Barron's (Online); New York (Mar 25, 2022).
Warren Buffett is getting his groove back, and investors are thrilled.
After several years on the sidelines, the CEO of Berkshire Hathaway (ticker: BRK.A and BRK.B) is spending big again. In just a matter of weeks, he reached an $11.6 billion deal to buy insurer Alleghany (Y) for an attractive price and purchased a nearly 15% stake in Occidental Petroleum (OXY) worth $8 billion.
The rapid accumulation of Occidental shares has spurred speculation that Buffett wants to buy all of the company in a long-sought "elephant-sized acquisition" —his phrase—that could cost $70 billion. Such a transaction would excite the Berkshire faithful because it would put half of its nearly $150 billion of cash to work at a much higher return than the near-zero yield currently on its large holdings of Treasury bills.
Berkshire class A shares are up 19.6% this year, to $538,949, trouncing the S&P 500, which is off 4.7%. The stock, which closed at a record high on Friday, is also ahead of the S&P over the past 10 years. The class B shares ended the week around $359.
The stock isn't as cheap as it was in late 2021, when Barron's named it a top pick for 2022 . Yet it is still attractive, particularly for patient individual investors, given the company's diversified earnings stream and superstrong balance sheet. At a time of global turmoil, Berkshire remains American-oriented, with 85% of its revenue coming from the U.S. Its major businesses include the Burlington Northern Santa FeBurlington Northern Santa Fe railroad, Berkshire Hathaway Energy (a big utility), and Geico.
"I'm very pleased with the pace and magnitude of cash deployment in recent weeks," says James Shanahan, an analyst at Edward Jones, who has a Buy rating on Berkshire. "The story has been about stock buybacks, but with the valuation improving, buybacks are slowing."
Buffett ramped up Berkshire's repurchases in late 2020, and the aggressive pace continued into 2021 with a quarterly average of $7 billion worth of shares bought. Buybacks, however, slowed in the first two months of the current quarter, to $2 billion, Barron's estimates, based on the share count listed in the company's proxy.
Buffett is price-conscious and may balk at buying back much stock with the shares trading for over 1.5 times estimated March 31 book value. That is the high end of its price/book range over the past 10 years.
"We still find Berkshire undervalued, but less so than in past years given the stock is up more than 50% since year-end 2020," says Chris Bloomstran, chief investment officer of Semper Augustus Investments, a St. Louis investment firm that holds Berkshire. "It should likely outperform the market over the next 10 years."
He pegged Berkshire's intrinsic value at about $600,000 a class A share at year-end 2021. The current stock price discount to this estimate isn't large, but intrinsic value isn't static. It should grow steadily with Berkshire's rising earnings and potential gains in its $350 billion equity portfolio, led by Apple (AAPL).
Buffett focuses on intrinsic value, but doesn't give his estimate of that important figure. An understated measure of intrinsic value long favored by investors is Berkshire's book value, which has tripled in the past decade. It could grow at a high-single digit rate annually this decade.
Here's the math: Annual earnings are expected to total $30 billion this year, or a 6% return on book. If the equity portfolio rises at a 6% annual rate, that would add about three percentage points to book value. Factor in buybacks, and Berkshire's stock could rise at close to a 10% rate.
The biggest risks to Berkshire are a sustained drop in the stock market, a deep recession, and CEO succession. At some point this decade, Buffett, who is 91, probably won't be running the company, and his likely successor, Vice Chairman Greg Abel, 59, is a largely unknown quantity.
Still, the recent transactions stand to put Berkshire on the right path. Berkshire is paying about 1.25 times book value for Alleghany—below the average price paid for property and casualty companies in the past six years. And the effective price is closer to 1.1 times book—a steal—when factoring in the value of Alleghany's attractive non-insurance businesses.
Alleghany's board sold the company without an auction—a questionable corporate-governance decision, but great for Buffett. Berkshire, however, could get outbid during a 25-day go-shop period now under way.
And why does Occidental appeal to Buffett? He knows it well, having invested $10 billion in Occidental preferred stock, which has a lush 8% dividend yield, in 2019, when the company needed quick financing in a bidding war with Chevron (CVX) for Anadarko Petroleum that it won. Berkshire also got warrants on nearly 10% of Occidental's equity as part of that deal; they are now just below their exercise price.
Shares of Occidental have doubled this year, to $59. Even with the gain, the stock has a projected free-cash-flow yield of close to 20%, based on projected 2022 earnings.
Berkshire could combine Occidental with Berkshire Hathaway Energy to create one of the largest energy and utility businesses in the country. And an Occidental deal at $70 billion, or $80 a share, would be right in Buffett's wheelhouse.
Investment manager Bill Smead, whose Smead Capital Management holds Occidental stock, thinks Buffett wants the whole thing. "This would be nirvana for Buffett," Smead says.
And an Occidental deal could be a great capstone to Buffett's extraordinary 57-year run as Berkshire's leader.
Write to Andrew Bary at email@example.com
Warren Buffett Gets His Deal Mojo Back. That's Good for the Stock.
Credit: By Andrew Bary