INITIATING COVERAGE ON BERKSHIRE HATHAWAY WITH A 2-EW RATING
We are initiating coverage on Berkshire Hathaway with a 2-Equal Weight rating and $88 price target ($132,000 per Class Ashare) based on 1.30x YE11 estimated book value per Class B share of approximately $68 ($101,500 per Class A share).Berkshire Hathaway, led by Warren Buffett, is a holding company with significant operations in investments, insurance,railroads, utilities, manufacturing, services, retail, and homebuilding. We estimate the company’s annual earning power to be$8-$9 billion including the recently completed Burlington Northern Santa Fe (BNSF) railroad acquisition, and investmentresults recovered in 2009 after a disappointing outcome in 2008.Warren Buffett anticipates that business conditions will improve at a slow place and currently are nowhere near 2007 levels.Based on our projections, Berkshire’s operating EPS growth will likely be constrained through 2011, reflecting decliningearnings in Insurance, a strong contribution from BNSF, and a slow recovery in the other major units including MidAmerican(utilities and energy), Manufacturing, Service, and Retail, and Finance and Financial Products (Clayton Homes).
We Recommend Waiting For A More Attractive Entry Point Before Adding To Positions
Berkshire Hathaway shares rose 21% (versus a 6% increase in the S&P 500) year-to-date 2010 in part, we believe, becauseof increased demand and liquidity in BRK shares resulting from being added to the S&P 500 Index and the Class B sharesplit, as well as anticipated benefits from an economic recovery. The stock’s current valuation of 1.41x book value per shareprobably already reflects anticipated benefits of an economic recovery. Plus, our 2010 and 2011 operating EPS estimates are8%-10% below consensus expectations, reflecting our outlook for a modest earnings recovery including contributions from theBNSF acquisition. As a result, we recommend investors wait for a more attractive entry point before adding to positions.
Berkshire Hathaway’s Operating Business Is Diversified
The largest contributors to Berkshire’s operating earnings are the Insurance, BNSF, and the Manufacturing, Service, andRetail segments. We expect BNSF (railway operator) to generate the strongest earnings growth among the operatingsegments. Meanwhile, we anticipate earnings could decline in Insurance (accounts for one-half of Berkshire’s operatingearnings), and recover slowly in MidAmerican (utilities and energy), as well as in the economically sensitive Manufacturing,Service, and Retail, and Finance and Financial Services units.
Figure 1. Berkshire Hathaway’s Business Mix - 2009
Total 2009 Revenues Proforma for BNSF Acquisition: $124.8 billion
Manufacturing,Service, and Retail49%BNSF11%Finance andFinancial Products4%MidAmerican9%Insurance27%
RevenuesTotal 2009 Pre-tax Earnings Proforma for BNSF Acquisition: $13.7 billion
Insurance49%MidAmerican11%Finance andFinancial Products6%BNSF19%Manufacturing,Service, and Retail15%
Note: Revenues and pre-tax earnings are pro forma for BNSF acquisition.Source: Barclays Capital research.
Book Value per Share Growth Has Resumed
Berkshire Hathaway has a successful long-term track record of increasing book value per share (a key valuation metric).Berkshire’s book value per share increased 20% to an all-time high of $56 per Class B share ($84,487 per Class A share) in2009 helped by a recovery in investment and derivative valuations after declining 10% to $47 per Class B share ($70,530 per Class A share) in 2008 due to the financial crisis. By year-end 2011, we anticipate Berkshire’s book value per Class B sharecould increase to roughly $68 ($101,500 per Class A share) driven in part by estimated operating EPS of $3.34 per B Classshare ($5,015 per Class A share) in 2010 and $3.47 per Class B share ($5,200 per Class A share) in 2011 and assumingongoing 8% annualized equity investment returns. Despite losing its AAA ratings from the rating agencies, the company’sbalance sheet and liquidity position remain strong, in our view. As a point of reference, Class B shares are valued at 1/1,500
of Class A shares.