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Berkshire Suffers from Insurance Biz

Zacks Equity Research

Berkshire Hathaway Inc. (BRK.A) (BRK.B) reported its fourth quarter 2011 operating earnings of $1.08 per share, which marks a year-over-year decline of 11%. The underwriting losses suffered by the company’s Insurance business, on account of the catastrophes, resulted in the decline in earnings.

However, the results were aided by strong performance from other business units – BNSF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy.

However, on a GAAP basis, net income came in at $4.14 per share, down 22% year over year. The drop in net income was due to a decline in investment and derivative related gains.

Total revenue grew 5.5% year over year to $143.7 billion, primarily led by higher, premium earned, sales and service revenues, railroad utilities and energy businesses, partly offset by investment and derivative related loss of $830 million compared with a gain of $2.3 billion last year.

Segment Results

The Insurance Group segment reported revenue of $110.7 billion, up 5.1% year over year. Revenues were boosted by an increase of 4.6% in net premium earned, partly offset by lower net investment income. 

The segment reported net insurance underwriting profit of $154 million, down eight times from $1.3 billion last year, due to huge underwriting losses from Berkshire Hathaway Reinsurance Group, which suffered from significant catastrophe losses. The company's insurance investment income was down 8% year over year to $3.6 billion as a result of the drop in the value of the company's derivatives.

The Railroad, Utilities and Energy segment’s total revenue increased 9.2% year over year to $30.8 billion. Of the total segment’s revenue, approximately 60% came from Burlington Northern Santa Fe, the railroad company, which was acquired in February 2010. An increase in industrial and agricultural activity has automatically revived the demand for rail services and this translates into greater consumer demand for the segment.

The trend is likely to continue in the coming years. Revenue from MidAmerican, which comprises other businesses of the segment, remained almost unchanged at $11.3 billion.

Total revenue of the Manufacturing, Service and Retailing segment climbed up 8.7% year over year to $742.4 billion, on the back of an increase in all the sub-businesses. Marmon’s revenue improved 16%, McLane’s revenue increased 1.8% and other manufacturing, servicing and retailing, which includes a wide array of businesses, saw a 15% increase in revenue.

The Finance & Financial Products segment’s total revenue declined 6% year over year to $4.0 billion. The decline was the result of a 10% drop in revenue from the manufactured housing business, Clayton Homes, which continues to be adversely affected by the soft housing market and the surplus of traditional single-family homes for sale. However, the drop was partly mitigated by a 13% increase in revenues from the furniture/transportation equipment leasing segment. 

Omaha-based Berkshire continues to grow its balance sheet. Consolidated shareholders’ equity or net worth, as of December 31, 2011, was $164.8 billion, up 4.6% from December 31, 2010.

Book value, a measure of assets minus liabilities, gained 4.6% year over year and was $66.6 per share, as of December 31, 2011.

Berkshire ended the quarter with $37.3 billion of cash in hand, up from $34.8 billion at the end of September 30, 2011. During the quarter, Berkshire made a small ticket buy, Omaha World-Herald, publishers of daily and Sunday newspapers. 

Given the significant amount of cash generated by the company consistently over the quarters, Warren Buffett announced his intention of further acquisitions. These will benefit the company when the economy recovers completely. 

During the quarter, Buffett also shed light on his succession plan. Though the name of the new CEO is yet to be disclosed, he announced that a decision has already been taken.

Berkshire is a conglomerate which houses over 80 different businesses, along with equity investments in many companies. The company has seen its earnings fluctuate from one quarter to another due to heavy exposure to stock option derivatives. However, most of these gains/losses are unrealized.

Other than the derivatives related earnings fluctuation, looking closely, we see that most of Berkshire’s businesses – Insurance, Railroad, Utilities and Energy, Manufacturing, Service and Retailing have performed well throughout the year. However, itsFinance and Financial products continue to pose challenges, given ongoing soft housing markets and the surplus of traditional single- family homes for sale, which will continue to negatively affect the results.

However, unless the economy weakens in 2012, eachof the company’s businesses should again set a record, with aggregate earnings comfortably topping $10 billion.

We maintain our Outperform recommendation on the shares of Berkshire Hathaway. The stock, however, retains a Zacks #3 Rank, which translates into a short-term Hold rating.

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