Berkshire after Buffett: One thing may not change
Warren Buffett continues to man the helm at Berkshire Hathaway (BRK.A, BRK.B) as its chairman, CEO and investment manager. But are investors ready to embrace his coming -- though still unscheduled -- retirement? Would they be all in for the long haul even after a new leader takes over?
Shareholders have had a chance for more than several years now to jump ship if they felt Berkshire would go adrift without the leadership of the legendary billionaire investor, who turned 85 in August 2015. Buffett has been chairman and CEO since 1970, and Vice Chairman Charlie Munger, who turned 92 at the beginning of this year, has served in that position since 1978.
Berkshire, which has grown through acquisitions, is structured as a holding company that fairly reflects the nation's economy: It has subsidiaries operating in insurance and reinsurance, energy and utilities, finance, freight rail transportation, manufacturing, retailing and service businesses. The core business of insurance is run primarily through GEICO and the Berkshire Reinsurance Group, and the second-largest segment is led by the Burlington Northern Santa Fe railroad.
The chief question is whether the quality of investment returns and capital allocation at Berkshire will continue to satisfy investors as they have over the years even after Buffett retires. He's the largest shareholder of Berkshire, which has two classes of common stock: Class A shares, which have voting rights and currently trade at about $207,945 a share, and Class B stock trading at around $138 a share, down from its 52-week high of $148.57. Buffett owns a 33.9 percent voting stake and a 19.6 percent economic interest in Berkshire.
Most interesting, more and more major shareholders are becoming convinced that they should stick with Berkshire. They've been increasingly assured that with Buffett's decentralized management style -- unit managers operate independently and make their own business decisions -- a solid structure has been put in place that would enable Berkshire to operate soundly even after his departure.
One reason is that in most cases, the executives running Berkshire's subsidiaries are the same people who sold their companies to Buffett. So, they have a real vested interest in the businesses they're operating. Both Buffett and Munger have on many occasions reassured shareholders and investors that the company's positive results will continue, in part because of the strong momentum in the underlying businesses, resulting from durable competitive advantages.
"Having been with the stock, off and on, for 20 years now, we aren't thinking of leaving it after Buffett departs since we're convinced the team that will take over will continue his investment style and his prudent but progressive manner of management," said the chief investment manager in the U.S. of a large Swiss-based bank, who preferred not to be named. "Berkshire shares have been a formidable holding -- and winner -- in our equity portfolio, and we are confident it will stay that way," he added.
Another wealth manager at a major Wall Street investment bank noted that there could be "initial rush selling" once Buffett announces the exact date of his retirement, but "that would definitely inspire us to jump in and buy more shares when the stock tumbles as a result." He said Berkshire is one of the important market plays on the economy. This manager also preferred not to be identified.
Catherine Seifert, equity analyst at S&P Global Market Intelligence, said she's maintaining her "buy" rating on Berkshire's stock, with a target price of $152 per Class B share, or 18.8 times her 2016 earnings projection of $8.10 a share, which is in line with historical averages. And for 2017, Seifert expects Berkshire will see earnings rise to $8.50 a share. "We think Berkshire's ability to grow revenue throughout economic cycles will help buoy the shares," she added.
Berkshire recently reported its fourth-quarter results, with pretax operating earnings leaping 26.4 percent from a year ago, and book value per Class A shares rising 6.4 percent year-over-year to $155,501. Buffett's leadership has resulted in the company's book value per share rising at a compound annual rate of 19.4 percent from 1965 to 2014, vs. the S&P 500's index's total return of 9.9 percent.
"There was little in wide-moat-rated Berkshire Hathaway's fourth-quarter and full-year results, which were relatively mixed, that would alter our long-term view of the firm," said Greggory Warren, senior equity analyst at Morningstar. And "we don't expect to make any changes to our $255,000 per Class A and $170 per B share fair-value estimate," he added.
But he believes that because of the size of Berkshire's operations, the company will struggle to generate similar levels of growth longer term. Warren expects Berkshire will continue to put money to work in value-creating projects in the medium term, much like its investments in Kraft Heinz and Precision Castparts this year, but Berkshire may become a victim of its own successes in the short term.
Warren cautions that the "huge sums of excess cash Berkshire generates on an ongoing basis will ultimately limit its ability to produce outsize returns."
On the issue of who'll succeed Buffett, the company has announced that it will split his roles as chairman, CEO and investment manager. A successor to Buffett as CEO has been chosen, but the person's identity hasn't been made public. Morningstar's Warren believes Buffett's son, Howard Buffett, will serve as nonexecutive chairman and Ajit Jain, who heads Berkshire Hathaway Reinsurance Group, will be offered the CEO role as the board's main choice to run the company.
Warren believes Jain "understands risk better than anyone else in the company" and recounts that Buffett has admitted on many occasions that Jain "probably made more money" for Berkshire than Buffett over the years.
Buffett's two investment lieutenants, Ted Weschler and Todd Combs, are expected to be named Berkshire's chief investment managers. "We continue to be impressed by the work of Weschler and Combs," said Warren, and what both have done -- "being more involved in the investment process overall than what we were expecting them to be at this point in their tenure," noted Warren.
Expressing confidence in Berkshire's future, S&P's Seifert said her continued "buy" rating reflects "our view that Berkshire's ability to grow its revenue base (both organically and through acquisitions) and maintain margins, despite a mixed economic outlook, will enable the shares to "retain their premium valuation -- versus the broader market and the company's closest peers."