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Berkshire Downgraded to Neutral

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We are downgrading our recommendation on the shares of Berkshire Hathaway Inc. (BRK.B - Free Report) to ‘Neutral’ from ‘Underperform’, following the company’s lower-than-expected earnings. Despite the miss, overall results reflected strong performance across all the business segments – Insurance, Railroad, Utilities and Energy, Manufacturing, Service and Retailing as well as Finance and Financial products.

Berkshire has grown over the recent decades by making numerous acquisitions. At present, the company has over 80 operating subsidiaries under it. These subsidiaries are operated as independent entities with respective managers responsible for operational decisions.

Berkshire’s property and casualty insurance business has been the key driver of growth. Its insurance and reinsurance businesses, such as Geico, have been positively contributing to the company's profits for a long time. Its insurance units generate strong "float", which is invested by the Chairman and CEO, Warren Buffet. Float represents funds that are held by an insurance business during the period when policyholders submit payment and funds are eventually paid out to settle claims. The insurance business maintains capital strength at exceptionally high levels. This strength differentiates Berkshire’s insurance companies from the competitors – Assurant Inc. (AIZ) and Reinsurance Group of America Inc. (RGA).

Berkshire’s economically sensitive non-insurance businesses – utilities & energy, and manufacturing, service & retail – are also performing impressively after suffering from the weak economy in 2009. The utilities and energy business is witnessing strong growth with increased revenues from BNSF, the railway which was acquired in February 2010. The segment accounted for more than 50% of the second-quarter profits. Although some units are dragged down by a weak economy, overall the company is performing quite well.

However, Buffett’s succession is the biggest matter of concern for the company’s shareholders at this moment. He is already in his eighties and has been suffering medical complications. Buffett announced that a competent successor has been chosen, but the identity remains undisclosed. Nevertheless, there is an air of uncertainty about the performance of the company under the new CEO.  In our view, the new management may find it challenging to enable the company to perform like it does under Buffett and Munger.

The stock retains a Zacks #3 Rank, which translates into a short-term Hold rating.


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