Berkshire Hathaway is often referred to as a “fortress” due to Warren Buffett’s obsession with maintaining a massive margin of safety. With $125 billion of cash on hand as of December 31, 2019, there is no doubt that the company does not face any sort of near term liquidity crisis due to the worldwide Coronavirus pandemic. As plaintive calls for government bailouts emerge across industries, the lack of any worry about a liquidity crisis at Berkshire is something shareholders should find comforting. That being said, no company can possibly be immune to widespread government imposed shutdowns of economic activity as shelter-in-place orders become more common. At the present time, on March 22, 2020, at least one-quarter of Americans are living under orders to not leave their homes except for “essential” activities. The number of similar orders will no doubt increase in the days to come.
It is not possible to evaluate with any precision the extent of damage that has been done to Berkshire’s business interests in recent weeks, but there is no doubt that Berkshire’s many operating businesses have been affected. We can measure with somewhat more precision the market value change in Berkshire’s large portfolio of marketable securities, although there are important limitations in this exercise as well. In the one month that has passed since the 2019 Berkshire Hathaway annual report was released, the world has changed in extreme ways.1
As long term investors, we should focus on what happens over several years and decades rather than months or quarters. This is the approach that Warren Buffett and Charlie Munger have advocated for decades. However, we are in the midst of a historic event and it is not only rational but essential to think about how the current events that are unfolding impact the businesses we own.
In this article, I will examine various aspects of Berkshire Hathaway in an attempt to draw some high level conclusions regarding the company’s prospects as we proceed through this crisis and eventually emerge into an economic recovery. Specifically, I will examine Berkshire’s large portfolio of marketable equity securities, the impact of the crisis on company’s operating earnings, and the potential for opportunistic deployment of capital.
Due to the length of this article, links are provided to the various sections below:
Berkshire is required to report the majority of its holdings of equity securities every quarter on Form 13-F.2 A convenient and easy-to-read synthesis of the SEC filing can be found on the dataroma website.
As of December 31, 2019, Berkshire reported holding equity securities with market value of $242.1 billion. We have no idea whether the securities that were held on December 31, 2019 continue to be held today. It is very possible, and in fact extremely likely, that Warren Buffett, Todd Combs, or Ted Weschler have made changes to the portfolio amid recent volatility in the markets. That said, if we assume that the portfolio is mostly unchanged, at least for the large positions, we can update the quotes as of Friday, March 20, 2020 and draw some basic conclusions.
If the portfolio of December 31, 2019 was unchanged through the close of trading on March 20, 2020, the value of the securities have declined by 34.5 percent, or $83.4 billion. However, this decline in market value is partially offset by a commensurate decline in Berkshire’s deferred income tax liability. As of December 31, 2019, Berkshire carried a $32.1 billion deferred income tax liability attributable to unrealized capital gains. The gross market value decline of $83.4 billion should be partially offset by a $17.5 billion decline in the deferred tax liability assuming a 21 percent corporate tax rate. The would reduce the net decline in book value from $83.4 billion to $65.9 billion. A $65.9 billion decline in book value is equivalent to $40,555 per A share or $27.04 per B share based on shares outstanding on December 31, 2019.
Of course, whether this 34.5 percent decline in the market value of Berkshire’s equity portfolio is justified by a commensurate decline in the intrinsic value of the securities in the portfolio is a valid question. I will not enter into an analysis of each of the holdings in this article, but it does seem useful to at least list the top fifteen holdings, ranked as of the beginning of the year, since this accounts for 89 percent of the market value of the portfolio. In addition, a summary of Berkshire’s financial and airline investments will be interesting to examine briefly.
Top Fifteen Holdings
The following exhibit displays the top fifteen3 holdings:
Berkshire’s large holdings in financial institutions and airlines have been particularly impacted by the current bear market. The overall damage to the portfolio would have been far greater if Apple had declined by more than 21.9 percent. Another bright spot in the portfolio is DaVita which declined only 13.4 percent, probably due to the non-discretionary nature of providing dialysis services to patients in any economic environment.4
Over half of Berkshire’s year-to-date losses are accounted for by the following ten financial institutions:
With the exception of Visa and Mastercard, all of the top ten financials in Berkshire’s portfolio declined by roughly 40 to 50 percent, with Wells Fargo suffering the largest decline. As of March 20, this group of financial stocks make up 34.4 percent of Berkshire’s overall equity portfolio.
Obviously, a lengthy shut down of major sectors of the American economy will have devastating impacts on most businesses and we could expect to see bad debts skyrocket in the quarters to come. Analysis of these institutions is beyond the scope of this article but several of them are clearly systemically important and “too big to fail”. Berkshire has, in the past, come to the aid of large financial institutions and might have opportunities to deploy capital in the future on favorable terms. However, whether such opportunities will arise in the current crisis is not knowable at this time.
In recent years, Berkshire has taken significant stakes in the U.S. airline industry. Perhaps due to some level of schadenfreude in the media, these investments have attracted much recent attention. Fortunately, they only accounted for 4.2 percent of Berkshire’s equity portfolio at the start of the year and 2.7 percent of the equity portfolio based on current quotes. The following exhibit shows the four airline stocks and how they have fared this year:
To say that this is not a pretty picture is an understatement and the carnage would no doubt be worse for equity owners in the airlines if there was not active talk of a massive $50 billion government bailout of the airline industry. As a shareholder of airline stocks, Berkshire would obviously benefit from such a bailout in terms of the market value of existing equity stakes. However, in the absence of a government bailout, it is possible one or more of these companies might approach Warren Buffett for additional capital. Whether Buffett would be amenable to providing such capital, no doubt at a steep cost, is unknown. However, he has said that he will not be selling airline stocks.
During the 2008-09 financial crisis and in the years that followed, Berkshire made a number of opportunistic investments and it is not inconceivable that the same might be possible for airlines and other distressed industries in the current crisis. The “Buffett playbook” when approached by distressed companies has been to acquire preferred stock paying a substantial cash dividend along with cheap or free warrants to purchase equity in the future. Buffett may or may not be interested in doing so for the airlines, but he would have little reason to if the government steps in first.
In the March 11 issue of Rational Reflections, I examined Berkshire’s investment in Occidental Petroleum. In addition to the $10 billion preferred stock investment, which is not included in Berkshire’s 13-F filing, Berkshire owned 18,933,054 shares of Occidental common stock as of December 31, 2019. These shares were valued at $780.2 million on December 31, 2019 and declined by 75.2 percent year-to-date leaving Berkshire with an investment valued at $193.7 million.
As discussed in the Rational Reflections issue, the significant decline in the price of oil is the main factor behind Occidental’s crashing stock price. Occidental has substantial debt and Berkshire’s $10 billion preferred stock investment cannot be considered entirely secure at this point. Obviously, the $193.7 million common stock investment is a rounding error compared to Berkshire’s overall equity portfolio but the $10 billion preferred stock position is material.
In recent weeks, investor Carl Icahn has increased his stake in Occidental common stock and launched an activist campaign which is now nearing a settlement. Icahn has been highly critical of Occidental’s management for agreeing to the terms of Berkshire’s preferred stock investment which was needed in Occidental’s acquisition of Anadarko Petroleum last year. Icahn’s involvement and increased stake in the common stock is a positive sign for Berkshire shareholders, as the vast majority of Berkshire’s exposure to Occidental is senior to Icahn’s investment in the common stock. Icahn has every incentive to preserve value at Occidental in the months to come, but the price of oil, which is of course unknowable, is likely to be the determining factor in the end.
Berkshire is fortunate to have a widely diversified group of operating businesses with vastly different economic characteristics. In normal times, this diversification can smooth overall results with difficulties in one area being offset by strong results in another. The following exhibit displays Berkshire’s operating earnings on an after-tax basis for the past five years:
Of course, the 2015-2019 period was one characterized by economic growth, which in retrospect was the tail end of the decade-long expansion following the 2008-2009 financial crisis. The results Berkshire’s subsidiaries will post in 2020 will almost certainly be far worse than the numbers posted in recent years.
We can attempt to look at how Berkshire withstood the 2008-2009 financial crisis, but this has limited utility for two major reasons. First, Berkshire was a different company twelve years ago. Many of the non-insurance subsidiaries that Berkshire has today were not yet acquired in 2008 with BNSF being the most notable (acquired in Q1 2010). Second, the 2008-2009 financial crisis, while severe, did not involve a mandated government shut-down of major sectors of the United States economy.
Nevertheless, despite these limitations, let us take a brief look at how Berkshire’s operating results fared on a quarter-by-quarter basis from 2008 through 2010. The exhibit below, utilizing quarterly data I have long maintained for Berkshire, is on a pre-tax basis and is broken down differently than the more recent data due to segment reporting changes:
We can see the most significant impact of the recession in the “other business” line of the exhibit. This diversified group of manufacturing, service, and retailing businesses hit a trough of $201 million of pre-tax earnings in Q2 2009, down from a high of $956 million in Q2 2008. While there are certainly variations in the other line items, which I will not delve into in detail here, suffice it to say that Berkshire’s overall operating earnings never came close to dropping into negative territory during the 2008-2009 financial crisis and recession.
As noted previously, we cannot expect the current crisis to mirror 2008-2009 so let’s take a brief and necessarily mostly qualitative look at Berkshire’s sources of operating earnings to see which might be at most risk of impairment in the quarters ahead.
Insurance – Underwriting
Berkshire has posted a remarkable run of underwriting results in recent years with underwriting profits in sixteen of the past seventeen years. The most immediate question being asked is the degree to which Berkshire has exposure to the Coronavirus pandemic itself. Has Berkshire written policies that explicitly cover pandemics? And how will the pandemic’s second and third order effects impact other lines of coverage?
I have not been able to locate specific information on Berkshire’s exposure to policies explicitly covering pandemics. However, Warren Buffett is clearly quite aware of the risk of pandemics and he has been for a very long period of time. The following excerpt is from an article published by Reuters May 2009:
Berkshire would consider writing insurance policies for pandemics, including one that Buffett said assumes the U.S. mortality rate rises by 25 percent in 2010, equivalent to roughly an additional 600,000 deaths.
“You could get us to quote a policy on the present potential pandemic,” Buffett said, though “you may not like” how much Berkshire would charge. “You need someone with a real sense of the probabilities” to write such policies, he said.
Three thoughts come to mind when reading these comments. First, Berkshire could very well have specific pandemic coverage on its books since Buffett has said that Berkshire would be willing to write coverage at the right price. Second, if such coverage has been offered by Berkshire, it is likely that the aggregate premiums received over the past decade have been substantial. Third, this event was not a “black swan” in Buffett’s mind and therefore there is no chance that he and Ajit Jain would have allowed uncapped liability for pandemic coverage to accumulate. Any coverage provided by Berkshire is certain to be capped.
Although this opinion is purely speculative, I doubt that Berkshire’s exposure to the pandemic itself would exceed its exposure to a typical summer hurricane in the Gulf of Mexico or the Atlantic. This could mean that Berkshire has a few billion dollars of exposure but probably not ten billion.
Does Berkshire have exposure due to second and third order effects of the pandemic? In particular, what about business interruption coverage? Again, Berkshire specific information is not available at this point but the general consensus within the industry seems to be that pandemic coverage is typically excluded.5 Does this mean Berkshire is in the clear entirely? Probably not, although it does not appear that the industry has been willing to include pandemic coverage in general lines as a matter of course. With Berkshire being one of the most sophisticated underwriters in the industry, the chance of being inadvertently exposed seems minimal.
The bottom line is that we can only make qualitative judgments at this point regarding Berkshire’s potential insurance exposure but a reasonable worst-case scenario might be thought of as equivalent to a large-scale natural disaster if Berkshire has written pandemic-specific coverage.
Insurance – Investment Income
The impact on investment income is likely to be significant but over a period of several quarters rather than all at once. In 2019, dividend income made up 69 percent of pre-tax investment income and some level of dividend cuts are inevitable in Berkshire’s portfolio of equity investments. Additionally, interest rates have plummeted in recent weeks which will dramatically reduce the income Berkshire can earn on its massive cash balance. This effect will be felt over the next quarter as treasury bills that mature that were likely earnings 1.5 – 2 percent are reinvested at rates not far above zero.
Berkshire did not own BNSF during the 2008-09 financial crisis, but we can look at BNSF’s results as a stand-alone business during that timeframe to see how results evolved around that time:
The exhibit contains data I collected around the time of the acquisition and reveals that net income remained strongly positive during the downturn. Of course, that has little bearing on how the railroad will respond to an unprecedented shutdown of a large segment of the U.S. economy if the current situation persists for many more weeks or months. It seems doubtful that the shipment of essential agricultural, industrial, and food products will entirely halt for any length of time. That being said, a railroad has high fixed costs and inherent operating leverage that could result in negative cash flow if the worst estimates of the shut-downs come to pass. Any quantitative guess would be just that – a guess on my part.
Utilities and Energy
Berkshire Hathaway Energy is comprised of a diverse set of subsidiaries as shown in the exhibit below:
Electricity and gas consumption is obviously a mix of residential and industrial uses and will be impacted to some degree by a major economic slowdown. As of mid-February, Reuters reported that China experienced a drop in electricity demand during their recent shutdown which represented about 1.5 percent of industrial power consumption. As the U.S. economy slows down, industrial power demand will fall, but this may be partially offset by residential power demand rising as more people are quarantined and spending more time in their homes.
Berkshire Hathaway Home Services, which is included in the Utility segment, is likely to experience major disruption because real estate activity will slow to a crawl if people are unable to tour homes. Even after lockdowns are lifted, people will be more reluctant to make a major home purchase at a time of economic uncertainty.
In aggregate, it seems unlikely that Berkshire Hathaway Energy will post operating losses due to the Coronavirus crisis and the overall impact should be relatively muted.
Manufacturing, Service, and Retailing
Berkshire’s widely diversified group of manufacturing, service, and retailing companies are likely to experience significant impact from the Coronavirus pandemic. The following exhibit shows the record of this segment over the past three years:
Let’s drill down further into the manufacturing businesses:
The industrial products group would be heavily impacted by an overall slowdown in economic activity. Companies such as Lubrizol, Precision Castparts, IMC International (Iscar), and Marmon can all be viewed as cyclical businesses correlated with GDP growth. Precision Castparts is significantly exposed to the struggles of the airplane industry.
The building products group includes Clayton Homes, Shaw, Johns Manville, Acme Brick, Benjamin Moore and other companies that would be impacted by a slowing housing market. At a time when millions of Americans are likely to face unemployment, there is no doubt that the businesses in this group will be heavily impacted. However, Clayton Homes operates in the lower priced segment of the home market and its affordable products could fare relatively well in an era of tighter household budgets.
The consumer products group includes Forest River (RV products), apparel and footwear companies, and various smaller subsidiaries. To the extent that these businesses manufacture discretionary products, especially RVs, the impact of a major recession will be unmistakably negative. Some of the basic apparel companies such as Fruit of the Loom and Garan could face less severe impacts.
In aggregate, the manufacturing group is likely to face significant headwinds in a protracted economic downturn. While it may be tempting to make quantitative guesses, there are too many unknowns at this point for that exercise to be productive.
A summary of the past three years of results for Berkshire’s service and retailing operations appears below:
The service group includes NetJets, FlightSafety, TTI, Dairy Queen, XTRA, CORT, BusinessWire, and some smaller operations. Each business will face different challenges. Demand for private aviation appears to be up as the super-rich avoid flying commercial airlines and this could help NetJets results in the near term. However, in the long run, private aviation will not be helped if stock markets enter a multi-year bear market decimating the net worth of the rich. Dairy Queen is a franchiser of quick service restaurants and the franchisees are likely to be in severe financial distress in the weeks to come as governments order the shutdown of restaurant operations in more states.
The retailing group includes Berkshire Hathaway Automotive, home furnishing retailers, jewelry retailers, See’s Candies, and other small subsidiaries. Although not a material source of earnings for Berkshire anymore, the retail group is obviously going to be heavily impacted by shutdowns that prevent people from visiting retail outlets. The severity of the situation will increase the longer large segments of the population are sheltering in place and unable to shop. It is plausible that once restrictions are lifted there will be pent-up demand, but that is contingent on the economy avoiding large-scale unemployment in the aftermath of the pandemic.
Operating Earnings – Concluding Thoughts
The discussion of Berkshire’s operating earnings presented here may seem unsatisfactory to many readers hoping for quantitative predictions regarding potential damage from Coronavirus. The inability to make precise estimates is unsatisfactory to me as well but it seem like there is inadequate information at this point to avoid simply making guesses beyond assessing the directional impact and making qualitative comments. We will certainly get more clues regarding the impact in Berkshire’s Q1 2020 results which will be published in early May.
Despite the inability to be precise, it seems to me that it is highly unlikely for Berkshire’s operating earnings to be negative or operations, in aggregate, to consume cash for any length of time. If there are quarters in which there are operating losses for the group as a whole, Berkshire certainly has ample cash resources to avoid any kind of financial distress.
The real long term risk for Berkshire’s operating earnings is the same as the risk for the overall economy. If we emerge from the pandemic with a much diminished GDP which does not bounce back quickly, then we will face many years before 2019 GDP is again achieved. We cannot expect Berkshire’s operating companies, in aggregate, to achieve 2019 level results under conditions of economic depression, should that be the outcome of the pandemic.
Berkshire Hathaway shareholders have been watching the company’s cash balance grow for many years and some of us have been impatient for opportunities to deploy this cash. Berkshire now will have major opportunities to deploy its cash, although under circumstances that I am sure Warren Buffett and Charlie Munger wish had never come to pass. However, in a capitalist system, those who have the ability to deploy capital in times of crisis play a constructive and essential role in the recovery process.
How might Berkshire allocate the $100+ billion that is available for investment beyond the $20 billion minimum reserve that the company has pledged to always maintain? We do not know, but the potential set of opportunities include investment in marketable securities, business acquisitions, opportunistic rescues of sound businesses facing liquidity problems, and repurchase of Berkshire stock.
There is no point in speculating regarding what Berkshire might do in terms of marketable securities, acquisitions, or “rescues” of distressed companies. However, we will continue the long tradition of repurchase speculation that has been a frequent subject on this website in recent years, most recently in February. Readers interested in the history of repurchase activity should review that article, which contains a full history of repurchase activity from 2011 to 2019, before proceeding.
We know that Berkshire has continued repurchasing stock in 2020. Berkshire’s 2020 proxy statement indicates that there were 1,620,691 Class A share equivalents outstanding on March 4, 2020 compared to 1,624,958 Class A share equivalents outstanding on December 31, 2019. We will not know the average cost of the repurchased shares until Berkshire files its 10-Q report in May but it is likely that at least $1.3 billion was allocated toward the buybacks.
There have been twelve trading days since March 4 and trading volume of Berkshire’s Class A and Class B shares has been far greater than average amid tremendous overall market volatility:
- Average volume of 1,000 Class A shares per day between March 5 and March 20 compared to average daily volume of 272 shares in 2019.
- Average volume of 13.6 million Class B shares per day between March 5 and March 20 compared to average daily volume of 3.8 million shares in 2019.6
With about 3.5 times as much volume as typical, Warren Buffett could have dramatically increased his repurchases of Berkshire stock on the public market. In addition, he advertised a willingness to consider private transactions of $20 million or more in the 2019 annual letter. Berkshire’s shares have been hammered since March 5 with a high of $318,605 per A share reached on that day and a low of $251,000 reached on March 20.
Berkshire’s book value per A share was $261,417 on December 31, 2019 but clearly book value is far lower than that today due to the significant decline in the equity portfolio. Using the data presented earlier in this article, we can estimate that the hit to book value is likely to be at least $40,000 per A share. Although Berkshire is likely to have posted at least some net income this quarter-to-date, let’s ignore that and simply deduct $40,000 from December 31, 2019 book value to estimate current book value at roughly $221,417. Based on Berkshire’s closing price of $257,346 on March 20, the shares trade at around 1.16x this very rough estimate of current book value.
The fact that Berkshire’s current price-to-book ratio is historically very low does not necessarily mean that Warren Buffett is repurchasing stock because he could have current or anticipated future opportunities that he considers superior to repurchases. However, given Berkshire’s recent repurchase activity, it seems likely that several billion dollars have been utilized to repurchase stock in recent days. We will not know for certain until the 10-Q is published in early May.
For the few readers who have reached the end of this unreasonably long article, hopefully the discussion has provided some level of insight regarding Berkshire’s prospects as we continue navigating an unprecedented shutdown of major sectors of the economy that has no clear end in sight.
Although we cannot make precise quantitative estimates, the damage to the equity portfolio presented above is probably in the ballpark given that Berkshire does not have much turnover, at least in the largest holdings. The discussion of the operating businesses serves the purpose of trying to grapple with whether they will start to post operating losses or bleed cash in this situation. I view a lengthy period of operating losses or negative cash flow to be unlikely in the aggregate although it is certain that individual subsidiaries will be heavily impacted in the weeks and months to come.
Berkshire is positioned as well as any company could be facing this type of exogenous shock to the system. While survival of the company is not in question, the long term intrinsic value of the business certainly is in question because we could be in the early stages of an economic depression. If that occurs, then the long term value of nearly every business in the country will be impaired.
Hopefully, intelligent government policy will prevent the worst from happening and we will enter a “V shaped recovery” that will return overall GDP to 2019 levels within the next year or two. If that occurs, the intrinsic value of Berkshire will still be somewhat lower than if Coronavirus had never happened, but the damage will not be severe. But if the 2020s is a repeat of the 1930s, Berkshire will struggle through and almost certainly do better than most large corporations, but its value at the end of the decade will be significantly diminished relative to what we expected just a couple of months ago.
Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway. Nothing in this article constitutes investment advice of any kind.
- A special issue of the Rational Reflections newsletter covered the 2019 annual report release. [↩]
- Equity securities traded on U.S. exchanges, including foreign securities traded on U.S. exchanges in the form of American Depository Receipts (ADRs) are reported on Form 13-F. Foreign securities traded on foreign exchanges are not reported on Form 13-F. For our purposes, analyzing Berkshire’s 13-F is sufficient given that the vast majority of its holdings are included in this filing. [↩]
- Note that the companies shown in the exhibit are the top fifteen based on ranking as of 12/31/19. However, as of 3/20/20, Charter Communications, Verisign, and Visa would replace Delta Air Lines, Southwest Airlines, and General Motors in the top 15 ranking due to market value changes between 12/31/19 and 3/20/20. [↩]
- We profiled DaVita’s business several years ago. [↩]
- A number articles regarding pandemic exclusions in insurance policies have been published by various organizations in recent days. A sample of such articles include:
It’s too late for this pandemic. But everyone wants insurance against the next one (CNN 3/19/2020)
Why Are Insurance Companies Denying Restaurant Claims in Wake of Pandemic? (Eater.com 3/20/2020)
Can insurance lessen the economic costs of the coronavirus pandemic? (The Hill 3/20/2020)
Can Insurance Really Save Retail and Hospitality from the Coronavirus Pandemic? (Risk and Insurance 3/16/2020) [↩]
- Volume data was obtained from Yahoo! Finance. [↩]