Stock Covered: Berkshire Hathaway Inc. (BRK-A & BRK-B)
Current Stock Price: BRK-A: $121,500, BRK-B: $81.00
Target Stock Price: BRK-A: $134,131, BRK-B: $88.00
Date of Coverage Update: 05/09/2011
Berkshire Hathaway announced Q1 2011 earning on 5/6/2010 (Friday). Revenue came in at $33.72 billion, 5.25% YOY increase from Q1 2010. Net Income came in at $1.51 billion, 58.4% decrease from Q1 2010.
One flow to Berkshire's bottom line last quarter was $1.7 billion in insurance losses related to the March 11 earthquake and tsunami in
Japan, the Feb. 22 New Zealand earthquake, cyclones and floods in , and other disasters. The magnitude and number of the disasters in one quarter was probably the highest in the past several decades. Thus, the loss was dimed abnormal to BRK’s business and beyond most people’s estimate (including mine). Per Buffet, "We had probably the second-worst quarter for the insurance industry in terms of disasters around the globe". Australia
Unfortunately for BRK, negative impacts from these abnormal insurance losses will probably keep on pounding the bottom line of its insurance segment for the rest of this year. The $1.7 billion in losses is an estimate of
Berkshire's insurance and reinsurance claims that will be settled and paid over time, though that figure could change, the company said. Basing on what I see in other similar disaster-driven loss-write-off events such as Katrina, BP oil spills, and more recently Japan auto makers’ estimates of production and asset losses, initial estimate almost always is too optimistic. Knowing that Buffet and his team are top of the industry financial gurus who should do better than average in forecasting financials, I would take only additional $400 billion (about ¼ of $1.7 billion that is already booked) off my estimated bottom line for 2011 to account for extra insurance losses from disasters.
A good news for its finance and financial products segment is that BRK has just reached a settlement with Goldman Sachs to redeem a $5 billion investment on bad credit securities (http://www.bloomberg.com/news/2011-05-09/berkshire-will-record-1-25-billion-gain-on-goldman-redemption.html?cmpid=yhoo). This will give BRK a one-time $1.25 billion gain on investment, which is expected to be recorded in the 2nd quarter. Beyond that, if BRK reinvest this capital into fixed income instruments, the return on financial investments it gets will be lower because of current low short and long term interest rates. For this particular reason, I believe that BRK will keep on utilizing its cash in acquiring operating assets, especially ones in emerging markets such as
China or Brazil, going forward because the relative returns it can get from these assets are much higher than that from financial assets in the U.S.
On an annual basis, due to significant loss from insurance business, which will be partially but not totally offset by $1.25 billion gain from settlement with Goldman Sachs, I adjusted my estimate of net income from its existing portfolio downward from $13.615 billion to $12.75 billion.
Also, it appears that recent incident of David Sokol has caused temporary turmoil in the top decision making group and drag on the execution of new acquisitions. Therefore, I believe that the probability weighted amount of acquisition on big caps in developed market has dropped from $25 billion to $20 billion, and the probability weighted amount of acquisition on small to mid caps in emerging markets has dropped from $5 billion to $3 billion. Naturally, the net profits contributed from these acquisitions have decreased.
As the updated table of pro-forma financials below shows, updated estimated 2011 net earning is now $15.03 billion and EPS of $8,942.
New Developed Market Value Acquisitions / Arbitrations
New Emerging Market Value Acquisitions / Arbitrations
Total Net Earning
The P/E ratios of the comparables used in my coverage initiation almost have not moved since my coverage initiation. Please see below table for updated ratios. Even after the incident of Sokol, investors still have high faith in the management team and the company and have no intention to lower the valuation level of the stock. I expect that the stock will stay above the valuation level of 15 times earning for the foreseeable future and thus decide to keep this ratio when composing fair value and target price of the stock. Applying 15 to the EPS of $8,942 will arrive a target price of $134,131 for BRK-A. I expect BRK-A to enjoy slight valuation premium over BRK-B and thus have assigned a target price of $88.00 for BRK-B.
Because the updated fair value is less than 15% higher than current stock price, it no longer satisfy my criterion for a buy rating. Thus, I accordingly changed my rating from buy to hold for both BRK-A and BRK-B even though it is still more likely than not for the two stocks to be higher than their current levels one year from now.
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