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Warren Buffett reveals winds of change in annual letter

Feb 29 2016 07:32

New York - Warren Buffett, the billionaire chairperson of Berkshire Hathaway, said subsidised wind and solar power in the US may erode the economics of electric utilities that care little for efficiency.

“The joke in the industry was that a utility was the only business that would automatically earn more money by redecorating the boss’s office,” Buffett wrote on Saturday in his annual letter to shareholders. “Some utilities ran things accordingly. That’s all changing.”

Berkshire is both a utility owner and a producer of electricity from renewable energy.

After it pledged in July to almost double its $16bn investment in renewables, its company NV Energy persuaded state regulators to raise fees and cut credits for new home-solar customers. Nevada casino operators have tried to break away, saying they can buy cheaper power in the open market, including some from renewable sources.

High-cost utilities

“Tax credits, or other government-mandated help for renewables, may eventually erode the economics of the incumbent utility, particularly if it is a high-cost operator,” Buffett wrote on Saturday.

Berkshire Hathaway Energy’s track record of efficiency “leaves us particularly competitive in today’s market (and more important, in tomorrow’s as well).”

The company’s utilities produce more power with fewer employees and a lower accident rate than before it bought them, Buffett said. The Iowa utility operated without a rate increase for 16 years, while average rates in the industry rose 44%, he said.

Berkshire’s pledge to spend another $15bn on renewable-power development “will make great sense, both for the environment and for Berkshire’s economics,” he said. “It seems highly likely to me that climate change poses a major problem for the planet.”

In the same letter, Buffett urged rejection of a shareholder proposal that would require Berkshire to report on the danger of climate change to insurance companies, its biggest business.

“As a homeowner in a low-lying area, you may wish to consider moving,” he said. “But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries.”

Buffett seeks more takeovers, likens Precision’s CEO to Da Vinci

Buffett is already counting on his newest deputy to pursue takeovers.

Just weeks after completing the purchase of Precision Castparts, Buffett told shareholders on Saturday that he expects the manufacturing company’s chief executive officer, Mark Donegan, to keep up his buying streak.

“In building his business, Mark has made many acquisitions and will make more,” Buffett said in his letter. “We look forward to having him deploy Berkshire’s capital.”

While Buffett snags most of the attention for his megadeals - like the buyout of Precision Castparts -- the comment is a reminder of how he’s set up Berkshire to have multiple avenues for reinvestment. He increasingly relies on deputies like the energy unit’s Greg Abel and Lubrizol’s James Hambrick to pursue their own deals.

As in years past, the billionaire highlighted how his deputies performed on the acquisition front. There were 29 so- called “bolt-on” deals last year, which will cost $634m in aggregate, he wrote.

‘Extraordinary products’

The addition of Precision Castparts this year for about $32bn in cash was one of Buffett’s largest deals ever. The company manufactures metal industrial components for jet engines and power plants along with pipes for the oil and gas industry. The billionaire likened Donegan to Jacob Harpaz, who runs Iscar, the Berkshire subsidiary that makes cutting tools.

“The two men transform very ordinary raw materials into extraordinary products that are used by major manufacturers worldwide,” Buffett wrote. “Each is the da Vinci of his craft.”

Buffett, 85, often uses hunting references to describe his never-ending quest for deals. His largest transactions are “elephants.” He and Berkshire vice chairperson Charles Munger, 92, don “safari outfits” to search for potential buyouts. And excess funds generated by Berkshire’s businesses help them reload their “elephant gun.”

As Berkshire has grown, that firearm has gotten formidable. The company had more than $70bn in cash at the end of December, a portion of which was subsequently used on the Precision Castparts transaction. Buffett said in August that the acquisition would probably keep him from doing another major deal for about a year.

Still, Berkshire doesn’t pay a dividend and rarely repurchases shares, meaning that dividends from subsidiaries provide what Buffett calls an “endless gusher of cash.” He suggested in Saturday’s letter that Berkshire could sell stocks to raise more if needed.

“Having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us,” he wrote.

Buffett reiterates praise for IBM, AmEx leaders amid share slump

Buffett reiterated his support for International Business Machines (IBM) and American Express (AmEx), even as those companies’ shares slump.

IBM and AmEx, along with Wells Fargo and Coca-Cola, “possess excellent businesses and are run by managers who are both talented and shareholder-oriented,” Buffett said in his letter. That passage is identical to what he wrote a year earlier.

IBM fell 14% in 2015 and AmEx plunged 25%, with both extending their declines since December 31.

While Berkshire is still sitting on huge gains from the American Express stake, IBM trades for less than what Buffett paid in 2011.

The unrealised loss on IBM widened to $2.6bn as of December 31 from $2bn at the end of the third quarter. “We currently do not intend to dispose our IBM common stock,” Berkshire said in its annual report Saturday, also echoing a prior filing. “We expect that the fair value of our investment in IBM common stock will recover and ultimately exceed our cost.”

Buffett is known for building large positions in his favourite companies and holding them for years or even decades. Berkshire’s stock portfolio was valued at more than $112bn as of December 31 and has grown with the recent addition of Phillips 66 shares. Wells Fargo has dropped about 12% over the last year and Coke is little changed in that period.

“We think American Express, IBM as well as the other major holdings like Coca-Cola and Wells Fargo, those will continue to be consistent long-term holdings of Berkshire,” Jay Gelb, an analyst at Barclays, said Friday in an interview on Bloomberg Television. “Holdings like American Express have billions of dollars of embedded gains for Berkshire. My sense is that Warren Buffett still has a positive long-term outlook on the company.”

Berkshire Hathaway profit up 32%

Berkshire Hathaway said fourth-quarter profit climbed 32% on investments and earnings from the company’s expanding stable of operating businesses.

Net income rose to $5.48bn, or $3 333 a share, from $4.16 billion, or $2 529, a year earlier, the company said on Saturday in a statement. Operating earnings, which exclude some investment results, were $2 843 a share, beating the average $2 814 estimate of three analysts surveyed by Bloomberg.

The results cap another record year for Buffett, Berkshire’s chairperson and chief executive officer. Over the past five decades, he has built the Omaha, Nebraska-based company into a sprawling enterprise with a stock portfolio valued at more than $110bn and interests in insurance, energy, manufacturing, media, retail and transportation.

While Berkshire’s insurance and investment results fluctuate widely, the company owns dozens of businesses that churn out steadier earnings. In recent years, profit from these units - including railroad BNSF and a collection of electric utilities - has become a bigger portion of the bottom line because of Buffett’s relentless dealmaking.

Cars, batteries

Berkshire bought a network of US car dealerships in 2015, and also struck one of its biggest deals ever: the $37.2bn buyout of aerospace manufacturer Precision Castparts. That transaction was completed after the fourth quarter. Buffett’s company said on Saturday that it also expects to complete the acquisition of the Duracell battery business from Procter & Gamble this month.

“We are getting a decent return on the capital we have deployed” for manufacturing businesses, a category that includes chemical company Lubrizol and toolmaker Iscar, Buffett said in his letter. “Earnings from the group should grow substantially in 2016 as Duracell and Precision Castparts enter the fold.”

Last year highlighted some of the challenges Buffett, 85, faces keeping his money-making machine moving forward. Even as he agreed to buy Precision Castparts and made billions on an investment in the food industry, some of Buffett’s major stock holdings slumped. Berkshire’s own shares ended 2015 down 12%, compared with the 0.7% fall in the Standard & Poor’s 500 Index.

Kraft Heinz

Since the start of 2016, however, Berkshire has outperformed. Shares were up 0.2% through Friday to $198 191, compared with the 4.7% slide in the equity benchmark.

Full-year net income rose to $24.1bn from $19.9bn in 2014, which had been a record. The 2015 result was fueled by a third-quarter investment gain in Kraft Heinz.

Book value, a measure of assets minus liabilities, rose to $155 501 per share at December 31 from $151 083 three months earlier and $146 186 at the end of 2014. That growth outpaced the gain in the S&P 500. Buffett’s stock picks and takeovers have helped build the figure more than 7 900-fold since he took control of Berkshire in 1965.

The insurance businesses had a fourth-quarter underwriting gain of $306m driven by improvements at General Re and BH Reinsurance. That compares with a gain of $191m a year earlier. Geico posted an $11m underwriting loss in the quarter, as the auto insurer has been pressured by higher claims costs. Some fourth-quarter results were calculated by subtracting figures for the first nine months from the full-year data provided Saturday.

Railroad, energy

Profit at Berkshire’s biggest unit, BNSF, fell 9.2% to $1.08bn, pressured by lower demand for coal. Volumes may fall this year as low fuel prices limit shipments of petroleum products and material used for extracting oil, the company said.

The utility segment, Berkshire Hathaway Energy, contributed $423m, an increase of 18% from a year earlier. The business operates electric grids in the UK, natural gas pipelines that stretch from the Great Lakes to Texas and power companies in states including Iowa and Nevada.

Profit from Berkshire’s businesses and investments continued to pile up. Cash increased 8.3% from the end of the third quarter to $71.7bn on December 31. Buffett spent $32bn in early 2016 to complete his acquisition of Precision Castparts, a deal in which he also assumed about $5bn of debt.

Stocks, derivatives

The stock portfolio was valued at $112.3bn at the end of the year, up from $110.3bn on September 30. Some of Buffett’s large holdings have come under pressure recently. IBM trades for less than he paid to amass the stake in 2011. AmEx has plunged over the past year. The billionaire has been adding shares of Phillips 66.

Buffett and his deputy investment managers, Todd Combs and Ted Weschler, spent $1.41bn on equities and $2.82bn on fixed-maturity securities in the quarter. Berkshire sold about $3bn in stock and $1.38bn of bonds during the period.

Berkshire had a gain of $805m on derivatives and investments in the fourth quarter, compared with a gain of $192m a year earlier. Some of the derivative contracts benefited recently because of a strengthening US dollar.

The manufacturing, service and retail segment added $1.07bn to earnings, compared with $1.05bn a year earlier.

Berkshire has about 361 270 employees, up 6.1% from the prior annual report. The biggest additions were tied to the acquisitions of Precision Castparts and the car dealership business formerly known as Van Tuyl.

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