait-and-see mode when it comes to precision scheduled railroading. With the gap in profitability likely to widen, where is BNSF with precision scheduled railroading? What are the opportunities and drawbacks of the strategy?
(3) Is the regulated utility model going to fall apart over the losses incurred from West Coast wildfires?
The compact between regulated electric utilities and their regulators has had the utilities operating and maintaining difficult-to-replicate networks of power generation, transmission, and distribution in exchange for allowable returns that should cover their cost of capital, as well as service territory monopolies. As noted in the annual letter to shareholders, the losses incurred by several utilities from wildfires in parts of the Western US and Hawaii risk upending that arrangement, potentially pushing some utilities into bankruptcy and the states themselves back to public power models. Given the new claims that have emerged against PacifiCorp tied to the 2020 Oregon wildfires, does Berkshire face the risk that one of its largest regulated US electric utilities will have to file for bankruptcy protection? Is Berkshire Hathaway Energy set up in such a way that this type of event at PacifiCorp would not take down the rest of the utilities/energy division? What does this say about the durability of the regulated utility model, especially with so much capital still needed to be invested in infrastructure?
(4) Have renewables become a double-edged sword for regulated US electric utilities?
While Berkshire Hathaway Energy has ridden the growth of renewables over much of the past decade—investing more than $20 billion in wind and solar projects over 2014-23—it has faced issues in markets where there is so much solar on the grid that demand can at times fall well short of supply, driving down the price of electricity. This works to the benefit of customers with connected solar panel arrays in markets with net metering, where the regulated electric utilities compensate solar panel electricity contributions to the grid at an unvarying rate, which is usually something close to the average retail cost for electricity. However, there are some markets where the electric utilities have been able to get regulators to accept distributed generation compensation closer to wholesale rates, having argued that the owners of connected solar panel arrays are benefiting from using the grid without fully paying for it.
Our understanding is that the differential between retail and wholesale electricity rates can be as much as $0.10 per kilowatt-hour, which is not insignificant. How exposed are each of BHE’s subsidiaries to the growth of distributed generation. What are the compensation arrangements for distributed energy sources for each of these subsidiaries?
Also, have renewables have become a double-edged sword for regulated US electric utilities, which benefit from the ability to drive down energy costs for their core markets, putting them in good standing with the state regulators, but then have to deal with the business model conflict presented by the growth of distributed energy generation?
(5) What is the long-term plan for Occidental Petroleum?
While Berkshire picked up preferred stock and warrants to purchase common shares of Occidental Petroleum after infusing the company with $10 billion in 2019 to help fund the acquisition of Anadarko Petroleum, it has been its purchase of close to 250 million shares of Occidental’s common stock since the start of 2022 that has raised some eyebrows. Although Berkshire has received permission from regulators to acquire as much as 50% of Occidental’s common stock, it has insisted that it will not buy the company outright.
We’ve generally believed that the impact of an independent exploration and production company like Occidental would probably be less volatile were Berkshire to own it outright, as opposed to just holding a large equity stake. On top of that, Berkshire would be picking up another capital-intensive business that could not only benefit from access to its large cash hoard but be able to operate more or less as a private company under the Berkshire umbrella. A full purchase would also help reduce that growing cash hoard.
With that in mind, what are the pros and cons of owning a company like Occidental outright? Are the negatives so much more detrimental than the positives that acquiring the company in its entirety is off the table? Has Warren Buffett ever discussed owning Occidental with Greg Abel?
(6) What is the long-term plan for the Japanese trading companies?
Close to four years ago, Berkshire started acquiring stakes in the five leading Japanese trading companies—Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo, known as sogo shoshas—and has since built up close to 10% equity stakes in each of them. Berkshire continues to issue yen-denominated debt, even as it has agreed with each of these companies to not buy more than 10% of their shares. This could be capital that Berkshire could use down the road in some yet-to-be-disclosed “incremental opportunities” with each of these companies. However, it is more likely that Buffett saw an opportunity to take meaningful stakes in these sogo shoshas and didn’t want the currency exposure of owning Japanese companies on the Tokyo exchange, so relied on debt capital that Berkshire had issued in the country, as well as funds raised in 2022 via the issuance of more yen-denominated debt, to fund the initial stakes. Given the continued low cost of yen-denominated debt, Berkshire issues more debt from time to time.
As we see it, as long as the sogo shoshas continue to pay their dividends, then Berkshire is covering the debt expense for the funds that have been used to buy the shares, and it would probably roll over the debt if rates are still accommodative when the obligations come due (assuming that it wants to stay invested). However, we don’t believe that Berkshire will repatriate the dividends, given that it does not need any more cash, and it will probably need the additional capital on the ground in Japan if a much larger deal arises in the near to medium term.
But if the trading houses stop paying their dividends and their value declines over time, then Berkshire would have to pay more out of pocket to cover the interest payments, as well as the amount that is ultimately due on the debt (assuming it has sold the holdings). Or Berkshire could just sell the holdings and sit on the capital in yen, pay the ongoing interest on the debt, and keep its powder dry for some other opportunity in the region.
Is this an accurate way to look at the investments? Are there are other attributes we might be missing when looking at Berkshire’s stakes in the sogo shoshas?
(7) Is there anything structural or behavioral keeping Berkshire’s managers from pursuing acquisitions?
One of the perceived advantages of being acquired by Berkshire is that it provides the management teams of the acquired companies with access to a ton of capital at what we assume are favorable rates. We’ve not seen a lot of outright or bolt-on acquisition activity from Berkshire’s subsidiaries in the past 10 years: The average annual outlay for acquisitions was $1.6 billion during 2013-22. Over the past five years, Berkshire spent slightly less, an average annual outlay of $1.5 billion. This is from a company that generated $24.5 billion in free cash flow annually on average during 2019-23.
Within the manufacturing, service, and retailing segment, there was some expectation that the 2016 purchase of Precision Castparts (which had been a serial acquirer), as well as the 2015 purchase of Van Tuyl Group (which operates in a market that has been ripe for consolidation for some time), would have led to more deals. Berkshire’s average amount of dry powder on hand the past five years is around $102 billion quarterly, so it has been surprising to see so few deals being done. Granted, valuations have been less than desirable for many of the types of quality companies that Berkshire prefers to buy, but we would have expected there to be more activity than we’ve seen in the past 5-10 years.
Is there anything structural or behavioral that is keeping Berkshire’s managers (who aren’t named Warren Buffett, Greg Abel, or Ajit Jain) from pursuing acquisitions? Is there any hesitancy on their part to ask corporate for capital when they want to pursue a deal? Should they be doing more to pursue more bolt-on acquisitions? Could think change now that Alleghany has been brought on board, given its penchant for pursuing deals more aggressively than perhaps Berkshire has done in the past?
(8) With rates expected to stay higher for longer, will Berkshire consider increasing its allocation to bonds?
Berkshire has benefited greatly from the jump in short-term rates since early 2022: Interest income for the insurance companies increased 36.6% to $7.7 billion in 2022 and 50.2% to $11.6 billion in 2023. However, the Federal Reserve is likely to start cutting rates later this year and into 2025. With longer-term bond yields higher than they’ve been in nearly 15 years, should Berkshire consider allocating more of its cash hoard to long-dated bonds, locking in these higher rates for longer than it would with T-bills? This would help to ensure that the interest income generated by the insurance companies would not fall off too dramatically as short-term rates come down, assuming that cash and equivalent balances aren’t drawn down precipitously.
(9) Does Buffett regret setting a $150 billion threshold for the cash on Berkshire’s balance sheet?
At the May 2017 meeting, Buffett said it would be incredibly difficult to come back to shareholders down the road and defend holding $150 billion in cash. During 2019-23, Berkshire held a cash balance in excess of $125 billion 15 times, in excess of $135 billion 11 times, in excess of $145 billion 6 times, and more than $150 billion twice. Generating $6.4 billion in free cash flow quarterly on average during 2019-23, Berkshire was only ever a few quarters away from surpassing the $150 billion threshold, unless it put capital to work in investments, acquisitions, and share repurchases.
As long as valuations are still inadequate for the companies Berkshire prefers to acquire or invest in, it seems to be stuck with share repurchases as the primary option for working down cash balances, especially with dividends off the table. This was exemplified by the commitment to an average of $6.2 billion in quarterly share repurchases in 2020, $6.8 billion in quarterly share repurchases in 2021, and just $2.0 billion in 2022, when Berkshire finally found stock investments and acquisitions to put capital to work in.
Knowing that Berkshire will probably have to find a home for $25 billion-$35 billion in free cash flow annually via investments, acquisitions, and share repurchases in order to keep its overall cash balance below $150 billion, and also needs to work down some $20 billion in additional excess cash that we estimate it currently has on hand, we wonder if Buffett’s 2017 remark painted the company into a corner with regard to capital allocation over the long run. Would Berkshire ever consider buying back shares even if it meant paying prices at or above intrinsic value, if that is the best option to keep the cash balance from pushing out beyond the $150 billion threshold?
(10) What is driving the disparity between the share classes?
We’ve seen a greater-than-normal disparity between Berkshire’s Class A and Class B shares since the middle of 2022. While the B shares have just 1/10,000th of the voting rights of the A shares, they hold 1/1,500th of the economic rights, so they should trade at 1/1,500 of the value of the A shares. Historically, Buffett has encouraged investors to buy the B shares instead of the A shares whenever the latter are trading at more than a 1% premium to the B shares, and when the two share classes are at parity, to buy the A shares, given their superior voting rights.
In the past two years, the A shares have traded at more than a 1% premium during 13 months, providing investors opportunities to buy the B shares at a discount to the A shares and recoup the difference once the two share classes return to their more natural trading differential. However, Berkshire seems to have bought back more A shares than B shares during the six calendar quarters ended December 2023.
We understand that Berkshire’s priorities are different from most investors’, as the goal of management should be to prioritize A share repurchases over B share buybacks, given the superior voting rights of the A shares. But it seems that Berkshire missed an opportunity to secure shares at a deeper discount by not buying back B shares more aggressively.
Does Buffett still stand by his recommendation to investors to buy B shares instead of A shares whenever the latter are trading at more than a 1% premium? If so, how does this work into the calculations when buying back stock for Berkshire’s own book?
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
