Chapter 9 Part 1: Berkshire 2015-2016

The Complete Financial History of Berkshire Hathaway | Adam J. Mead | ISBN: 978-0-85719-912-6

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Chapter 9 opens Berkshire’s sixth decade. Mead’s framing is blunt: a conglomerate this size had never existed before. Cash was piling up faster than Buffett could deploy it. The playbook had to evolve, but the first five years (2015-2019) still looked a lot like the prior decade.

2015: Good operations, bad stock price

Net worth rose 6.4%, beating the S&P’s 1.4%. But Berkshire’s preferred yardstick, change in market value per share, fell 12.5%. Buffett told shareholders to ignore one year and watch normalized operating earnings instead. On that measure, 2015 was solid.

The Powerhouse Five (BHE, BNSF, Iscar, Lubrizol, Marmon) hit record earnings. BNSF bounced back from its 2014 service problems. Insurance delivered year thirteen of underwriting profits and grew float to $87.7 billion.

Buffett also changed how he reported intrinsic value inputs. For the first time he included underwriting profit in per-share operating earnings, arguing insurance earnings were more stable than they used to be.

Kraft Heinz round two with 3G

The big deal was merging Heinz with Kraft. Iconic brands, high returns on tangible capital (55% pre-tax for Kraft), and another 3G cost-cutting playbook.

Berkshire and 3G ended up with 51% of Kraft Heinz. Kraft shareholders got 49% plus a $10 billion special dividend funded by new equity from Berkshire and 3G. Berkshire’s Heinz stake became a 26.8% Kraft Heinz position. Accounting forced a $6.8 billion non-cash gain even though no cash changed hands.

Mead’s going-in return math for Berkshire on Kraft: about 5.1% pre-tax. Not cheap. But the brand portfolio and operating partner mattered.

Van Tuyl and the auto empire

Berkshire bought Van Tuyl Group for $4.1 billion ($9 billion in annual sales). It became Berkshire Hathaway Automotive, the fifth-largest U.S. dealer group. The model: extreme decentralization, local managers who feel like owners. Sound familiar?

Ted Weschler also led the acquisition of Detlev Louis Motorrad, a German motorcycle gear retailer.

Portfolio cleanup

Berkshire sold stakes in Swiss Re and Munich Re. Buffett explained at the 2016 meeting: too much capital flooding reinsurance, and European insurers were hurt more by near-zero rates because they had fewer options than Berkshire.

He added to Wells Fargo and IBM. The Big Four still dominated.

Buffett on productivity

The 2015 letter spent real space on productivity. Farming went from 40% of workers in 1900 to 2% in 2015. Railroads moved far more freight with far fewer people. Utilities generated more power with fewer employees.

Productivity raises living standards, but it hurts displaced workers. Buffett argued for safety nets, not blocking efficiency. The Kraft Heinz context made that political. 3G was famous for cutting heads. Buffett and Munger were on the side of running tight operations.

2016: Precision Castparts and the elephant returns

Market value rose 23.4% versus 12% for the S&P. Net worth up 10.7%. And Berkshire finally spent real money on a mega-deal.

Precision Castparts ($32.6 billion)

Todd Combs brought PCC to Buffett’s attention years earlier. PCC made critical metal parts for jet engines and turbines. Aerospace was 70% of revenue. Returns on tangible capital ran in the mid-40% range. CEO Mark Donegan got comparisons to Iscar’s Jacob Harpaz.

Berkshire paid 6.7x tangible capital for a sub-7% going-in pre-tax return. Buffett admitted low rates pushed the price up. PCC added about $1.5 billion to normalized earning power and disappeared into the manufacturing segment. Another Fortune 500 company swallowed by the conglomerate.

At the annual meeting, Andrew Ross Sorkin asked whether Berkshire’s lean diligence process was reckless. Buffett’s answer is worth remembering: checklists catch leases and labor contracts. They do not catch wrong industry economics or Amazon killing your moat. Berkshire’s “due diligence” is really judgment on long-term business quality.

Duracell via split-off

Berkshire traded Procter & Gamble shares for Duracell in another cash-rich split-off. Value about $4.2 billion. Saved roughly $400 million in taxes. Duracell needed restructuring when it arrived.

Operating snapshot

MSR pre-tax earnings rose 19% with PCC in the mix. Without PCC, industrial products were flat to down on oil and currency headwinds. Insurance hit year fourteen with every major unit profitable. GEICO’s combined ratio worsened (smartphone distraction driving claims), but the group still earned underwriting profit.

After-tax operating earnings grew from $670 million in 1999 to $17.6 billion in 2016. Share count up only 8.3% since the Gen Re deal. That is the per-share story Buffett cares about.

The thread through 2015-2016

Berkshire is doing what it always does: partner with 3G on brands, buy permanent operating businesses, tuck in bolt-ons, and let insurance fund the rest. But prices are higher and elephants are rare. PCC was the exception.

Cash is building. Succession structure is taking shape (Combs, Weschler, Abel, Jain as vice chairmen). The question Mead keeps asking: where does all the earnings go when nothing big is for sale?

2017 and 2018 answer part of that with Apple, tax reform, and a new way to think about Berkshire’s value.

← Prev: Chapter 8: Berkshire’s First Fifty Years | Next: Chapter 9 Part 2: Berkshire 2017-2018 →