Is Berkshire Undervalued?

Buffett's Berkshire in bear territory
July 2, 2008 - 3:45PM
Source: http://business.theage.com.au/buffetts-berkshire-in-bear-territory-20080702-30je.html?page=2

It must be a bear market because even billionaire Warren Buffett's Berkshire Hathaway has slumped almost 20% since December.

The decline exceeds the 15% drop of the Standard & Poor's 500 Index from December 10 through yesterday. It's the worst first half for the investment and holding company since 1990, as price competition drove down revenue at Berkshire's insurance units, which account for about half of its income.

Berkshire is "close to getting more fairly priced,'' said Charles Hamilton, an analyst at FTN Midwest Securities. "I wouldn't say it presents a buying opportunity right now.

''After reporting record 2007 earnings of $US13.2 billion ($13.7 million), the 77-year-old Buffett told shareholders in February that profit margins from insurance will drop. "That party is over,'' Buffett wrote in his annual letter to shareholders in February. "It is a certainty that insurance industry profit margins, including ours, will fall significantly in 2008.''

Berkshire also has been hurt by the declines of Wells Fargo, American Express and US Bancorp, three of the company's 10 biggest equity holdings at the end of March. Wells Fargo, Berkshire's second-largest holding, dropped 18% in the second quarter, while American Express and US Bancorp slipped 14%.

Berkshire closed at $US120,100 yesterday in New York Stock Exchange composite trading, down from their all-time high of $US151,650 in December. That's the sharpest drop in more than five years.

Berkshire spokeswoman Jackie Wilson didn't respond to a request for comment. The slide hasn't deterred Buffett devotees, who think Berkshire's decline represents a buying opportunity. "I'd put a new client in Berkshire right now,'' said Frank Betz, a partner at Carret Zane Capital Management. "It's probably the highest-quality collection of individual companies that's ever been assembled. Long slides are not in the Berkshire Hathaway lexicon.''

Berkshire bulls are betting with history on their side: the shares advanced in 17 of the past 20 years. The last annual decline was 3.8% in 2002. The company had record earnings last year as Buffett booked a $US3.5 billion profit on a $US500 million investment in oil producer PetroChina, and insurance units made money selling coverage against storms that never came.

The decline in financial shares may provide Buffett an opportunity to boost holdings, said Whitney Tilson, a principal at New York-based hedge fund T2 Partners, which counts Berkshire among its investments.

"Where Buffett makes his money is taking advantage of weak, chaotic markets,'' Tilson said. "The odds that Buffett could do a large transformative deal have gone up substantially.'

'Buffett built Berkshire over four decades from a failing maker of men's suit linings into a $US185 billion company. He plows revenue into companies whose management he trusts and whose business models he deems superior. The billionaire's Berkshire stake makes him the world's richest person, according to Forbes magazine.

With Berkshire's $US35 billion in cash, Buffett can scoop up bargains on beaten-down securities and make acquisitions while near-frozen credit markets curb purchases by leveraged buyout firms, Tilson said. Tilson calculates the so-called intrinsic value of Berkshire's assets and operations at $US157,000 a share. The stock reached intrinsic value in 11 of the past 12 years, Tilson said. The discount was about 24% at yesterday's close.

This year's gap emerged amid a drop in commercial property rates from their peaks after Hurricane Katrina in 2005. Property and casualty prices in the US fell 14% in the first quarter from the same period a year earlier, according to a survey by the Council of Insurance Agents and Brokers.Berkshire, which owns National Indemnity, General Re and Geico, saw first-quarter earnings from underwriting insurance policies fall 70% to $US181 million.

Pretax underwriting profit at Berkshire Hathaway Reinsurance Group, which sells catastrophe coverage, dropped 95%.

Also damaging to Berkshire's earnings is the biggest housing slump since the Great Depression, which slowed the company's building-related businesses, including Acme Brick, wallboard maker Johns Manville and Shaw Industries, the world's largest carpet manufacturer.