- Berkshire Hathaway’s results were largely mixed.
- The company’s railroad business continues to struggle, but the insurance business came back strongly.
- There was a key lesson for investors in the latest quarterly results.
Previously, I wrote that the Omaha, Nebraska – based company will likely report an increase in earnings and revenues, but the results could be mixed as the growth will be driven partly by acquisitions while its insurance and railroad businesses will continue to struggle.
As per consensus data from Thomson Reuters, analysts were looking for operating earnings of $2,910.8 per share from revenues of $56.47 billion. However, Berkshire Hathaway failed to meet these estimates. In the second quarter, the company’s revenues climbed 6% to $54.46 billion while operating income, which excludes the impact of derivatives and some investments, increased 18% to $4.61 billion, or $2,803 per Class A share.
The growth in revenues, as expected, was driven by recent acquisitions, particularly the $32.1 billion purchase of aircraft parts maker Precision Castparts. The April to June period was the first full quarter in which Precision operated under Berkshire Hathaway. The acquisitions also lifted pretax profits at the conglomerate’s industrial products segment (which is a part of the larger manufacturing business) by 33.6% to $1.13 billion. In fact, if it weren’t for the takeovers of Precision and battery maker Duracell, profits in the industrial products segment would have declined.
Railroad Struggles While Insurance Business Surprised
Meanwhile, Berkshire Hathaway’s railroad business continues to struggle, partly due to persistent weakness in commodities space, such as coal and oil. The unit, which has operations in 28 states of the US and three provinces in Canada, reported 19.4% decrease in pre-tax profit to $1.24 billion, thanks to weak freight volumes.
However, the insurance business, which brings in tens of billions of dollars of “float” that acts as Berkshire Hathaway’s life blood and allows it to invest in other companies, turned out to be a bright spot. That’s particularly impressive considering that the second quarter was a challenging one for property and casualty insurers in North America, thanks to the natural disasters, such as the massive Canadian wildfires that knocked off more than million barrels a day of oil supply, and an uptake in auto policy claim costs which was evident in Hartford Financial's (NYSE:HIG)’s latest quarterly results. .
In the first quarter, Berkshire Hathaway’s earnings from insurance dipped 16.5% due to weakness in property/casualty reinsurance. But in the second quarter, the unit turned around, posting a 40% increase in earnings, including investments, from a year earlier to $1.32 billion, thanks to a rebound in underwriting earnings which swung to a profit of $337 million from a loss of $38 million last year. In underwriting, Berkshire Hathaway Reinsurance business swung to a profit of $184 million from a loss of $411 million a year earlier, but this was driven largely by currency fluctuations. What’s really impressive is that Geico, Berkshire Hathaway’s auto insurance division, saw its underwriting earnings, before income taxes, climb almost three times to $150 million.
Meanwhile, Berkshire Hathaway also generated $394 million profit from investments and derivatives, up from $123 million a year earlier. The company ended the quarter with cash reserves of $72.68 billion, up from prior periods. The increase can be partly attributed to Kraft Heinz's (NASDAQ:KHC) $8.3 billion redemption of preferred stock. Buffett owns 26.8% of the Ketchup maker. Note that Berkshire Hathaway has $6 billion more cash now than it did a year ago, at the end of the second quarter of 2015, before it bought Precision.
A Lesson For Investors
There’s a crucial lesson for investors here. The results show that Berkshire Hathaway’s biggest strength is that it is a conglomerate with around 90 different operating businesses. When it comes to revenues and earnings, Berkshire Hathaway has no meaningful exposure to any single business. Thanks to an extremely diversified base, Berkshire Hathaway continues to grow its revenues and earnings, even though some of its major operating businesses, such as railroads and energy-related units, are struggling.
In the second quarter of this year, we saw that the insurance and manufacturing businesses were able to completely offset the weakness in railroad operations. That’s the real beauty of this company. Whenever one of its units struggles, another one picks up the slack. As a result, the conglomerate continues to grow, despite setbacks. Then there is its massive stock portfolio of $133 billion, representing 45 different companies, including Kraft Heinz, Wells Fargo (NYSE:WFC), Coca-Cola (NYSE:KO) and IBM (NYSE:IBM). These holdings also support Berkshire Hathaway’s net income and cash flows.
Moreover, it’s also impressive to see how quickly Berkshire Hathaway has grown its cash pile after buying Precision, which was its largest takeover ever. The conglomerate announced the deal last summer and completed it earlier this year. This was followed by more than a 12% decline in Berkshire Hathaway’s cash reserves between 2Q-2015 and 1Q-2016. But in the second quarter, the company managed to post a 24.6% increase in cash reserves from the first quarter. Berkshire Hathaway is now in a great position to make another major acquisition.
Berkshire Hathaway’s quarterly results were mixed. It missed analysts’ estimates while its railroad operations continued to struggle. But the company’s insurance business came back strongly. This, along with acquisitions, allowed Berkshire Hathaway to grow revenues and income. The results highlight the biggest strength of the empire which Warren Buffett has built – a diverse revenue and earnings base which enables the company to continue growing, even if one of its major businesses struggle.
For investors, this means that although the railroad business might continue to struggle, that’s not going to stop Berkshire Hathaway’s growth. In fact, the company has rebuilt its cash reserves after completing the major acquisition of Precision Castparts and looks set to make another big purchase in the near future. That’s also going to fuel Berkshire Hathaway’s growth. For these reasons, investors should continue to hold Berkshire Hathaway stock.