Warren Buffett’s Berkshire Hathaway Is Down, But Not Out

  • Warren Buffett’s Berkshire Hathaway has been under pressure.
  • Berkshire Hathaway Stock is trading slightly higher than the implied floor of 1.2x book value.
  • But the company’s future, driven in part by investments in IBM, Wells Fargo, Coca-Cola and Kraft-Heinz, is still looking bright.

Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) has been under pressure. Last year, the conglomerate reported its worst run since 2008, with shares dropping by nearly 13%. Since then, shares haven’t recovered. The S&P 500 (INDEX:SPAL) has fared much better with a decline of 7.9% since the beginning of last year.

SPAL stock chart

Source: Berkshire Hathaway stock price chart by amigobulls.com

The weakness is due, in large part, to the soft commodity price environment. Berkshire does not have direct exposure to commodities since it does not own resource producers, but its subsidiaries, such as the railroad and manufacturing businesses, rely on the commodities sector for revenues. Furthermore, the cheap fuel prices at gas stations have already led to an increase in driving activity which could lift the number of road accidents, dimming the prospects of Berkshire’s insurance business.  On top of this, the poor performances of IBM (NYSE:IBM) and Wells Fargo (NYSE:WFC), two of Berkshire’s biggest investments, have also dragged Berkshire stock.

Following the drop, Berkshire stock is now trading at just 1.3 times book value.  That’s slightly higher than the implied floor of 1.2 – a level where Buffett has said that he would be willing to buy back stock.  I believe that in the short term, Berkshire stock may continue to remain under pressure due to fears about the US economy and persistent weakness in commodity prices. But Berkshire investors shouldn’t panic since the company’s long-term future, driven in large part by some of its biggest investments that make up more than 50% of its US long portfolio – IBM, Wells Fargo, Coca Cola (NYSE:KO) and Kraft Heinz (NASDAQ:KHC) – is still looking bright.

IBM and Wells Fargo have been notable underperformers.  The technology giant’s shares have declined 18% since the start of 2015 while the big bank stock has fallen 13% in the same period. IBM has taken a beating due to its anemic growth. The big blue’s sales have been shrinking for the last four years. But it is still a cash flow machine that loves to reward shareholders through dividends and buybacks.

Over the last six years, the company generated $89 billion in net income and returned nearly all of it to shareholders through dividends and buybacks. If it continues to go this way, IBM’s per-share earnings and dividends will keep moving higher, even with zero bottom-line growth. This should take the stock higher. That’s perhaps one of the reasons why Berkshire remains a buyer of IBM stock, despite losing nearly $2 billion on the original investment.

Wells Fargo, on the other hand, has struggled along with other players in the banking space due to the slump in oil prices. The energy sector weighed heavily on the bank’s fourth-quarter results released last month in which it failed to meet consensus estimates. Loans made to the energy sector represent a little less than 2% of Wells Fargo’s loan portfolio, one of the highest in its peer group. The persistent weakness in energy prices may continue to weigh on Wells Fargo stock.

However, it is still one of the best bank stocks to hold in this volatile market due to a great management team who are well known for their excessive focus on risk management and ability to wrench more profits from their resources as compared to any other major US bank. No wonder Wells Fargo has consistently reported best-in-class returns on asset and equity over the last four years. Wells Fargo also enjoys one of the best credit ratings in the industry credit ratings in the industry, which is a testament to its solid financial health.

Despite its woes, Wells Fargo is positioned to benefit from improvement in interest rates which should lift its net interest margin.  The bank is also going to be one of the biggest beneficiaries of the recovery in US housing sector following several years of stifled demand and improvements in the labor market.

Meanwhile, Coca-Cola, much like IBM, gets little love from Wall Street. The beverage maker has been battling against the rise of health-conscious consumers and increasing pressure from regulators. The strength of the US dollar and re-franchising efforts have further dragged Coca-Cola’s profits. Despite these headwinds, Coca-Cola remains a dividend aristocrat. The company’s board recently approved an approximately 6% increase in annual dividend for an astounding 54th year in a row. This envious track record has come on the back of Coca-Cola’s ability to generate predictable earnings, despite the tough environment.  The company is targeting 4% to 6% EPS growth this year, on a constant currency basis. The profits will be bolstered by better pricing and decline in commodity costs. The improvement in earnings should continue to support future dividend increases.

Kraft-Heinz, on the other hand, is fairly new to Wall Street. North America’s third-biggest food and beverage company debuted at the stock markets in mid-2015 following the merger between the ketchup maker H.J. Heinz and Jell-O maker Kraft Foods. The deal, which was engineered by Buffett and Brazilian private-equity firm 3G Capital, gave a $4.4 billion boost to Berkshire’s earnings in the third quarter, pushing the conglomerate’s net income to a record $9.43 billion. Moreover, Kraft-Heinz aims to become a leaner organization with a solid balance sheet by achieving $1.5 billion in annual cost synergies and reducing the debt, which should have a positive impact on its stock in the near term.

Conclusion

Berkshire Hathaway may remain under pressure until investors regain confidence in US economy and commodities begin to rebound. But its biggest bets are on companies – IBM, Coca-Cola, Wells Fargo and Kraft-Heinz -- that are not only some of the most well-established players in their respective industries, but also positioned to withstand the tough environment and continue growing in the long term. IBM and Coca-Cola get little love from Wall Street, but they generate predictable earnings and have a rich history of rewarding shareholders through dividends and buybacks. Wells Fargo comes with a solid track record of generating above average returns and will likely benefit from higher interest rates and improvement in housing sector. Kraft-Heinz is a behemoth in the food and beverage space, a great self-help story whose stock could rise as it delivers on synergy-related promises and strengthens its balance sheet.

Hence, while Berkshire stock may continue to remain under pressure in the short-term, the stock continues to remain an attractive long-term investment option.

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