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Berkshire Down on Cat Losses

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Berkshire Hathaway Inc. ( (BRK.B - Free Report) reported its first quarter 2011 operating earnings of $1.64 per share, which marked a 49% year-over-year drop. The deterioration was caused by a decline in operating earnings from its insurance businesses that suffered due to high catastrophe claims.

However, net income, which takes into account investment and derivatives, came in at 61 cents per share, down 59% year over year. The plunge in net income was attributable to a loss of $136 million in investment and derivatives during the reported quarter, as against a gain of 1.7 billion in the year-ago quarter.

Total revenue climbed 5.3% year over year to $33.7 billion, primarily due to increase in revenue derived from its Railroad, Utilities and Energy segment.

Segment Results

Insurance group reported revenue of $8.7 billion, almost unchanged from the prior-year quarter. While net premium earned remained constant year over year at $7.5 billion, net investment income was down 2.7% year over year.

The segment witnessed a net underwriting loss of $1.3 billion in stark contrast to net underwriting gain of $345 million recorded in the prior-year quarter. This was led primarily by losses of $1.1 billion from Berkshire Hathaway Reinsurance Group on account of several significant natural calamities such as earthquakes in Japan and New Zealand as well as floods and cyclone in Australia in 2011. After-tax losses from catastrophes in the prior-year quarter stood at approximately $340 million.

Railroad, Utilities and Energy: Total revenue increased 8.8% year over year to $7.4 billion. The segment’s 61% revenue came from Burlington Northern Santa Fe, the railroad company, which was acquired in February 2010.

Rail demand is bouncing back with an increase in industrial and agricultural activity as well as reviving consumer demand, a trend that is expected to continue. However, revenue from MidAmerican declined 3.3% year over year to $2.9 billion.

Manufacturing, Service and Retailing:  Total revenue increased 7.8% year over year to $16.6 billion, led by a 40% surge in Marmon’s revenue and 4.5% hike in McLane’s revenue. Revenue from the segment’s other manufacturing activities for the quarter stood at $4,553 million, a 12% year-over-year increase.

The growth in revenues reflected higher sales of apparel products (7%), building products (8%) and recreation vehicles, metal-cutting tools, and systems for grain, poultry, egg and hog production (27% in the aggregate). While the first quarter 2011 revenue from the building products group increased over 2010, these businesses generally continue to be negatively impacted by slow construction activity, particularly in the single-family housing markets.

Finance & Financial Products: Total revenue declined 6.6% year over year to $913 million, led by 12.4% drop in revenue from the manufactured housing business, Clayton Homes, which continues to be adversely affected by the soft housing market and the surplus of traditional single-family homes for sale. However, the drop was partly mitigated by a 12.7% increase in revenues from furniture/transportation equipment leasing segment.  

Berkshire, the Omaha based company, continues to grow its balance sheet. Consolidated shareholders’ equity or net worth as of March 31, 2011 was $160.1 billion, reflecting an increase of 1.8% from December 31, 2010.

On March 13, 2011, Berkshire and The Lubrizol Corporation entered into a merger agreement. As per the agreement, Berkshire will acquire all the outstanding shares of Lubrizol common stock for cash of $135 per share. The aggregate merger consideration is expected to be approximately $9.0 billion.

The acquisition is subject to the approval of Lubrizol shareholders and also to various regulatory approvals as well as other customary closing conditions. It is expected to close in the third quarter of 2011.

Though the quarter’s results were affected by catastrophe claims, we do not expect such high claims at least for the rest of the year. We hold a positive view on the company’s numerous businesses and expect the company to post solid earnings going forward.

The stock carries a Zacks #3 Rank, which implies a Hold recommendation over the near term (1-3 months). We rate the shares Outperform over the long term (6+ months), as the controversy regarding Buffett’s successor gets clearer.

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