Always treat others with respect and kindness, even if you disagree with them. Avoid making personal attacks or insulting others, and try to maintain a civil and constructive tone in your discussions.
- Manlobbi
Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A)
No. of Recommendations: 10
No. of Recommendations: 24
The esteemed Greg Warren’s and his thoughts on BRK valuation…more weekend reading. Enjoy!
It's a good summary, but to my mind, it doesn't adequately address what worries me, i.e. the concerns that Buffett himself has raised regarding regulators and their effects on the profitability of the railroad and, particularly, the energy utility. Here's what they say:
BHE also contended with an increase in energy operating expenses, including increases in estimated pretax loss accruals by PacifiCorp for wildfires (net of expected insurance recoveries) of $1.6 billion during 2023, plus higher interest expense and lower electric utility margin year over year.
We view this as a blip in BHE’s overall results. We continue to believe ongoing constructive rate-case outcomes will lead to EBITDA growth in an average 5%-6% range annually over the next five years for its regulated US utilities, even as it ramps up growth and operating capital expenditures.
And here's what Buffett said about the utilities (the worst parts bolded by me, and there are lots of 'em):
Our second and even more severe earnings disappointment last year occurred at BHE. Most of its large electric-utility businesses, as well as its extensive gas pipelines, performed about as expected. But the regulatory climate in a few states has raised the specter of zero profitability or even bankruptcy (an actual outcome at California’s largest utility and a current threat in Hawaii). In such jurisdictions, it is difficult to project both earnings and asset values in what was once regarded as among the most stable industries in America.
For more than a century, electric utilities raised huge sums to finance their growth through a state-by-state promise of a fixed return on equity (sometimes with a small bonus for superior performance). With this approach, massive investments were made for capacity that would likely be required a few years down the road.
With this model employed by both private and public-power systems, the lights stayed on, even if population growth or industrial demand exceeded expectations. The “margin of safety” approach seemed sensible to regulators, investors and the public. Now, the fixed-but-satisfactory return pact has been broken in a few states, and investors are becoming apprehensive that such ruptures may spread. Climate change adds to their worries. Underground transmission may be required but who, a few decades ago, wanted to pay the staggering costs for such construction?
At Berkshire, we have made a best estimate for the amount of losses that have occurred. These costs arose from forest fires, whose frequency and intensity have increased – and will likely continue to increase – if convective storms become more frequent.
It will be many years until we know the final tally from BHE’s forest-fire losses and can intelligently make decisions about the desirability of future investments in vulnerable western states. It remains to be seen whether the regulatory environment will change elsewhere.
Other electric utilities may face survival problems resembling those of Pacific Gas and Electric and Hawaiian Electric. A confiscatory resolution of our present problems would obviously be a negative for BHE, but both that company and Berkshire itself are structured to survive negative surprises. We regularly get these in our insurance business, where our basic product is risk assumption, and they will occur elsewhere. Berkshire can sustain financial surprises but we will not knowingly throw good money after bad.
Whatever the case at Berkshire, the final result for the utility industry may be ominous: Certain utilities might no longer attract the savings of American citizens and will be forced to adopt the public-power model. Nebraska made this choice in the 1930s and there are many public-power operations throughout the country. Eventually, voters, taxpayers and users will decide which model they prefer.
When the dust settles, America’s power needs and the consequent capital expenditure will be staggering. I did not anticipate or even consider the adverse developments in regulatory returns and, along with Berkshire’s two partners at BHE, I made a costly mistake in not doing so.
I have seen several assessments of Buffett's letter, the Morningstar one above, and also those by Tilson and Rationalwalk, and to my mind, none of them take these things very seriously; they all reassure us that Berkshire's sources of operating income are diverse, and when one is doing badly, like the utilities and railroad last year, others pick up the slack, insurance being the slack picker-upper this year. But Berkshire will not always have such favourable underwriting results, and I think it is legitimate to ask whether the utilities can really still be relied on to pick up the slack in future years, given Buffett's comments.
dtb
No. of Recommendations: 25
I have seen several assessments of Buffett's letter, the Morningstar one above, and also those by Tilson and Rationalwalk, and to my mind, none of them take these things very seriously; they all reassure us that Berkshire's sources of operating income are diverse, and when one is doing badly, like the utilities and railroad last year, others pick up the slack, insurance being the slack picker-upper this year. But Berkshire will not always have such favourable underwriting results, and I think it is legitimate to ask whether the utilities can really still be relied on to pick up the slack in future years, given Buffett's comments.
My theory for why analysts aren't taking those comments so seriously is because they're a combination of over the top and uncharacteristically whiny. He makes utilities and their investors sound like victims of some socialist conspiracy when, in fact, the utilities' infrastructure -- in many cases outdated and poorly maintained -- is generally to blame for the wildfires that bring about their liability.
It's particularly Rip Van Winkle-like to observe that nobody wanted to pay the "staggering costs" of underground transmission lines "a few decades ago." Well, duh. High-voltage transmission lines weren't causing massive wildfires a few decades ago. This might have been a subconscious note of regret about the enormous transmission infrastructure project BHE undertook years ago.
The oddest part is he makes it sound like all this just occurred to him. PG&E went into bankruptcy over its wildfire liabilities five years ago. I'm guessing that Greg Abel has been well aware of these developments all along. He just doesn't get to complain about them publicly. And it is true, of course, that there is more uncertainty, and perhaps more variability, in electric utilities' previously predictable returns in this environment. But that doesn't mean the model is broken. It just means some adjustments are required. Managers may have to turn off the auto-pilot.
The theory that this diatribe was aimed at regulators and/or politicians makes some sense. As a resident of the fire-prone western U.S., I can confirm that utilities are less popular now than usual. Of course there are politicians making confiscatory noises given the rolling blackouts and brownouts in California.
But the reference to Nebraska's public power district reminded me of an effort in Boulder, Colorado a few years ago to municipalize its power infrastructure. It, too, cited a nearly 100-year-old precedent, another Colorado town that established a municipal utility in the 1930s. Needless to say, the power grid has grown somewhat more complex and expensive since then. Boulder discovered that carving a municipality out of Xcel Energy's infrastructure was much more difficult than they had imagined. Various substations would have had to be duplicated to serve one side of the municipal border or the other. Despite city leaders deeply committed to the ideological project, years of legal and regulatory failure forced them to give up and sign a new franchise agreement with Xcel. They won some promises to get greener in the future.
Yes, high-voltage transmission lines in vulnerable areas will have to be buried or otherwise hardened against high winds. PG&E has proposed to bury a couple thousand miles at a cost, if I recall, of about $6 billion, or an additional $40 a month for ratepayers. Politicians and others will certainly grumble about such increases in the rate base, but unless they're willing to settle for a level of unreliability in electricity service that resembles developing countries, it's really the only alternative. Where's the money coming from for a public takeover of hundreds of billions of dollars worth of infrastructure? In fact, the current trend, fueled by public indebtedness, is the opposite -- governments divesting public infrastructure to private equity.
Climate change is going to require lots of adjustments in lots of places. In the western U.S., the electric grid needs to be hardened so it stops causing wildfires. Utility operators can kick and scream, but unless they want to follow in PG&E's footsteps, they will eventually accept it as a new cost of doing business. As will state Public Utility Commissions and ratepayers, grumbling all the way.
This is going to take a long time, but I can't think of a more likely outcome.
No. of Recommendations: 2
I liked pictures.
The graph of Berkshire Hathaway’s historical price/fair value ratio is worth a thousand words.
No. of Recommendations: 18
"and I think it is legitimate to ask whether the utilities can really still be relied on to pick up the slack in future years, given Buffett's comments."
Buffett's last comment on BNSF section:
A century from now, BNSF will continue to be a major asset of the country and of
Berkshire. You can count on that.
Buffett's last comment on BHE is much more negative.
A confiscatory resolution of our present problems would obviously
be a negative for BHE, but both that company and Berkshire itself are structured to survive
negative surprises. We regularly get these in our insurance business, where our basic product is
risk assumption, and they will occur elsewhere. Berkshire can sustain financial surprises but we
will not knowingly throw good money after bad.
BHE is a smaller fraction of earnings than the railroad though maybe we thought it would grow faster and longer. BRK/BHE explain that they will exit states that break the "the fixed-but-satisfactory-return pact" If they leave a state or two it might stop the spread.
If BHE profits decline linearly for 5 years and then becomes a zero and confiscated by the government, how much does that alter your value of BRK looking out 10 years? 9%? More? It is a good business but not a great business, right? I think most states will realize BHE is one of the best partners in the game and give them their good but not great returns to keep the lights on. It's a massive undertaking with massive amounts of capital needed so I suspect it will be OK in the end and continue to provide at least the income that it did in 2023. I suspect we've seen the floor on BHE's earnings. Anything can happen though so I am curious of what people think the hit would be in a worst case scenario.
No. of Recommendations: 9
"If BHE profits decline linearly for 5 years and then becomes a zero and confiscated by the government, how much does that alter your value of BRK looking out 10 years? 9%? More? It is a good business but not a great business, right? I think most states will realize BHE is one of the best partners in the game and give them their good but not great returns to keep the lights on. It's a massive undertaking with massive amounts of capital needed so I suspect it will be OK in the end and continue to provide at least the income that it did in 2023. I suspect we've seen the floor on BHE's earnings. Anything can happen though so I am curious of what people think the hit would be in a worst case scenario."
Exactly! This is the thing- states have the exact same incentive as Berkshire in terms of fixing the problem. All Warren did was point out the negative which is his fiduciary responsibility and also a part of his general makeup, but he didn't mention anything by way of a solution because frankly speaking there is none yet. Does anyone really think states expect to just dump this on corporations or that they want to undertake the massive investment involved in doing it themselves?
You can bet there are already extensive discussions going on between Berkshire and the states involved on solving the problem and there's a lot of ways to do that including the usual suspects- tax incentives, subsidies, guaranteed profits etc.
