Jeremy Glaser: From Morningstar I'm Jeremy Glaser. The Berkshire Hathaway Annual Meeting is this weekend, and I'm here with Gregg Warren, he's our senior analyst who covers the firm, to look at if the stock's a buy today.
Gregg, thanks for joining me.
Gregg Warren: Thanks for having me.
Glaser: Let's look at the operating business, I know we talk a lot about maybe the witticisms that we get out of the meeting, but sometimes less the actual underlying operating business. What is happening, what happened in 2017, what's working, what's not?
Warren: I think that's the interesting thing to think about. Everybody focuses around Warren and Charlie. The fact is that the business itself is completely decentralized. All these operating businesses are running themselves. Warren and Charlie are basically just sitting there gathering up the excess cash and looking for ways to put that to work. They are not focused as much on dealing with the day-to-day operations of the business. That doesn't mean they are not cognizant of what's going on, and they are expected to have answers about strengths and weaknesses within the organization. The beauty of Berkshire overall historically has been you can have one or two or three operating businesses underperforming and still produce decent book value per share growth.
We've seen that over past five to six years. If we look back BNSF has gone from record levels of profitability in earnings and has had some really tough years. Right now, they look to be improving. Coal shipments are up dramatically over the past year, but they were down dramatically for two years there. Going forward our expectation is coal shipments are going to be down on a secular basis. That's going to diminish at least a fifth of their business. Then we got to look at intermodal shipments as well because the Panama Canal has been widened and deepened, so lot of the West Coast port business that they have done historically is probably likely to fall off as well. That's one part of the business to look at, and you address the headwinds there and figure out what's the best way to run it over the long run.
Then there is stuff like Geico, we've talked about that previously. I mean they are intentionally taking higher losses on their underwriting portfolio just so that they could take additional share in the market and drive their own premium growth. It's a smart move for the business and they can do it because Geico sits within a larger insurance portfolio and it sits within a larger organization overall. There's always going to be businesses that are doing better and doing worse at any given time, but it's been rare to see a lot of businesses underperforming and pulling the entire business down.
Glaser: Let's talk about the economic moat. It's a wide-moat company. Do you see drivers of that moat widening, is it getting smaller? Where do you see it's competitive positioning?
Warren: I think it's pretty stable at this point. I don't see a whole lot out there that can pull down. At the least you got a lot of solidly narrow- to wide-moat firms within the portfolio. You are generating a lot of excess cash. What's kind of always put it over the top for us has been this capital allocation prowess that has come from the top. Now our expectations going forward, because our moat ratings like to look forward, is once Warren and Charlie are gone some of that prowess that had been there historically is going to be diminished. Instead of getting 11% or 12%, extending credit to somebody during a crisis they may get 9% or 10%. They are not going to earn as much as they have historically with some of the deals they have done in the past. At the end of the day we are still looking at a company that can outearn their cost of capital over an extended period of time. If you look just back at the past five years, they have not done a lot of big deals. Cash has been building up dramatically and they are still earning decent return on their book value. From that perspective, the next guys, even if they are just running it on autopilot, it should do pretty well.
Glaser: Let's talk about valuation then. Are shares expensive today?
Warren: It's kind of hard to get excited about them. They are trading at about little bit over 1.5 times trailing book. Historically the stocks traded between 1.4, 1.5 on that basis. When we look at our projections for book value per share this year and next, it's trading about 1.3 times this year and 1.2 times forward. We generally are more aggressive with the name when it gets down to, say, below 1.3 times book value. Buffett has put a threshold out there at 1.2 times book value. It rarely gets there. Generally if you are waiting to like 1.25 you waited too long. We actively encourage folks to start looking at it once it gets down to about 1.3 times trailing book value. Given where the markets are right now it's tough to see that unless we have a big sell-off.
Glaser: Gregg, thanks for your take on Berkshire.
Warren: Thank you for having me.
Glaser: From Morningstar I'm Jeremy Glaser. Thanks for watching.
