No. of Recommendations: 47
For each Post of the Week, Manlobbi writes “The community wants, dare I say needs, your Shrewdness.” This has caused me to think about why most of our recent posts on our board are short term oriented. We share news about Ajit selling stock and wonder about the implications. We have a lot of posts concerning puts and calls – trying to profit from BRK’s volatility. We do on occasion have people post about their early involvement with BRK – posts I thoroughly enjoy. But we don’t talk much any more about fundamentals and factors impacting BRK long range.
We certainly have Shrewdness in abundance in our group. I recognize some names from the early AOL board. And many more from the Motley Fool board. There are a number of new (to me) posters, but they sure seem to know their way around BRK and business. We have at least 60 members based on past Rec counts – and doubtless more that continue to just lurk. There’s a lot of Shrewdness available.
So, I wonder – as I mentioned in a post some time back about a long lunch with a BRK friend – if maybe we’ve about talked BRK “out”?
In earlier days, we spent a lot of time on estimating IV and how to track it. We debated the value of float. We wondered about succession. And we admired Buffett’s continuing ability to find acquisitions and equity purchases even as BRK continued to grow the size anchor.
But lately, we’ve come to realize that finding homes for BRK’s cash flow and cash hoard is becoming increasingly difficult. We maybe see the end of an era.
Not that this makes BRK a bad investment. As long as it retains cash, and the market is willing to pay a multiple of that cash (added book value) we’ll still see some price gains. (Note: This is long term. Changes in market multiples can overwhelm this for years.) And we treasure the diversity and safety of the Berkshire holdings.
So now I come to one fundamental that maybe justifies more discussion. What does BRK do going forward with its continuing cash flow AND with the large existing cash hoard?
I’ll share my views on these subjects, and maybe some specific areas for discussion. The purpose is to disclose what I’m thinking and to seek other insights and corrections. (Here’s where it may get too long.)
Utilizing BRK Continuing Cash Flow
BRK continues to throw off a lot of cash. And added float. I’ve tried to look at how much might be reinvested internally, and then how much is available for external investment.
Internally with business growth there is some need for added working capital. A simple measure would be growth in Receivables and Inventory minus Payables. But it’s damn hard (for me anyway) to sort out the Receivables minus Payables cleanly from what BRK discloses. BRK seems to run a pretty tight ship in this regard. There is a spread, but it doesn’t seem to be growing much. BRK does publishe inventory figures for Ins + MRS. And probably BNSF and BHE in separate documents. I haven’t researched that for this post.
I suspect Greg has paid a lot more attention to this area than Buffett did. I looked at the working capital estimates at the stockanalysis web site –for the period 2019 to TTM. It has bounced around a lot. Up several billion, down several billion recently. Averaging 2019 to last TTM, maybe it’s $2-3 billion growth a year? Not a stable period for forecasting.
BRK breaks out figures for capex and depreciation by business segment. Backing out BNSF and BHE (see below), the MSR businesses consume $1-2 billion a year over depreciation. So maybe $3-4 billion a year total working capital ex BNSF and BHE?
I back out BNSF and BHE because they basically fund themselves in a regulated business environment. They borrow cash for their business needs (capex and working capital), not look to BRK for it. And BRK HQ keeps its distance. It doesn’t guarantee their debt. For both liability and regulatory reasons, it acts to try to preserve their separate identities. At least that’s my take – more skilled analysts may disagree. This is one area where I seek discussion.
This brings up a bigger issue. It’s common to hear people talk about the big opportunities that BNSF and BHE offer for consuming BRK cash at a reasonable return. But they don’t actually use BRK cash - except maybe for a big acquisition. Then it would probably be in the form of a preferred loan that would pass regulatory review in setting prices. BNSF does send dividends to BRK HQ for reinvestment. BHE doesn’t – it retains all earnings. The only money that BHE sends to HQ is a small amount of interest plus some significant tax credits. Do others see this differently?
If I’m roughly right in the foregoing, then maybe only 10-12% of operating earning plus float changes (ex. BHE) are reinvested within BRK operations. The bulk of it must find a home elsewhere. Outside the regulated businesses, Buffett has built a collection of low capital intensity businesses!!
Now there are still buybacks. Here others can offer much more than I can contribute. In theory, there will be X% of trading days when BRK is trading below a conservative estimate (now by Buffett) of IV. On those days, BRK can purchase Y% of trading volume without moving BRK prices up to the cut-off price. So multiplying these factors, BRK can consume Z% of new cash flow in buybacks. I haven’t the foggiest guess what these factors are. (I’m excluding rare market crashes – i.e., what would be a normal expectation over time?) This is where the put/call traders who track such can help us understand expectations.
There are occasional opportunities for block purchases. These seem to come primarily from gifts to charity. I doubt Buffett pays much below market price for such purchases. He wouldn’t stiff charities – not his style. How many heirs will be willing to cash in below market prices and competitive bidding?
This only leaves dividends as a last resort use of operating cash flows. With the overwhelming number of long-rich BRK shareholders who don’t want dividends for tax purposes, I can’t expect any dividends until after Buffett is gone.
So my view is that some significant part of new cash flow must go into new investments – absent a very favorable buyback period. As the Red Queen stated to Alice, we must run fast to stay even.
Utilizing BRK’s Cash Hoard
Here I’m talking about those existing cash equivalents above what Buffet considers a reserve for unexpected Insurance and other events. These once had limits that we thought Buffett would never exceed – but that’s now all changed.
Or has it? Jim points out that as a percent of assets, we’re not that far above historic norms.
In what follows, I’m assuming that Buffett wants to reinvest $150-200 billion of this. But only at prices favorable to BRK shareholders. And he’s decided to wait for the opportunities. And even build more cash for such.
My view is that Buffett believes a major market downturn WILL provide him large opportunities for investing this cash. He has even stated that he wants to do a better job this time than he did during the last major downturn. Then he invested significant cash in short term support of companies and made good money. But only BAC seemed to be a long-lasting investment. And now he’s cutting back on BAC. He says he wants to make longer lasting investments in the next opportunity.
Given how high above history current market prices are, how much must the market drop before Buffett acts? And with the Fed fighting for a soft landing without a major recession, how long might this take? As the Fed cuts interest rates, the earning on retained cash drop. And discount rates on earnings drop driving stock prices still higher. Not a rosy near term outlook.
Will it take a major external shock for this opportunity to happen? War and a debt crisis from excess long term debt would seem to be the major potential events outside the Fed’s control. What else?
Moving on, now comes the question of competition for equities and acquisitions assuming a major downturn occurs. There’s no point in rehashing that competition from PE and retirement funds that now exists versus the halcyon days when Berkshire was the lender of last resort. Can BRK expect to achieve that position again? Or will the government intervene?
I’ll divert for a moment on a related topic. Buffett has a number of self-imposed restrictions on investing. Mostly these revolve around no negotiation, one-and-done offers. I don’t expect him to change in his lifetime. Will this change after he is gone? Will the board controlled by the Buffett family view this as a violation of the Berkshire culture? Will this be necessary to compete for future investments?
The exception to the foregoing scenario would be a massive “whale” acquisition such as Chubb. Or even Mars? I wouldn’t expect Buffett to overpay. Would he fully pay?
I don’t have firm thoughts about the many questions I’ve raised. What I do feel is that I need to be prepared for a long wait to see BRK redeploy cash in any major volume. And to be both positioned and willing to ride out a tough period in the interim.
I’ve already sold the last of my BRK in the tax deferred IRA. I’m basically locked into holding my non-IRA BRK, still the majority of my portfolio, because of capital gains taxes and the hope of a step-up for my heirs. Then they can decide if they have better options.
What are you folks doing?
