Berkshire Hathaway Is Trading At A Discount To Its Intrinsic Value

Jonathan Ball |

Berkshire Hathaway is undervalued by 17%

Berkshire owns Burlington Northern Santa Fe, the nation's largest railroad.

BNSF will be a major driver of earnings.

The stock should rise to $251 by 2020.

I think Berkshire Hathaway's Class B stock (BRK.B) is undervalued and has the potential to rise 17% to $251 by 2020.

Berkshire Hathaway has two classes of stock. The original A-shares (BRK.A), which closed at $320,000 a share on Sept. 28, and the more affordable B-shares, which closed at $214 a share. The company's current market capitalization is $528.4 billion. I believe that the shares are trading at a significant discount to its intrinsic value of $619.5 billion.

In order for market cap to catch up to one times book value, the stock would need to be $251, or 17% higher, than the $214 share price on September 28.

Berkshire is a multinational conglomerate holding company controlled by Warren Buffett, considered one of the most successful investors in history, and the third-richest person in the world. Based in Omaha, Neb., the company is involved in insurance underwriting, insurance investment income, railroads, utilities, energy, and other businesses. Overall it owns 63 subsidiaries.

For the second quarter, Berkshire's posted total revenue of $62.2 billion, a 9% jump over the year-ago quarter. Net income surged to $12 billion, or 4.87 cents a share, a 180% rise over the $4.2 billion, or $1.73 a share, in June 2017.

I shall break down how I come to this $619.5 billion valuation.

In the company's earnings statement for the quarter ended June 30, it reported equity investments equal to $197.2 billion, including Kraft Heinz. At the time, 70% of the aggregate fair value was concentrated in five companies: American Express (AXP) – $14.9 billion; Apple (AAPL) – $47.2 billion; Bank of America (BAC) – $19.7 billion; Coca-Cola (KO) – $17.5 billion and Wells Fargo (WFC) – $26.4 billion. Since the S&P 500 Index gained 7% in the third quarter, we will value this at $211 billion.

Add in the $111 billion worth of cash on the balance sheet and we're at $322 billion.

Next I looked at the non-public companies that Berkshire owns.

Since Berkshire doesn't break out the valuation of its individual parts,

I needed to get creative in valuing these subsidiaries. To get an estimated market cap for each of Berkshire’s non-public subsidiaries, I found a competitor with revenues of a similar size. Then I assumed the Berkshire subsidiary had the same market valuation.

Berkshire owns Burlington Northern Santa Fe (BNSF), the largest railroad in North America. Berkshire bought Burlington for $45 billion in February 2010. Since then the Dow Jones Transportation Average has advanced more than 200%. Burlington Northern Santa Fe posted second-quarter revenue of $5.9 billion, while its competitor Union Pacific (UNP) reported revenue of $5.7 million. Union Pacific has a market cap of $120.4 billion. I used this as a proxy for Burlington’s market cap and gave it the same value.

A significant amount of earnings growth will come from BNSF, which moves more crude oil than any other U.S. railroad, according to federal data.

Demand for rail transport is rising, according to Reuters, with production in West Texas and Canadian oil fields outpacing pipeline capacity.

"Railcars full of sand have helped producers unlock record amounts of crude in the Permian Basin. The resulting surge of crude supply has pushed regional prices well below the going rate on the Gulf Coast as pipelines needed to carry the oil to the market are full and the railroads are backed up with sand shipments," the Dallas Morning News reported in May.

The Permian is the leading destination for fracking sand shipments for two of the country's major rail service providers, Union Pacific and Burlington Northern Santa Fe, Joseph Triepke, founder of oilfield research firm Infill Thinking, told the paper.

The Dallas Morning News also reported inquiries to move Permian oil by rail have picked up, with BNSF and Union Pacific providing the long-haul rail shipment routes that will move the barrels from the Permian Basin to the U.S. Gulf.

Next I looked at Berkshire Hathaway Energy, a global energy business, which reported revenues of $5.0 billion. For comparison, NextEra Energy (NEE), reported revenues of $4.0 billion. NextEra’s market cap is $79 billion. Again, I’m using that as a proxy valuation for Berkshire Hathaway Energy.

McLane operates a wholesale food distribution business to retailers, convenience stores and restaurants. It reported revenues of $12.4 billion. A corporation with a similar business is Sysco (SYY). It reported revenue of $15.3 billion. Sysco has a market cap of $38 billion, which I will use for McLane.

Berkshire's most famous insurance company is GEICO, the country's second-largest private-passenger auto insurance company in terms of earned premium rankings. GEICO wrote $8.2 billion in premiums in the second quarter. Travelers (TRV) wrote $7.1 billion worth of premiums. Travelers’ market cap is $34.7 billion, which is what I will use for Geico.

In March 2011, the company acquired Lubrizol, a specialty chemicals company, for $9.7 billion. It was hard to find Lubrizol’s revenue. So I compared it to Celanese (CE), another chemicals company, which has a market cap of $15.4 billion.

Adding together the market caps for the large units I came up with $287.5 billion. Then I added the $322 billion from cash and the equity portfolio to come up with a subtotal market cap of $609.5 billion. Berkshire has a total of 63 subsidiaries. Subtracting the top five leaves 58 subsidiaries that I'm not able to value. I'm adding $10 billion to cover this, although I think they have a much greater value. That gives me a total market cap of $619.5 billion for Berkshire Hathaway. Which is probably very low as I’m undervaluing the 58 subsidiaries.

Mkt. Cap  of comparable  public corp. Berkshire Hathaway Assets
      Cash $111
      Stock  $211
Name Ticker Mkt. Cap Berkshire Subsidiaries  
Union Pacific (UNP) $120.4 Burlington Northern 120.4
NextEra (NEE) $79 Berkshire Energy 79
Sysco (SYY) 38 McLane 38
Travelers (TRV) 34.7 Geico 34.7
Celanese (CE) 15.4 Lubrizol  15.4
      Remaining Units 10
      Subtotal $297.5
Market Caps in Billions   Total Market Cap  $619.5
Our Market  Cap estimate   minus BH 619.5-528.4 = 91.1  
91.1/528.4 =  17% upside       
New Target  Price is $251      

Subtracting the current market cap of $528.4 billion I determined the company was undervalued by $91.1 billion. This means there is 17% upside to the stock, which should lift the price to $251.

This is a conservative estimate of intrinsic value of what all the businesses are worth.

Currently, Berkshire Hathaway is not making any large acquisitions and it's increasingly committed to a capital return program. Berkshire has a share buyback program. Buffet has said he wants to keep at least $20 billion in cash on the balance sheet, which leaves $90 billion to buy back stock

Ajit Jain, Berkshire's vice-chairman of insurance operations, is expected to become the number one man in the company when Buffett and Charlie Munger, his vice-chairman, retire. The company could use $90 billion of the cash available to buy back shares and could buy an additional $20 billion worth of stock a year going forward. This will lower the shares outstanding, raise the earnings per share and push the share price higher. At the end of August, Berkshire announced it had bought back shares, but did not release the number.

With the buybacks and the upside potential in the stock, I find Berkshire to be an aggressive buy.

Disclosure: I am/we are long BRK.B, AAPL, AXP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.