Digging into Berkshire Hathaway's first-quarter earnings

Up next in this week's series on Berkshire Hathaway (BRK-B), today I'll break down the company's excellent first quarter...

In yesterday's e-mail, I covered the highlights from my weekend trip to Omaha, Nebraska for Berkshire's annual meeting – my favorite event of the year.

And in addition to the meeting itself on Saturday, the company released its first-quarter earnings report (the full 10-Q is posted here and the press release is here).

Setting aside mark-to-market changes in the investment portfolio of $34.8 billion in last year's first quarter versus only $1.9 billion this year – which are largely meaningless over short periods of time – Berkshire had a great quarter overall.

Here's the breakdown in this table from the press release (the dollar figures are in millions, except for per-share amounts):

Operating earnings grew an exceptional 39% during the quarter, driven almost entirely by Berkshire's insurance operations, as you can see in this next table from the press release (the dollar figures are in millions):

During the annual meeting, Berkshire CEO Warren Buffett was asked about two of Berkshire's largest segments: North America's largest railroad, Burlington Northern Santa Fe ("BNSF")... and one of the largest utilities, Berkshire Hathaway Energy ("BHE").

Both are good (I wouldn't say "great") businesses, but are facing a number of headwinds. Though BHE's profits rose in the first quarter, both have been performing poorly, with profits down substantially in the past two years.

Regarding BNSF, in my February 28 e-mail about Berkshire's fourth-quarter earnings, I wrote:

I think BNSF would be well served to start adopting more of the "precision railroading" techniques pioneered by industry legend E. Hunter Harrison and adopted by most railroads other than BNSF.

Buffett agrees. During the annual meeting (the full transcript is here), he said:

I think one thing we do recognize, when the other railroads have implemented precision scheduled railroading, there's other metrics that we have to continue to pay attention to and challenge ourselves. If we're not at their level, what are the things that are driving it?

... We have to look at our rail yards and understand how we're managing that. We have to look at our locomotive fleet, both the size and how we're utilizing that, and challenge ourselves. And we have to then go back to how we're using our employee resources and allocating them across the business. So there's a lot to be done there.

Another problem Buffett mentioned is that BNSF misjudged demand after the supply chain disruptions of 2022:

But as we moved into [2023], the business cost level, cost structure, we didn't reset it to the underlying demand we were seeing. We anticipated more demand, and we did not reset our cost structure. And the team's working very hard as we speak, to both reset the cost structure and allocate the cost resources where they need to be...

Overall, [demand] is generally going to be relatively flat. So we need to get our cost structure right, and we need to get it right, both for the coming year, but for the long term. And that means it's going to be a continuous exercise. We can't stop...

We have to have a cost structure [that] allows us to compete both within our rail industry and within the transportation sector as a whole. So the team at Burlington is working very hard to address the cost structure, just like we have in the past.

Finally, Buffett addressed the elephant in the room: Did he make a mistake in buying BNSF in 2009 (the deal closed in February 2010)? He doesn't think so:

Well, we already owned 22% of it, but overall, it was $35 billion, which was a significant part of our capital. We were able to put it to work in a business we liked. And there's certain tax advantages that come in terms of making money in something that's more than 80% owned... and we got $35 billion out during a recessionary period...

So it's worked out. Actually, it's worked out very well, but it's because we were putting out capital in 2008 and 2009, and if we put money in anything, we'd have made a lot of money. But it's more satisfying, and it's actually better in certain ways, taxwise, to make it from something that's 100% owned than a bunch of 5%- or 10%-owned businesses.

As Buffett put it, Berkshire "loves" owning that kind of business:

It's going to be around 100 years from now, won't be the best growth business in the world at all during that period, but it will be essential. And what it earns in its relation to its replacement value is a pittance. But we'll do fine in terms of what we paid for it. And we'll distribute substantial amounts in relation to what we paid to Berkshire in a very tax efficient way...

And we think it's been a very important asset to the country. And I just hope we can find something in other industries that makes as much sense as that, where we can put a whole bunch of money to work at an advantageous time.

Turning to BHE, in Buffett's annual letter earlier this year, he lamented the big earnings disappointment at BHE in 2023:

[The] regulatory climate in a few states has raised the specter of zero profitability or even bankruptcy (an actual outcome at California's largest utility and a current threat in Hawaii). In such jurisdictions, it is difficult to project both earnings and asset values in what was once regarded as among the most stable industries in America...

Other electric utilities may face survival problems resembling those of Pacific Gas and Electric and Hawaiian Electric. A confiscatory resolution of our present problems would obviously be a negative for BHE, but both that company and Berkshire itself are structured to survive negative surprises.

We regularly get these in our insurance business, where our basic product is risk assumption, and they will occur elsewhere. Berkshire can sustain financial surprises but we will not knowingly throw good money after bad.

Buffett also mentioned what could be an ominous "final result" for utilities:

Certain utilities might no longer attract the savings of American citizens and will be forced to adopt the public-power model. Nebraska made this choice in the 1930s and there are many public-power operations throughout the country. Eventually, voters, taxpayers and users will decide which model they prefer.

When the dust settles, America's power needs and the consequent capital expenditure will be staggering. I did not anticipate or even consider the adverse developments in regulatory returns and, along with Berkshire's two partners at BHE, I made a costly mistake in not doing so.

The key line here, "we will not knowingly throw good money after bad," was a shot across the bow of politicians and regulators: that if they don't remove "the specter of zero profitability or even bankruptcy," neither BHE nor other utilities will be willing to make the necessary investments to supply the electricity that every growing economy needs.

Buffett was asked about this at the annual meeting:

The Utah legislature recently mandated the state's right to serve as sole purchaser of energy from an in-state power plant and under some circumstances, purchase the power plant before it can be retired.

The state utility regulator will be legally bound to prioritize public purchases of power and facilities that could include assets owned by Berkshire Hathaway Energy [PacifiCorp] utility Rocky Mountain Power.

Will Berkshire, through BHE, continue to invest resources in jurisdictions where corporate assets may be subject to confiscatory state policies and actions? And how is Berkshire Energy working with officials in Utah to minimize potential corporate losses if and when state control is asserted over its electrical utility sector?

Here are excerpts from Buffett's reply, in which he spoke favorably about Utah, but warned other states, repeating the words "we're not going to throw good money after bad":

I would say our feeling is that Utah is actually very likely to treat us fairly...

[There's] going to be enormous amounts of money... spent on power. And if you're going to do it with private owners, there's nobody better situated than Berkshire to satisfy the portion, but a large portion of the needs of the country.

And we will do it at a rate of return that is not, you know, it's not designed to make us rich or anything like that. It's a sensible rate of return, but we won't do it if we think we're not going to get any return. It would be kind of crazy. And we've seen actions in a few states where some of the costs associated with climate change, they're not being regarded as cost of the utility shouldn't incur. Well, believe me, if it was publicly owned, they would have incurred it too.

But we'll do what society tells us and we have got the money and we've got the knowledge to participate big in something that is enormously important for the country. But we're not going to do it. We're not going to throw good money after bad in the field... I don't regard Utah as being unfriendly to the idea of utilities being treated fairly.

Buffett's anointed successor and the chairman of BHE, Greg Abel, then spoke at length, echoing Buffett's points and twice repeating the warning line that BHE isn't going to "throw good money after bad":

Fundamentally, as we go forward, we need both legislative and regulatory reform across the PacifiCorp states if we're going to deploy incremental capital, make incremental contributions into that business.

As Warren said, we don't want to throw good capital after bad capital, so we'll be very disciplined there. But the reality is there are opportunities to both solve the legislative and regulatory solutions. And the best example we actually have, and I think it's the gold standard across the country, is Utah. So as Warren touched on, it's a state we're happy we're investing in...

The risk of regulatory compacts not being respected is a much broader one that will always evaluate and be careful how we deploy our capital...

Somebody's going to put up many, many hundreds of billions, maybe in the trillions, and climate change enters into that, and it can be done through public power or it can be done through private enterprise to quite a degree. And we would be certainly good for $100 billion or more, but we're not going to throw good money after bad.

Next, turning to Berkshire's other businesses, fortunately the weakness in BNSF and BHE has been far more than offset by spectacular growth in Berkshire's vast insurance operations – which are led by the incomparable vice chairman of insurance operations, Ajit Jain.

As you can see from this table (item 2 in the 10-Q, with the dollar figures in millions), all three segments reported spectacular underwriting profits thanks to higher prices and lower claims, in particular no major "super-cat" events like a Florida hurricane:

And on the investment side, profits rose from $2 billion to $2.6 billion because Berkshire holds $189 billion in cash plus $17 billion in bonds. These were earning next to nothing two years ago... but now that interest rates have soared, they are earning much more in annual interest income.

Turning to the cash-flow statement, cash flows from operating activities came in at $10.6 billion, up 22% from $8.7 billion in last year's first quarter.

Capital expenditures were $4.4 billion – up from $3.7 billion in the same quarter last year – as Berkshire continues to invest heavily in maintaining and growing its many businesses.

Buffett – and his colleagues Ted Weschler and Todd Combs, who have been handling the investing side of the business – purchased $2.7 billion of stocks and sold $20 billion in the quarter.

This was mostly from trimming Berkshire's enormous stake in Apple (AAPL) by 13% (here's the video from the annual meeting of Buffett explaining this move, which I think makes sense).

That means they were net sellers to the tune of $17.3 billion, which isn't surprising given that the market notched 22 record highs in the first quarter.

Lastly, let's look at share repurchases...

Buffett started buying back shares in 2018 and ramped it up heavily in 2020 and 2021.

He then slowed buybacks to a trickle in early 2022 as Berkshire's share price hit an all-time high (and briefly reached my estimate of intrinsic value).

But as the stock (and markets) pulled back, Buffett resumed buying in size in late 2022 and the first quarter of last year.

Then he pulled back a bit during the rest of 2023 and this year's first quarter (although buybacks for this past quarter increased a bit from the final quarter of 2023) as the stock jumped higher. Take a look at this chart:

These share repurchases have reduced Berkshire's share count by 12% – a meaningful amount.

Tomorrow, I'll continue my Berkshire series with my updated estimate of the company's intrinsic value... Stay tuned!

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.