- An increase in first quarter earnings for 2016 driven by a one time gain from investments.
- Complete divestment from two European re-insurance operations due to reduced yields and increased competitive pressure.
- Warren Buffett and Charlie Munger's continued faith in the Sequoia Fund and their disdain for Valeant Pharmaceuticals.
Berkshire Hathaway Inc (NYSE:BRK.A) held it's 2016 annual meeting this past weekend in Omaha, Nebraska. This year's meeting was the first one to be web cast (via Yahoo Finance) and translated into Mandarin. The so called "Woodstock of Capitalism" included an extended question and answer session with Berkshire leaders Warren Buffett and Charlie Munger. Below are excerpts from the Q&A session and a review of first quarter earnings.
Q1 2016 Earnings
Before diving into Berkshire's first quarter earnings, it's important to note that Berkshire Hathaway is the most diversified company in the world. Berkshire completely owns businesses in retail (See's Candies), consumer goods (Duracell), furniture (Nebraska Furniture Mart), insurance (GIECO and others) as well as planes (Precision Castparts and NetJets), trains (BNSF) and automobiles (Van Tuyl Group - the fifth largest US dealership) and many others. This large diversification protects Berkshire from slowdowns in any particular industry but also makes the company very difficult to analyze.
Versus first quarter 2015:
- Net earnings increased 9% to $5.58 Billion from $5.15 Billion
- Operating and insurance earnings each declined over 9%
- Gains from investments and derivatives nearly doubled to $1.85 Billion
A few key takeaways:
- Insurance earnings decreased due to an increase in claims from hail storms in Texas. Berkshire shareholders voted down an investor resolution that would require the company to disclose the impact climate change would have on its insurance division.
- Railroad earnings decreased due to reduced tonnage from the energy sector. The continued reduction in coal utilization for power generation (partly driven by Berkshire utilities Mid American Energy and NV Energy) will continue to be a strong headwind for Burlington Northern.
- Buffett urged investors to ignore the large investment gain as it was primarily driven by the completion of the Duracell acquisition. Berkshire exchanged it's $4.7 billion of Procter & Gamble (P&G) (NYSE:PG) stock for Duracell. Berkshire's Procter & Gamble shares were attained when P&G acquired Gillette in 2005 where Berkshire was a long time investor. Buffett stated the total cost of Berkshire's P&G investment was only $336 million.
European Re-Investment Divestment
One of the first questions asked to Buffett and Munger regarded Berkshire's divestment from Munich Re and Swiss Re; two large European re-insurance firms. Berkshire acquired its stake in Munich Re in 2010 and began divesting in September 2015. Berkshire reduced its Swiss Re position in September as well after holding that stock for nearly 7 years. What caused Berkshire to exit two large re-insurance operators?
Buffett stated the re-insurance business was less attractive in a world with zero or negative interest rates. Investments returns on the float will be more restricted due to lower capital cushions caused by lower rates. Buffett's second reason for exiting the business was due to increased capacity in the re-insurance market. Many investment managers have established offshore re-insurance operations to avoid taxes. Buffett noted that a re-insurance is easy to create and only requires a handful of employees to manage. Supply in re-insurance has gone but demand has not. This competitive environment is great for customers but not great for business owners.
Buffett and Munger on Valeant
One of the liveliest exchanges of the meeting occurred when Buffett was asked if he stood by his repeated endorsements of the Sequoia Fund even after the fund had taken an outsize position in Valeant Pharmaceuticals (NYSE:VRX). Buffett's partner, Charlie Munger, has repeatedly stated that Valeant is deeply immoral. To understand the importance of this question, it's useful to know the history Buffett has with Sequoia.
Prior to acquiring and running Berkshire Hathaway, Warren Buffett was a hedge fund manager in Omaha, Nebraska. On May 29, 1969, Buffett decided to liquidate the partnership and advised many of clients to invest their money with Bill Ruane; a fellow Ben Graham disciple who had launched his own fund, the Sequoia Fund, in 1970. Ruane operated the Sequoia Fund continuously until shortly prior to his death in 2005. Buffett noted that during Ruane's nearly 35 years at the helm, Sequoia easily outperformed the S&P 500.
Two years ago, over the objection of numerous board members, a manager at Sequoia purchased a large stake in Valeant and continued to increase it even after problems began to manifest. Buffett noted that the fund manager is no longer at Sequoia and more sensible analysts have taken control of the fund. Buffett believes Sequoia's new management is way better than the average firm. Buffett and Munger both recommend Sequoia to friends and family.
What did Buffett and Munger have to say about Valeant?
Here Buffett simply stated that Valeant's business model was deeply flawed and stated that Berkshire passed on investing in the company on numerous occasions. Buffett further elaborated that all the years of experience he and Munger have, enable them to recognize patterns in business. Buffett and Munger noticed that Valeant fit the patterns where a business seemed great in the short run but would eventually turn bad. Munger followed by stating Valeant is a sewer. Buffett and Munger stand by their praise of Sequoia and their disdain for Valeant.
Warren Buffett in undoubtedly the best investor to have ever lived. Similar to how investors dissect his annual letters for insights, investors should also pay attention to this annual meeting. Since 2016 was the first meeting that was web cast, investors can watch a replay here.