Crucial Takeaways From Berkshire Hathaway’s Third Quarter 2022 Earnings

Berkshire Hathaway (BRK/A, BRK/B) reported a loss of $2.7 billion in the third quarter versus a profit of over $10 billion in the same quarter of 2021. The second straight quarter of bottom-line losses is thanks to sharp declines in the stock market since results have been dominated by losses from the investment portfolio with unrealized losses from their portfolio included in earnings. Operating earnings, which remove the distortion from market changes and better reflect the firm’s earnings power, for the quarter rose by 20% 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 third quarter increased by 23% 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 third quarter of 2022 are 4% below 2019. The relative decline is entirely attributable to the insurance segment, excluding insurance results were 14% above 2019 levels. But thanks to share repurchases, operating earnings per share for the third quarter were still 7% above 2019.

A further look into the different operating segments in 2022 shows a mixed bag across the segments versus 2021. Insurance underwriting and the railroad business were the weaker segments in the third quarter. Notably, the operating income for those same two segments plus investment income was softer relative to the pre-pandemic levels of 2019.

Insurance: Third-quarter investment income was 21% higher than in 2021, 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 2022 to fight inflation. Investment income should continue to see improvement as the Federal Reserve is likely to be in hiking mode through at least early next year. Underwriting results were poor for the quarter, with all three insurance segments, GEICO, Berkshire Hathaway Primary Group, and Berkshire Hathaway Reinsurance Group, having underwriting losses. Underwriting suffered from a significant catastrophe event in the third quarter, with Hurricane Ian causing $3.4 billion in pre-tax losses for the quarter. 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 is the primary driver of Berkshire’s year-to-date underwriting loss after posting an underwriting profit in 2021. Short-term uncertainty will remain regarding GEICO’s margins. Still, increased claims and severity are an industry issue, so premiums are likely to be increased by all the insurers, which should eventually lift results.

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. Despite Berkshire’s underwriting loss for the third quarter of 2022 and year-to-date, it posted underwriting profits for calendar years 2021, 2020, and 2019. Berkshire’s float was higher at approximately $150 billion versus the $147 billion 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 $102,253 from $99,961, also aided by share repurchases. Berkshire completed its purchase of Allegheny in October 2022, which will increase float by roughly $13.5 billion in the fourth quarter.

Railroad: Berkshire owns the Burlington Northern Santa Fe (BNSF) railroad operating in the U.S. and Canada. Net operating earnings fell 6% over the same quarter in 2021 and 2% over pre-covid 2019. Revenue was higher due to higher pricing and a fuel surcharge driven by higher fuel prices, but volume declines and higher operating costs dinged the bottom line.

Utilities and Energy: Berkshire owns 92% of Berkshire Hathaway Energy Company (BHE) which generally provides steady and growing earnings, as one would expect from what primarily consists of regulated utilities and pipeline companies. Overall, BHE posted 6% higher operating earnings in the third quarter relative to 2021 and 35% above the same quarter in 2019. 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, with third-quarter operating profits 72% below 2021. 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
PCP
(PCC) business due to its exposure to the COVID-disrupted aerospace industry. PCC’s pre-tax earnings fell in the third quarter relative to 2021, primarily due to lower pension income and higher costs. Berkshire sounds more optimistic about the outlook of PCC with a rebound in domestic flight and the restart of Boeing 787 production in the third quarter. Management suggested that future growth is predicated on the ability to increase production since the company has suffered from worker shortages and supply chain disruptions. Berkshire’s FlightSafety and NetJets continued to see a sharp rebound, with training hours up 17% and customer flight hours rising 14% year-to-date versus 2021. Earnings from aviation services were helped by a relative decrease in costs from less usage of subcontracted aircraft.

Housing-related businesses like Clayton Homes, Shaw, Johns Manville, Acme Building Products, Benjamin Moore, and MiTek posted sharply higher earnings relative to 2021, a 34.9% increase in quarterly pre-tax profits versus 2021. Berkshire noted that higher prices offset cost pressures, and demand was strong. Despite the good news for the quarter, management indicated that “comparative revenues and earnings in the near term will likely decline from current levels” due to the impact of higher interest rates on housing construction and demand.

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The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had higher quarterly revenues with a higher average unit sale price. Unit sales were constrained, reflecting significant new vehicle supply shortages attributable to the global computer chip shortages and other supply chain disruptions. Berkshire noted that third-quarter apparel and footwear earnings plunged 75% relative to 2021. Management said that the weakness in these two areas was likely to continue in the fourth quarter “due to low customer demand and high costs.” In addition, earnings were lower for Pampered Chef and their furniture retailers, including Nebraska Furniture Mart. This weakness in some of the retailing exposed businesses is not a surprise, given similar results from others in the industry.

Berkshire’s McLane unit had higher profits in 2022 versus 2021. McLane is a wholesale distributor to retailers and restaurants. The increase in earnings was primarily due to “slightly higher gross margin rates.” Still, supply chain constraints, labor shortages, truck driver shortages, and higher inventory costs continue to bedevil the business. Berkshire continues to expect the challenging environment for McClane to continue through 2022.

Other: The segment had a significant profit for the third 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-U.S. 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. The equity method earnings will include Occidental Petroleum
OXY
(OXY) beginning in the fourth quarter of 2022. After purchases in the third quarter, Berkshire now owns 20.9% of the outstanding shares of Occidental, with a market value of $11.9 billion at the end of September. More about the possible reasons for the Occidental investment is here.

Berkshire bought back a little over $1 billion of its stock in the third 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 almost 1.5 times during the quarter, so it makes sense that the pace of repurchases slowed. Berkshire only intends to repurchase shares when the “repurchase price is below Berkshire’s intrinsic value, conservatively determined.” The P/B ratio remains a reasonable proxy for gauging Berkshire’s intrinsic value. Still, Warren Buffett and Charlie Munger’s judgment about its intrinsic value versus other available uses of capital could differ from that simple measure in the future.

In addition, Berkshire made other purchases. Berkshire bought $9 billion in stock while selling $5.3 billion in stocks for a net additional investment of $3.7 billion in publicly traded equities. One purchase was additional shares of Occidental Petroleum (OXY), but more details will be released when the 13F is filed in mid-November.

Summary: Quarterly results are generally not meaningful for Berkshire since it is managed with a focus on increasing long-term value and not meeting quarterly hurdles. This ability to take advantage of time arbitrage has served the company and shareholders well over the years. The goal in looking at the results is to see if the segments are generally operating as expected and consider the capital allocation decisions made by Warren Buffett and Charlie Munger.

Operating earnings for the third quarter of 2022 grew by 20% over 2021 but are 4% below pre-pandemic 2019 levels. 2022 year-to-date operating earnings growth is impressive at 19% and 22% above 2021 and 2019, respectively. In recent years, a significant capital allocation decision was made to increase share repurchases. This activity signals that Buffett and Munger believe Berkshire Hathaway’s price is below their intrinsic value estimate. If they are correct (and there is no reason to doubt them), the purchases are a value-creator for the remaining shareholders. Year-to-date operating earnings per share for 2022 are now 36% above 2019, benefiting from the share repurchases. The slowing repurchases in the third quarter reflect the higher valuation of Berkshire until recently and the ability of the duo to find some other opportunities with an attractive risk versus reward for investing capital.

The underwriting loss for the quarter across the insurance businesses is disappointing, but some were unavoidable due to catastrophe losses from Hurricane Ian. More problematic in the short term is that GEICO, one of Berkshire’s crown jewels, continues to be challenged by the impact of the pandemic. The continued underwriting losses at GEICO are disappointing, but results should improve as auto claim severity normalizes and auto premium pricing increases. The better news was the investment income from the insurance business continued to rebound sharply as the Federal Reserve aggressively raised short-term interest rates. Cost pressures from rising inflation have caused non-insurance profit margins to decline relative to third-quarter 2021 levels, but margins remain higher than the pre-pandemic third quarter of 2019.

Berkshire’s stock price outperformed the S&P 500 in the third quarter, declining by 2.2% versus a total return of -4.9% from the S&P 500. Year-to-date through the end of September, Berkshire’s price is -10.7%, while the S&P 500 has a total return of nearly -24%. Despite additional investment purchases, cash levels were above last quarter. Berkshire retains a fortress balance sheet with cash and equivalents of over $105 billion, which provides flexibility to take advantage of opportunities, including repurchasing its own stock. Berkshire has stated that there would be no stock repurchases if it would cause cash levels to fall below $30 billion.

Despite the headline loss in the third quarter, Berkshire’s businesses are performing well, aside from woes at GEICO, the catastrophe losses at the insurance operations, and some slowing due to macroeconomic headwinds. Management warned that some businesses are beginning to see the negative revenue and earnings impact from slower economic growth and weakness in the housing market. Berkshire retains its Fort Knox balance sheet and a diversified mix of businesses. The firm maintains the unique ability to take advantage of significant opportunities when disruptions or crises provide them. Shareholders should take comfort in knowing that the firm continues to be managed to survive and emerge stronger from any economic or market downturn.