OXY - Berkshire Hathaway Q3 2023 Earnings And Book Value Estimates - Are We Approaching Fair Value?

2023-10-02 11:38:58 ET

Summary

• Berkshire Hathaway has pulled ahead of the S&P 500 for the year.
• Price/Book value at the end of Q3 is ~1.45x, at the high end of recent history.
• Q3 operating earnings could exceed $11 billion, another record operating profit.
• Berkshire only repurchased a token amount of shares in Q2, providing a clue to how they feel about the attractiveness of cash in this environment.
• Intrinsic value via the "two column method" shows a small undervaluation in the shares.

In Q3, Berkshire Hathaway ( BRK.A ) ( BRK.B ) ended its YTD underperformance relative to the S&P 500, outperforming the index by 6.8% in the quarter.

This was a bit surprising as Berkshire's largest holding, Apple ( AAPL ) fell nearly 12%, and the rest of Berkshire's holdings in aggregate had a poor quarter. Investors seem to be more focused on the performance of the wholly owned operating companies and the tailwind provided by higher short term interest rates on Berkshire's $150 billion in cash equivalents.

Q3 Holdings Update

The value of Berkshire's investments in equity securities excluding Chevron ( CVX ) and Occidental ( OXY ) fell $28.7 billion, or 8.1% to $323.6 billion.

From the $28.7 billion loss, after decreasing the liability for future income taxes on the balance sheet as "income taxes, principally deferred" by 21%, we see a net book value loss of $22.7 billion for Q3.

As it currently stands, I don't have a positive view of Berkshire's portfolio. I think Apple is an amazing company, but it's overvalued.

Coca-Cola ( KO ) I do not like at 20x earnings and I still believe there is little reason to own it . Despite the negative commentary I got when I wrote that article, KO has underperformed the S&P 500 by 10%. KO is a great example of a firm that made sense as a conservative holding during 0% interest rates, but makes much less sense with short term rates above 5%. I think fair value for Coke is around $40.

I don't like banks here, especially Bank of America ( BAC ) and while I like the energy exposure, it's not enough to move the needle.

Q3 Operating Earnings

Insurance underwriting could show ~$1.3 billion underwriting profit . The recovery at GEICO should continue driven by industry wide price hikes. In Q2, GEICO swung from a $487 million loss last year to a $514 million underwriting gain. I expect this to continue, along with strength in Berkshire Primary and Reinsurance due to a low level of catastrophe events. Allstate ( ALL ) reported July and August combined events lower than June (mostly Maui fires.)

Insurance investment income should come in around $ 2.5 billion , driven by higher short term interest rates and increased dividends.

BNSF earnings should come in around $1.3 billion , a drop-off from the $1.44 billion in earnings from last year. Intermodal transport is still down significantly year to date, but improved somewhat in Q3. Higher diesel prices and a small rebound in volume are making intermodal transport more appealing.

BHE should come in around $1.4 billion, slightly lower than last year. Berkshire Hathaway HomeServices being a $50+ million drag. This is the strongest seasonal period for this business.

Other Controlled Businesses containing dozens of companies like Precision Castparts, Lubrizol, Marmon, and other industrial businesses, now including Pilot , should be up year over year. Note this is not apples-to-apples and Pilot should add $350-$400 million of this increase this quarter, one of the strongest seasonal periods.

I'll estimate $ 3.6 billion in earnings from this group.

Non Controlled Businesses, defined as business where Berkshire has between a 20% and 50% ownership interest, which represents the interests in Occidental, Kraft-Heinz, and Berkadia. I'll estimate $700 million in earnings again here , with the sequential jump coming from OXY (both high ownership stake and higher earnings.)

Other should show a $400 million gain due to the resurgent strength of the US Dollar.

In total, I expect Q2 operating earnings around $ 11.2 billion , up 44% from last years $7.8 billion, and setting another record for Berkshire.

Current Book Value

As reported in Berkshire's 2023 Q2 10-Q book value as of June 30, 2023 was $539.9 billion.

Subtracting the loss of $22.7 billion from the equity investments and adding $11.2 billion in operating earnings, I project Q3-23 book value at $528.4 billion.

Berkshire's market cap as of September 30 was $764 billion. Dividing this by $528.4 billion yields a Price/Book Value of 1.45x for Q2.

Intrinsic Value via the 2-column method

The "2 Column Method" is another way to look at Berkshire's Intrinsic value, which was popularized by Whitney Tilson and others. In this method, we add Berkshire's total cash and investments together with pre-tax EPS excluding the income from Investments.

I'm going to modify Tilson's approach and use after tax numbers. This is primarily because of Berkshire Hathaway Energy. BHE has a deeply negative tax rate because Berkshire has taken advantage of tax credits, especially with wind energy. Berkshire certainly takes taxes into account when making investments, so we should measure the results on that basis. (If it were not for BHE and its negative tax rate, I'd be OK with using pretax numbers.)

Over the last four quarters (last three actuals plus my estimates for Q3) Berkshire had $27.2 in Operating Earnings after excluding all investment income.

Using my estimates for this quarter, Berkshire has $501 billion in cash and investments excluding equity method investments (as those get counted in earnings.)

If we use a 13x after tax multiple, this implies an Intrinsic Value of $855 billion, not too far above Berkshire's current market capitalization of $764 billion.

Note that what multiple is appropriate is a matter of opinion. In the current environment, I think that's about right for Berkshire's mix of businesses.

2023 Outlook and Recommendations - Are we approaching fair value?

Looking at Berkshire via a variety of valuation methods makes me believe we are near, or at, a fair value for the shares. 1.45x Book Value is near the highs of recent historical ranges, and the two column method suggests we are perhaps 11-12% undervalued.

From there, each investor should make their own judgments on how they believe Berkshire's businesses will perform (both wholly owned, and partially owned via equities.) My view is that the valuations for these businesses, in aggregate, are probably in the 70-75% percentiles - not insanely expensive, but far from cheap.

Apple, which Berkshire owns $156.7 billion of, is a great example. It trades at 28x this years estimates (an earnings yield of 3.5%) and 26x 2024 estimates (an earnings yield of 3.8%) compared to the 10-year treasury at 4.57%. If I was handicapping which would do better over the next 10 years, I'd say it was 50/50 either way. In any case, it's hard to argue Apple is undervalued presently.

Berkshire's repurchase activity is another clue we may be approaching fair value, or at least that Berkshire believes earning 5.3% in short term treasuries and keeping the optionality of cash is an attractive alternative to repurchasing Berkshire's shares. In Q2, Berkshire only repurchased $1.4 billion in shares, a significant decrease from the $4.4 billion in Q1. Since then, Berkshire has only gotten more expensive. I believe Q3 share repurchases will be at a token level, similar to Q2.

I remain long, with a January 2024 $380 call still sold against my shares.

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