Warren Buffett’s Worst Year Since 2009 Splits Investors

(Bloomberg) -- Bill Ackman piled in. David Rolfe exited.

Berkshire Hathaway Inc.'s rotation of investors over the past few months points to the question lingering over the conglomerate as it heads for its worst annual underperformance since 2009: Is it worth waiting for Warren Buffett to make a dent in his record $122 billion cash pile?

Ackman's stake in Berkshire, disclosed in August, is a bullish bet. His idea is simple: Growth at Berkshire's underlying businesses and the company's competitive position will boost earnings even if the funds aren't deployed. Rolfe, whose firm had been a Berkshire investor for decades, grew tired of waiting.

“He has missed this glorious bull market,” said Rolfe, chief investment officer of Wedgewood Partners Inc. His company, which oversees $2.2 billion, trimmed its Berkshire stake in the second quarter and exited completely in the third. “The bullish thesis that this massive amount of cash is going to come to bear incredible fruit -- hasn't.”

Berkshire's third-quarter results, set to be released Saturday, should give investors a sense of how Buffett is handling the “Niagara” of cash generation in a period with no major acquisitions to ramp up growth. Berkshire stock climbed 4.2% through the end of October, short of the 21% price gain in the S&P 500.

Part of that underperformance stems from disappointment that Berkshire's mountain of cash sits idle, UBS Group AG analysts led by Brian Meredith said in an October note. Buffett has sought out major acquisitions but has failed to strike a large deal in recent years amid what he called “sky-high” valuations.

“If you look at sort of all the ingredients in that stock, it's a stock without a catalyst,” Cathy Seifert, an analyst with CFRA Research, said in an interview.

Buffett, Berkshire's chairman and chief executive officer, has turned to share buybacks to deploy some cash, repurchasing $2.1 billion this year through the end of June. That's a “modest” amount, according to UBS analysts. JPMorgan Chase & Co., which counts Berkshire among its largest investors, repurchased more than $6 billion on a net basis in the third quarter alone.

Buffett was able to put some of his cash to work earlier this year. He agreed in April to invest $10 billion for preferred stock of Occidental Petroleum Corp., which was pursuing Anadarko Petroleum Corp. Berkshire didn't respond to a request for comment.

Some credit Buffett's patience for his ability to secure well-priced deals that have taken his company from a struggling textile mill to a conglomerate worth more than $500 billion. As the S&P 500 keeps setting records, sitting on the M&A sidelines might be the right move because of high valuations, according to analyst Meyer Shields.

“That's when everyone else is being greedy, in which case you should be fearful and that's very consistent with their philosophy,” Shields, of Keefe, Bruyette & Woods, said in an interview. “It does translate into doing nothing. But maybe nothing is the right approach or the best of all the bad alternatives.”

Rolfe said the biggest driver for Berkshire's growth will be the billionaire investor's ability to reinvest the funds at Berkshire, which enjoys what Buffett has called a “Niagara of cash-generation.” The record funds on the balance sheet and the cash coming from its multitude of insurance companies, retailers and energy businesses every quarter make that task challenging, he said.

“He has a gigantic task ahead of him,” Rolfe said. “If he is successful doing that, really successful, then Bill Ackman will be right and I'll be wrong.”

For now, Rolfe took the roughly $200 million that was invested in Berkshire and redeployed the vast majority into the stock of a company Buffett once said he regretted not betting on: Alphabet Inc.

Here are some other topics that might come up Saturday:

Kraft Heinz

Berkshire's bet on the packaged-food giant has stumbled in recent quarters as Kraft Heinz Co. grappled with writedowns, a management shakeup and investigations. Buffett, who teamed up with 3G Capital to help orchestrate the merger of Kraft and Heinz, has admitted that they overpaid for Kraft and said in February that he had no plans to sell or buy more of the company's stock.

Kraft Heinz shares surged 13% Thursday after the company reported strong earnings driven by higher prices for products such as macaroni and cheese. While sales beat estimates, they still declined from a year earlier, highlighting the challenge ahead for CEO Miguel Patricio.

Thursday's gain narrowed Kraft Heinz's loss this year to 25%, helping ease the pressure on the value of Berkshire's stake. Still, the holding value has fallen below how it's marked on Berkshire's books. That could mean that Buffett's company will take an eventual writedown, according to CFRA's Seifert.

“The Kraft Heinz deal is a big black mark on the track record of Berkshire's acquisitions,” she said in an interview.

Share Buybacks

Berkshire loosened its repurchase strategy last year, then bought back $928 million of stock during the third quarter of 2018. It has spent a total of $3.4 billion on repurchases since the policy tweak.

KBW's Shields says he expects Berkshire to report about $536 million in share buybacks. UBS analysts are assuming that Berkshire repurchased around $900 million of its stock in the quarter. Both estimates would outpace its repurchases in the second quarter.

“I don't think it's evolved enough,” Seifert said of Berkshire's buyback policy. “I think it was, in some respects, a way to placate shareholders.”

Insurance

Insurers including Travelers Cos. are warning about challenging legal issues. Travelers CEO Alan Schnitzer has said he's seen a “more aggressive” level of attorney involvement on some claims. That could factor into Berkshire's insurance results, according to KBW's Shields.

“Companies are acknowledging that the environment for litigation has gotten more difficult,” Shields said.

Shields also said that rate cuts at auto insurer Geico could weigh on margins, even if it sees faster policy growth.

And natural catastrophes hit during the quarter, including Typhoon Faxai and Hurricane Dorian. The typhoon, which pummeled Japan in September, caused as much as $7 billion in insured losses, according to risk modeler AIR Worldwide. Dorian tore through the Bahamas in the third quarter, leaving behind as much as $3 billion in estimated insured losses.

Rail Recession

U.S. railroads have been dealing with the fallout from trade disputes, leading to concerns about a “rail recession.” BNSF's rival in the Western U.S., Union Pacific Corp., reported third-quarter profit that missed analyst estimates and the steepest drop in carloads in three years.

UBS analysts said in a note that BNSF's volumes probably declined in the third quarter, but the railroad might benefit from a boost in revenue per car.

“They have one of the top franchises in the industry, but there's some cyclical pressures there,” Seifert said.

Market Swings

Gyrations in Berkshire's $200 billion stock portfolio now factor into net income, an accounting change that Buffett says investors should look past. Barclays Plc said the investment gains could total $7 billion before taxes.

To contact the reporter on this story: Katherine Chiglinsky in New York at kchiglinsky@bloomberg.net

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Dan Reichl, Josh Friedman

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