During their latest episode of the VALUE: After Hours Podcast, Bloomstran, Taylor, and Carlisle discuss Berkshire Hathaway’s Breathtaking Earnings. Here’s an excerpt from the episode:
Tobias: He pinned their colors to the mask by putting that slide up, and making it public, and talking about that regularly. How do you feel about Berkshire, the entity? Can you walk us through how you think about it?
Christopher: I think about it like it’s a bond to a degree. The predictability of the earning streams, which are coming from all the myriad sources, even the profits you get from the energy business, from the railroad, from their manufacturing service, retail and leasing businesses are very knowable, very durable, very well capitalized. Then you’ve got by far the world’s best assembly of insurers on the planet, which are just massively overcapitalized. I’ve gone through the math with you guys before, but you’ve got $275 or so billion of capital. You can write $3 of auto premium for every dollar of statutory surplus. They probably get $20 billion of capital. The specialty business gets another $20 billion of capital. The balances and the reinsurers.
You just picked up the Allegheny assets, which I think Berkshire just stole. We owned Allegheny, which we bought in the financial crisis or in the pandemic at about half a book. I think it was worth at least 20% more than Berkshire paid. Weston Hicks told me recently that the operating businesses, he heard, they were way more profitable for the last year. They were earning 12 on equity a year ago, not inconceivable that they were into the 2020s returns on equity. And so, given what Berkshire can do with the Allegheny investment portfolio, flipping it from what was largely bonds to largely stocks, retaining more business when it’s written– You’re picking up $5 billion of premium from TransRe of the $7 billion of total reinsurance premium that the Allegheny collective of insurers write.
So, that reinsurance operation at Berkshire– and I’ve got a chart in this year’s letter that shows you how much capital the aggregate of the reinsurance industry has globally. Berkshire has more than a third of it, and they write seven cents on the dollar of capital in premium volume. Well, the Swiss and the Germans, Swiss Re and Munich re write at about a buck of premium for a buck of capital, which is insane. The Europeans have never met an insurance policy they didn’t like, an insurance risk, [Jake laughs] and the banking system in Europe never met a loan they didn’t want to make. These have been horrible investments for decades. You look at the stock price charts and they’re just dying a slow death over time.
Berkshire is so massively capitalized with that reinsurance business again writing seven cents on the dollar of statutory capital. You can’t kill it. It allows Berkshire to have largely a common stock portfolio versus a bond portfolio. So, you put it all together– I’ve got $53.9 billion, I think it was this year in total Berkshire earnings. A big slug of that comes from the stock portfolio. You’ve got the retained earnings, obviously, of the investees that is now running close to $17 billion. You’ve got $5.5 billion pushing $6 billion in dividends. Here’s where my number. Some people say, “Well, Chris, you make these adjustments for the railroad and the energy business.” They use accelerated depreciation, and I presume a timing benefit of fully depreciating an asset in year one or year two. That’s about a billion dollars. You can pick at that and throw that assumption away.
The big assumption is, if Berkshire only earns the earnings yield on the portfolio, which now gets you to $17 billion plus $5 billion, the thing had been 19 to 20 times earnings for the prior couple of years. Well, with the stock portfolio down last year, and with Berkshire investing almost $60 billion net back into the stock portfolio, you’ve got a way bigger earnings number coming and it’s trading at a 7% earnings yield. So, if the stock portfolio only makes 7% a year between dividends and retained earnings, that’s the number that exists in my $53.9 billion. But if the $300 plus billion dollar stock portfolio makes another 3% a year and averages 10%, it’s another $10 billion in earning real-
Jake: Starting to talk about real money here.
Christopher: -effectively inures for shareholders benefit, that’s not counted. So, I’ve got a case in the– I’ve always assumed 10 ROE, and Berkshire earns a little more than 10. Well, it’s the delta, really, between the stock portfolio doing better than the earnings yield of the stock portfolio over time.
Jake: One thing you had in the letter that surprised me was that you said that BNSF wasn’t going to be somewhere where he could plow capital back in like he had been able to, and that was closed off, especially relative to BH Energy. Can you explain that a little bit?
Christopher: Yeah. When they bought the Burlington Northern, and the financial crisis in 2009, it closed in 2010, they had the opportunity to put more leverage in the business. They paid, what, $36 or so billion dollars for it, including the piece they already owned. You were able to go add corridor track. You were able to blow out all the tunnels in the west to allow for intermodal, [crosstalk] the double stacking. There was a lot of what you would call capacity improvement of the system that was there for the picking. It was right for the picking. And so, Berkshire was spending in the rail $2 of Capex for every dollar of depreciation. Well, normally it kind of 120%, 130% Capex would be maintenance Capex relative to depreciation. But there was a big delta there where they’re able to really improve.
Now, they didn’t add net track miles. The whole thing has been 36,000 track miles from the get go. But there were a lot of improvements to the system that allowed for ongoing profitability. So, this is a business that earns low to mid-teens returns on capital. That Capex has run its course. And so, you’ve now got Capex at the rail running a little under 150% of depreciation for the last couple of three years. And so, the cadence of that spending has declined. You’re not going to go from 36,000 track miles, 46,000 to 56,000. There’s only so much you can do with the system. But the system is what it is. It’ll continue to throw off abundant cash presuming a lot of profitability.
The energy business, on the other hand, where you’re adding wind capacity, you’re adding solar capacity, you’re building the grid, every dollar of profit that’s earned by the energy operation since they bought MidAmerican has been retained and invested. If you understand accounting and the regulation of regulated utilities, you’re going to augment equity capital with roughly a like amount of debt, capital running between 40% and 60%. If you’re 40% debt, the regulators think you’re not spending enough on maintenance. If you’re running 60%, you’re gorging on leverage. So, you tend to run half and half. But they’re retaining $4 billion-
Jake: Yeah, the dividends.
Christopher: -$5 billion would you consider the joint venture pieces that Berkshire doesn’t own 100% of and augmenting it with debt. So, you’re running Capex, and for the duration of their ownership, retaining all that money and spending $2 of Capex for every dollar of depreciation. That’s genuine growth Capex. It’s a great use of about $5 billion of retained capital every year. The railroad, since they bought it has dividended up almost all of its profits, I think all of its profits to the parent company for use elsewhere. There’s only so much capital that the rail could take, but Berkshire’s appetite for the energy assets is endless for the time being and it’s heavily subsidized by the taxpayer. And so, that energy piece is going to be bigger than the railroad within a couple of three years and will continue to grow. It’s by far going to be the second most important asset to Berkshire next to the insurance operation.
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