Thread by @ChrisBloomstran

Berkshire Hathaway released its 3Q 10-Q and earnings release this morning. In what was a very quiet quarter on the capital allocation front, there are a number of interesting developments in the filing and particularly the MD&A. A few comments on the quarter and developments. 1/

Typical of Berkshire’s earnings, profits are reported by observers with little understanding of the underlying economics of the company. Headline reported GAAP profit for the quarter shows losses of $10.4 billion for the quarter and $50.0 billion for the first nine months. 2/

Reported profit now includes market value changes in BRK’s equity and fixed holdings and reported values of derivatives net of deferred tax. Stripping realized/unrealized gains/losses logically allows an assessment of operating earnings including interest and dividend income. 3/

You see many reports in the media that Berkshire’s operating earnings grew 20% during the quarter to $7.8 billion and 19.4% for three quarters to $24.1 billion. No. These figures INCLUDE foreign currency gains on non-U.S. dollar denominated debt. 4/

Properly excluding currency gains Berkshire’s profits should have been reported as $6.9 billion for the quarter, up 10.1% over 2021’s third quarter and $21.7 billion year to date through September, up 11.2% over 2021. Impressive but few get to the correct profit measure. 5/

By comparison, despite strong revenue growth for the companies making up the S&P 500, up 8% for the year (not annualized), reported operating profits are flat for the year, indicating substantial erosion in profit margins, particularly if excluding strong profits in energy. 6/

Berkshire’s A shares declined 10.5% for the year through 9/30 against a total return loss of 23.9% for the S&P 500. Through Friday Berkshire is down 4.1% vs 19.8% for the index. Book value per share was down 1.1% during the quarter and down 9.3% for the year to 9/30. 7/

Berkshire’s stock portfolio, nearly all held in the insurance operation, is down an estimated 20.3% through 9/30 and 14.4% to Friday. Berkshire purchased $9 billion of common stocks during the quarter and sold $5.3 billion, for a net purchase of $3.7 billion. 8/

YTD buys of $66.2B exceeded $17.3B sales making net buys for the year $48.9B. The stock portfolio was $350.7B yearend and $306B at 9/30, the net decline reflecting the $48.9B in net purchases offset by declining prices and a new accounting treatment for Occidental Petroleum. 9/

Berkshire’s ongoing recent purchases of OXY took its ownership above 20% to 20.9% during the third quarter, compelling equity method treatment. Hence you see a bump in equity method investments on the balance sheet from $17.4B at 12/31, $17.5B at 6/30 to now $28.7B at 9/30. 10/

The OXY common stock position moved from investment equity securities to equity method. The equity method position EXCLUDES BRK’s $10 billion investment in 8% OXY preferred, which give it warrants to purchase 83.86 million common shares at a $59.62 strike. 11/

OXY at $73.22 on Friday makes the warrants now $1.1B in the money. Assuming exercise, BRK now controls 29.2% of OXY. Interestingly, despite the common now reported using the equity method, the preferred/warrants are still included as equity securities. Gotta love accounting. 12/

The cost basis on Berkshire’s stock holdings was reduced by $7.4 billion during the quarter. It appears the Bank of America position was trimmed, I estimate by $1.25 billion, as well as perhaps a very small trim in American Express (could be rounding). 13/

Additional financial sales took place. We’ll see when the 13-F is released in 10 days. Interim filings show the large purchase of OXY and CVX (big investments in oil and gas) and trims of BYD. Again could be rounding but it looks like a very small addition was made to AAPL. 14/

Berkshire repurchased a modest $1.06 billion of its common shares during the quarter at an average price of $436,672 per A share equivalent. For the year to 9/30 BRK bought back $5.25 billion of the stock at an average price of $460,822. It's $432,000 today. 15/

Since 9/30 repos totaled another 1,231.42 A equivalent shares which at an average price of $417,500 to 10/26 suggest an additional $514 million in shares repurchased. For the year to 10/26 BRK bought back 0.85% of its shares and since repos began in 2018... 16/

...spent $63.7 billion repurchasing 11% of the shares outstanding at an average price of $353,952 per share, a terrific use of capital buying shares at wide discounts to intrinsic value. 17/

No dout with zero shares issued to insiders at BRK, all shares repurchased shrink the overall share count. Berkshire behaves very differently. Companies like Twitter and Facebook/Meta operate using a different playbook, with big dilution offset with price insensitive repos. 18/

Cash, always reported as stunningly large/inefficient, totaled $109B at 9/30, up modestly from $105.4B at 6/30 but well below $146.7B at 12/31. Net buys in common stocks, share repos and growth capex absorb operating income and drive ongoing good returns on capital employed. 19/

BRK is earning $4.6B on its cash. Debt totals $116.5B and has lengthened over recent years when rates were low. At 3.6%, BRK’s rate paid on debt is now lower than interest earned. $4.2B interest paid is $400m less than earned on cash despite cash balances lower than debt out. 20/

Much of BRK’s cap ex is oriented to growth. Capex totaled $10.9B YTD, $7.9B of it at BNSF and BHE. The two will spend an additional ~$3.7B during Q4. Growth capex at these two subs earns north of 10% annually, a great use of cash with a long runway for ongoing deployment. 21/

Operationally Berkshire looks stronger than many companies so far this year, though seeing volumes decline at many subs. Inflation is taking a toll at GEICO, with ongoing high used car prices and replacement parts prices hammering severities. Ditto health and litigation. 22/

Very unusual to see policies in force decline outright at GEICO by 4.6% year to date. A 25% decline in underwriting expenses during the quarter, 17% for nine months, is almost all a huge cut in in advertising spending. Underwriting loss was 108% for the quarter. 23/

GEICO & industry struggling w/ seventies/frequencies and are (and will be) filing for rate hikes. Some state insurance commissions are more receptive to rate hikes. It appears that until price firms adequately that GEICO doesn’t want certain new business, hence the ad cuts. 24/

Progressive has certainly passed GEICO as number two in market share to State Farm. The underwriting climate will firm, particularly as insurers get price. Will be great to see GEICO find a permanent CEO. Trailing on technology. Lots of ground to make up to PGR. 25/

Overall BRK’s insurers were hammered by hurricane Ian to the tune of $3.5 billion pretax, $2.7 billion after-tax, matching my estimate. National Indemnity/GenRe bore the brunt of this naturally, but Primary Group was stung for $660 million in cat losses during the quarter. 26/

Yet Primary still underwrote at a modest underwriting gain (appropriately excluding developing losses in retroactive re and periodic payment annuity which nearly always will show losses from an accounting standpoint). 27/

P/C re showing healthy premium volume/price. Life/health premiums down but profitability vastly improved and back to gain as pandemic mortality is far below last year. Nice to see positive reserve development at re and in primary, confirming ongoing underwriting conservatism. 28/

Continuing in insurance, the Alleghany acquisition closed after quarter-end, on 10/19. I’ve written about the attractiveness of the deal for BRK - retaining more premium, investing more of the reserves in equities and picking up Joe Brandon as a very good insurance executive. 29/

Interesting the degree to which falling stock/bond prices & Ian losses altered deal economics at closing versus when the acquisition was announced in March. Y assets declined from $32.3B to $31.2B, liabilities grew from $22.8B to $23.4B, thus BV declined from $9.5B to $7.8B. 30/

Given purchase price of $11.6B in cash remained unchanged, the multiple paid to book was not 122% as reported at the announcement but much higher 149% at close. Still great deal for BRK but makes me a bit happier to lose Y at higher premium to book value than when announced. 31/

A $7.8 billion book value presumably improves assuming a recovery in stock and bond prices. Also, Y likely had more than $500 million Ian loss. BRK will pick up $13.5B in float from Y, adding to reported $150B float at 9/30, up from $147 billion at both 12/31 and 6/30. 32/

BNSF weakened somewhat with ongoing declines in volumes (car loadings) in all areas but agriculture. Revenues were up 17% for the quarter and 14% for the year but masking outright 7% decline in pre-tax profit during the quarter (up 3% for 9 months). Margin thus way down. 33/

Overall volumes down 5% in both 3Q/YTD. Sales no doubt bolstered by rising fuel cost passed through to customers as surcharges. Rail traffic down sufficiently at BNSF/other class 1 rails to suggest we are in a recession. Ag revs up on higher grain/renewable diesel shipments. 34/

The utility and pipeline/distribution energy business was again strong with profits up 4.4% for the quarter and 3.9% for 9 months. An oddity is real estate brokerage held within BHE. Rising rates are pummeling mortgage refinancing and now units transacted/closed. 35/

Housing affordability dually harmed by not only rising interest rates over the past year but home prices which surged thanks to low rates and free money thanks to the Fed. That the central bank was buying mortgages until April was insane. Who created the inflation? 36/

On housing, Clayton Homes remains a superstar within BRK. Revenues up 25% for the quarter and year to date. Profits up 64% and 41%, respectively. BRK warns of imminent slowing here and across many of its MSR portfolio companies. 37/

Unit sales expected to drop, already see slowing growth site-built homes. Furniture retail/consumer durables hit wall. Building products likewise strong, sales up 15%/profits up 35% -higher sell prices/value gains many categories. Again expect slowing comps in sales/profits. 38/

Forest River was a pandemic star but the RV craze hit the wall. Sales down 7% in 3Q where YTD were up 22% (including the 3Q disaster). Unit sales down 28% in 3Q. Apparel/footwear very weak. Sales down 2% but profits way down. 39/

Volumes down, reduced mfg efficiency, higher raw material/freight/labor. Consumer looks very weak/weakening. TTI sales strong, up 16% and 20%. Profit growth matched, but warning again of weakening. Aviation very strong, helped by decline lower margin subcontract aircraft use. 40/

Retail group weak and weakening with the exception of auto retail. New and used car sales up 11% 3Q and 5% YTD, though with high prices masking declining units, a common theme not only in the BRK quarter but across many companies reporting over the past few weeks. 41/

BH Auto margins/profits were very strong, up 25% 3Q. Balance of retailers with profit drop of 32%. Ouch. Lots of inventory in the channel and on balance sheet. The rise in inventories across so many businesses we follow and industries won't be clearing anytime soon. 42/

If you made it this far the most interesting comments in the Q are in regard to the 15% corporate AMT on “adjusted financial statement income” as part of the 2022 Inflation Reduction Act (code for the Inflation Creation Act). 43/

I read the mind-numbing but pertinent sections of the act (now law) and concluded BRK is likely to see the insurance operation caught paying some tax on UNREALIZED GAINS given the mesh of gains now on the income statement and the new 3-year rolling average AMT. 44/

Language in bill unclear/nebulous about exemptions by the Treasury Secretary. BRK states does not expect material impact on consolidated financial statements. Interesting language as well. Expects future guidance from the Treasury department. I love the tone of this language. 45/

Assuming a full tax on unrealized gains at 15% and a 10% annual average total return on the stock portfolio, the tax could hammer BRK’s intrinsic value as I calculate it by as much at $60 billion and increase the annual average CASH taxes sent to DC by more than $3 billion. 46/

Even if implemented adversely to BRK, I wouldn’t expect the law on the books for long. A corporate AMT passed and used a few years ago, an unmitigated disaster. Further, the concept of taxing UNREALIZED GAINS defies any semblance of logic. Politicans fail to surprise though. 47/

Overall a quiet quarter on activity but generally stronger than many companies. BHE is and becomes hugely important. Energy will pass the railroad as BRK’s second largest and most important subsidiary to insurance. Great advantaged home for retained profits and growth capex. 48/

Given the unwinding of so much speculative excess, BRK remains a safe harbor. Exemplary behavior, outstanding capital allocation and a general misunderstanding of BRK combine for a super core investment. With value higher since yearend and a lower stock price, what’s not to like?

* This should say “reinsurance” still underwrote, not “Primary.” Retro and PPA are reinsurance lines.