Sequoia Fund: Why We Love Buffett
Sequoia Fund comments on its Berkshire Hathaway position from its 2015 annual letter:
Berkshire Hathaway’s stock performed poorly in 2015 and now trades at a multiple of less than 12 times earnings, the cheapest it has been in some time. Look-through earnings most likely increased about 9%, but the year could fairly be described as challenging. The company’s largest unit, the Burlington Northern Santa Fe railroad, ended the year on a sour note as the industry faced several weak end markets simultaneously, with coal and petroleum the most notable examples. On the plus side, service metrics improved markedly from 2014 levels and earnings growth likely exceeded 12% for the year. Volumes were basically flat for the year, outperforming its number one competitor in the West by 5.8 percentage points. However, excluding coal, Burlington’s volumes were no better than the industry in 2015, and it seems less certain that BNSF’s coal business will outperform in 2016. Moreover, a portion of the earnings gain in 2015 was attributable to a lag in the re-pricing of fuel surcharges as the price of diesel fuel declined, a benefit that cannot be counted on to recur this year.
The insurance business was a mixed bag. GEICO continues to grow rapidly in a stagnant industry, but profits were lower as accident frequency and severity picked up - most likely because lower gas prices led to an increase in the number of miles driven. GEICO is raising prices in response to higher claims experience. Reinsurance profits were down as a result of intense price pressure amid a lower-than-usual level of catastrophes the last couple of years. Berkshire chose to write less business for super catastrophes because it thought rates were inadequate. The growth of BH Specialty, essentially a startup primary commercial unit staffed with hires from industry competitors, was a bright spot.
The manufacturing and service businesses started the year strongly but comparisons deteriorated during the year as demand from markets reliant on higher
commodity prices weakened and the translation of profits in foreign markets was hurt by the stronger dollar. Among the major investees, American Express’s earnings were hurt by the loss of a contract with co-brand partner Costco and IBM’s results suffered from the strong dollar and the fact that corporate buyers are increasingly turning to lower cost hardware and “cloud” storage solutions.
In 2016, Berkshire committed over $40 billion to acquisitions. The purchase of Precision Castparts is, by one measure, the largest acquisition in Berkshire’s history at $37 billion - including debt assumed. The deal value of the Precision acquisition was struck at a historically high multiple of 15 times trailing operating income. Berkshire will fund about 30% of the deal costs with low-cost borrowed money but, even with leverage, Precision’s earnings will need to grow relatively rapidly for the acquisition to work out well. Berkshire also injected over $5 billion into Heinz to help facilitate Heinz’s merger with Kraft to form a larger food company.