3 Key Things To Watch When Berkshire Hathaway, Inc. Reports Its Earnings

  • Legendary investor Warren Buffett’s Berkshire Hathaway will release its second quarter results in the coming days.
  • The company will likely post growth in manufacturing which will mask the weakness of its insurance and railroad operations.
  • The one thing which is going to be watched closely by investors will be Berkshire Hathaway’s stock portfolio.

Legendary investor Warren Buffett’s Berkshire Hathaway Inc (NYSE:BRK.ANYSE:BRK.B), one of the world’s largest conglomerates in terms of market cap, will likely release its quarterly results over the next few days in which its earnings could climb 20.5%, according to consensus data from FactSet.

Analysts believe that Berkshire Hathaway’s earnings will clock in at $2,857 per Class A share in the second quarter of this year, up from $2,367 per Class A share reported in the corresponding period last year. Note that these are operating earnings, not the earnings per share estimates that are reported by other companies. The operating earnings, as Warren Buffett has frequently said, is a better measure of gauging Berkshire Hathaway’s performance since it excludes the impact of derivatives and investment gains or losses, and this is what analysts estimates are about. Its revenues are projected to climb to $56.5 billion from $51.4 billion a year earlier, a growth of little less than 10%.

Berkshire Hathaway’s management usually does not discuss the details of their quarterly performance, but despite the decent growth, we can say with a fair amount of certainty that the results will be largely mixed. Here are three key things regarding the second quarter results which investors should know. 

1 - Impact of acquisitions

In the first quarter of this year, Berkshire Hathaway posted a 7.7% increase in revenues and 8.2% increase in earnings. But this growth was driven in large part by the acquisition of Precision Castparts (NYSE:PCP). Warren Buffett acquired the maker of complex metal equipment and components for aerospace, energy and power industries last summer and closed the $37.2 billion deal in January. That was one of the biggest deals in Berkshire Hathaway’s history. In February, Berkshire Hathaway closed the Duracell acquisition. The company got the battery maker for more than $2 billion.

The Precision Castparts transaction pushed Berkshire Hathaway deeper into the heavy industries space, reducing the conglomerate’s exposure to insurance and stock picking activities that have fueled Berkshire Hathaway’s growth for the last five decades. The acquisitions also powered 12.7% growth in manufacturing, service and retail earnings and drove the company’s top and bottom-line growth in the first quarter. The unit made the biggest contribution to Berkshire Hathaway’s operating earnings. We’ll likely see a similar impact of acquisitions on Berkshire Hathaway’s manufacturing segment in the second quarter.

2 - Weakness in insurance and railroad operations

The growth in manufacturing in the second quarter will likely mask the weakness in Berkshire Hathaway’s insurance and railroad operations.  The company’s insurance business was responsible for a little less than a third of the company’s operating earnings in the first quarter that featured a 16.5% drop in the unit’s earnings. The results have been dragged by the poor performance of the company’s property/casualty reinsurance business.

But more importantly, the reinsurance market has been hit by the low-interest rates. The US and major economies have been keeping interest rates near historic lows, with some countries like Japan even opting for negative interest rates, in order to boost the flagging economic growth. The Federal Reserve did nominally increase interest rates at the end of last year, but it has been reluctant to hike interest rates again in 2016. The low-interest rate environment has hit insurance companies who get a large chunk of their income by investing the float. Low-interest rates translate into low investment income for the insurance companies. As long as the Fed keeps a lid on interest rates, Berkshire Hathaway’s insurance operations will likely struggle.

Meanwhile, Berkshire Hathaway’s Burlington Northern and Santa Fe, or BNSF, has also been showing signs of weakness. In the first quarter, the railroad operations earnings dropped by more than 16% due to soft cargoes, thanks to weak demand for coal, oil and other energy-related products. The business has turned out to be a casualty of the commodities super-cycle. Although prices of some of the commodities, such as oil, have gained substantially in the second quarter as compared to the first, they are still below last year’s level.

The spot price of WTI oil, for instance, averaged more than $40 a barrel in 2Q-2016, showing a gain of more than 36% from 1Q-2016, but was still down when compared to an average of more than $55 in 2Q-2015. Meanwhile, other commodities, such as coal, haven’t risen as sharply as oil on a sequential basis. In short, the commodities super-cycle is far from over. Therefore, BNSF will likely continue to struggle with low shipments of coal and products used by the energy industry. BNSF, however, is working to reduce its capital expenditure which should soften the blow coming from weakness in cargoes.

3 - Stock portfolio

That being said, the one thing which is going to be watched closely by investors from around the world will be Berkshire Hathaway’s stock portfolio. According to its most recent SEC filing, the conglomerate owns shares of more than 45 different companies which, together, are worth approximately 36% of Berkshire Hathaway’s market cap. Its five largest holdings are Kraft Heinz (NSDQ:KHC), Wells Fargo (NYSE:WFC), Coca Cola (NYSE:KO), IBM (NYSE:IBM), and American Express (NYSE:AXP). Together, they represent a little less than 70% of Berkshire Hathaway’s stock portfolio.

In the second quarter, American Express stock has remained largely flat while Coca-Cola and Wells Fargo have declined by more than 3%, but IBM and Kraft Heinz have posted gains of 2.6% and 11.83% respectively. The strong double-digit gain seen by Kraft Heinz stock should have a positive impact on the value of the entire portfolio, considering the food company is Berkshire Hathaway’s top holding, accounting for more than one-fifth of the conglomerate’s portfolio. In other words, we’ll likely witness a slight increase in the size of the stock portfolio which stood at roughly $128.57 billion at the end of the first quarter.

Note that Berkshire Hathaway has been increasing its stake in Phillips 66 (NYSE:PSX) and recently bought additional 643,000 shares of the oil refining and marketing company for $64 million. The energy company is Berkshire Hathaway’s sixth largest holding, behind American Express but ahead of Walmart (NYSE:WMT). This increase, however, may not have a positive impact on the total portfolio value since Phillips 66 stock has declined by 9% in the second quarter.

Conclusion

Berkshire Hathaway will likely release its quarterly results over the next few days. The company could post double-digit growth in revenues and earnings on a year-over-year basis, but the increase will be driven partly by acquisitions. The company’s insurance and railroad operations, which together accounted for more than 60% of the company’s operating earnings and more than 40% of net earnings, will likely struggle. The total value of Berkshire Hathaway’s stock portfolio, however, will likely increase, driven by the strong performance of Kraft Heinz stock, which is Berkshire Hathaway’s largest holding. Overall, it’s going to be a mixed quarter.

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