Crucial Takeaways From Berkshire Hathaway’s Second Quarter 2022 Earnings

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Berkshire Hathawa

y’s (BRK/A, BRK/B) slipped to a loss of over $43.7 billion in the second quarter versus a profit of over $28 billion in the same quarter of 2021. Thanks to sharp declines in the stock market, that result is dominated by losses from the investment portfolio since unrealized gains from their portfolio are included in earnings. Operating earnings, which remove the distortion from market changes and better reflect the firm’s earnings power, for the quarter rose sharply by 39% versus 2021. Year-to-date operating earnings rose by 19% over the same period in 2021. Providing an illustration of the value from share repurchases, per-share operating income for the second quarter increased by 43% versus 2021.

Because the Covid-19 pandemic negatively impacted most businesses, including Berkshire, in early 2020, comparing current results to pre-pandemic 2019 results is helpful. Operating earnings for the second quarter of 2022 are 51% above 2019. And thanks to share repurchases, operating earnings per share are a whopping 68% above 2019.

A further look into the different operating segments in 2022 shows strong earnings growth across most segments versus 2021. Notably, the operating income for all segments is significantly above the pre-pandemic levels of 2019.

Insurance: Second quarter investment income was 56% higher than 2021 and 27% better than 2019, primarily due to higher interest income from short-term investments. Investment income was depressed by ultra-low interest rates implemented in response to Covid, but the Federal Reserve has raised rates aggressively in the second quarter to fight inflation. Investment income should continue to see improvement as the Federal Reserve is likely to be in hiking mode for the remainder of the year. While underwriting results were positive overall, Geico had an underwriting loss. Geico continues to suffer from more frequent auto claims and rising claims severity due to the higher valuation of used vehicles. Geico has posted an underwriting loss year-to-date, which drove the 53% decline in Berkshire’s year-to-date underwriting profit relative to 2021. During the annual meeting earlier in the year, there was a question about the strength of Berkshire’s Geico car insurance business relative to Progressive
(PGR). Progressive has done better than Geico recently based on their earlier adoption of telematics. Geico recently moved in that direction, and it will be instructive to see if Geico can close the gap in the coming years.

The two most essential concepts in insurance investing are “float” and underwriting profit, In simple terms, float is created for insurance companies because insurance premiums are paid before any claims are made by the insured. Insurance companies can invest the float, sometimes for years, before insurance losses are reimbursed. Berkshire has a history, unlike many insurance companies, of earning an underwriting profit, meaning that their float costs them nothing and makes them money in addition to allowing them to earn a profit off of investing the float. An underwriting profit means the insurance premium exceeds all insurance claims and expenses. Berkshire had an underwriting profit for the second quarter of 2022, year-to-date 2022, and calendar years 2021, 2020, and 2019. Berkshire’s float was flat at approximately $147 billion versus the level on December 31, 2021, and above the $138 billion on December 31, 2020. Though float is not as valuable in a low interest rate environment, its value increases as yields rise. Float per share has increased to $99,961 from $98,960, aided by share repurchases.

Railroad: Berkshire owns the Burlington Northern Santa Fe (BNSF) railroad operating in the US and Canada. Net operating earnings rose 10% over the same quarter in 2021 and 24% over pre-covid 2019. Revenue was higher due to higher pricing and a fuel surcharge driven by higher fuel prices, while volume was slightly lower.

Utilities and Energy: This business generally provides steady and growing earnings, which one would expect from what primarily consists of regulated utilities and pipeline companies. In June 2022, Berkshire bought the Berkshire Hathaway Energy Company (BHE) common stock owned by Greg Abel, Berkshire’s Vice Chairman – non-insurance operations, for $870 million, and Berkshire now owns 92% of BHE. A question about a possible conflict of interest stemming from Abel’s partial direct ownership of a Berkshire subsidiary was asked at the annual meeting, so this transaction ends any concern in that area. Interestingly, this group also operates Berkshire Hathaway HomeServices (BHHS), the largest residential real estate brokerage firm in the country. The slowdown in housing activity is evident in the results. The 2022 earnings suffered from lower mortgage and refinance activity thanks to higher interest rates and a decline in closed brokerage transactions.

Manufacturing, Service and Retailing: This segment consists of many diverse businesses, so this analysis will focus on a few significant themes when looking at this segment. Berkshire’s aerospace exposure remains substantial despite selling its publicly traded airline holdings earlier in 2020. Berkshire previously took a $10 billion impairment charge on the Precision Castparts (PCC) business due to its exposure to the COVID-disrupted aerospace industry. PCC’s pre-tax earnings rose in the second quarter relative to 2021, primarily due to higher demand for aerospace products. Berkshire sounded more optimistic about the outlook of PCC with a rebound in domestic flight and the need for narrow-body aircraft. Management suggested that future growth is predicated on the ability to increase production since the company has suffered from worker shortages and a restart in Boeing 787 production. Berkshire’s FlightSafety and NetJets continued to see a sharp rebound, with training hours up 29% and customer flight hours rising 25% year-to-date versus 2021. Unfortunately, the earnings of aviation services were dented by increased costs, including those for subcontracted aircraft , due to the sharp jump in customer flight hours.

Housing-related businesses like Clayton Homes, Shaw, Johns Manville, Acme Building Products, Benjamin Moore, and MiTek posted sharply higher earnings relative to 2021. Berkshire continues to note that prices were increased to offset cost pressures, and supply chain disruptions remain an issue . Perhaps the early signs of a slowing housing market are showing up in the group, with higher selling prices due to higher costs being the primary driver of revenue growth rather than unit volume and product mix. The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had lower quarterly revenues despite a higher average unit sale price. Unit sales were lower, reflecting significant new vehicle supply shortages attributable to the global computer chip shortages and other supply chain disruptions. Berkshire noted that second-quarter apparel and footwear revenues plunged relative to 2021. In addition, earnings were lower for their furniture retailers, including Nebraska Furniture Mart, with prices higher due to increased costs but lower transaction volumes. This weakness in some of the retailing exposed businesses is not a surprise, given similar statements from others in the industry. Berkshire’s McLane unit had lower profits in 2022 versus 2021. McLane is a wholesale distributor to retailers and restaurants. The decline in earnings was primarily due to supply chain constraints, labor shortages, truck driver shortages, and higher inventory costs. Berkshire continues to expect the challenging environment for McClane to continue through 2022.

Other: The segment has a significant profit for the second quarter and year-to-date 2022 primarily due to foreign currency gains and an increase in equity method earnings at Kraft Heinz (KHC) and Pilot. The foreign currency exchange rate gains were generated from bonds issued by Berkshire Hathaway and denominated in British Pounds, euros, and Japanese Yen. Investment losses from non-US dollar investments generally offset these gains. These foreign currency liabilities are not a concern as Berkshire has significant assets and earnings denominated in these foreign currencies. This segment includes companies’ profits that must be accounted for under the equity method due to the size of ownership and influence on management. The after-tax equity method earnings have Berkshire’s proportionate share of profits attributable to its investments in Kraft Heinz (KHC), Pilot, Berkadia, Electric Transmission of Texas, and Iroquois Gas Transmission Systems.

Berkshire bought back $1 billion of its stock in the second quarter. Until an announcement in mid-2018, Berkshire had only made repurchases when the stock was trading at less than 1.2 times the price to book (P/B) ratio. While that constraint is now relaxed, it is still a good indicator of the general range when aggressive repurchases will likely be seen. Berkshire’s P/B ratio was between 1.2 times to above 1.5…


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