We are upgrading Berkshire Hathaway Inc. (BRK.A)(BRK.B) to Outperform from Neutral following its second-quarter earnings outperformance. The quarter reflected strong performances across all the business segments – Insurance, Railroad, Utilities and Energy, Manufacturing, Service and retailing as well as Finance and Financial products.
Berkshire has grown over decades by making numerous acquisitions and at present holds over 80 operating subsidiaries under it. These subsidiaries are operated as independent entities with respective managers responsible for operating decisions.
Berkshire’s property and casualty insurance business has been the key driver of growth. Its insurance and reinsurance businesses, such as Geico, have been positively contributing to the company's profits since a long time. Its insurance units generate strong "float", which is invested by the Chairman and CEO Warren Buffet. Float represents funds that are held by an insurance business during the period when policyholders submit payment and funds are eventually paid out to settle claims. The insurance business maintains capital strength at exceptionally high levels. This strength differentiates Berkshire’s insurance companies from their competitors – Assurant Inc. (AIZ) and Reinsurance Group of America Inc. (RGA).
Berkshire’s economically sensitive non-insurance businesses – utilities & energy, and manufacturing, service & retail – are also performing strongly after suffering under the weak economy in 2009. The utilities and energy business is witnessing strong growth with increased revenues from BNSF, the railway which was acquired in February 2010. The segment accounted for more than 50% of the second-quarter profits.
Although some units are dragged down by a weak economy, overall the company is performing impressively.
However, Buffett’s succession is the biggest matter of concern for the shareholders. He is already 82 years old and has been suffering medical complications. Though he announced that a competent successor has been chosen, the identity remains undisclosed. Nevertheless, there is an air of uncertainty about the performance of the company under the new CEO. In our view, it would be a very difficult job for any new management to be able to make the company perform like it did under Buffett and Munger.
The stock retains a Zacks #2 Rank, which translates into a short-term Buy rating.
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