Berkshire's Energy Edge

 | May 05, 2013 | 8:00 AM EDT  | Comments
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Warren Buffett's Berkshire Hathaway (BRK.A) owns a number of utility and energy companies. Through its subsidiary MidAmerican Energy Holdings, Berkshire owns local distribution companies, pipelines, transmission lines, power plants and green energy facilities. Unlike utility companies, Berkshire does not pay dividends.

That lack of payouts is an unusual competitive advantage in the energy sector. Retaining earnings enables MidAmerican to reinvest, grow and become the best-in-breed.

The ability to retain earnings also makes Berskshire's utility and energy component unusually stable for shareholders. Because there are no distributions, the stock's value is not distorted by investors exiting Treasuries and chasing after what they believe to be relatively safe dividends.

To see how utility yields can distort market capitalizations, look at Dominion Resources (D), Duke Energy (DUK) and Exelon (EXC). These utility stocks have price-to-earnings ratios above 20x. If Treasury yields change, these stocks could find themselves whipsawed.

Berkshire Hathaway's stock is not distorted by investors chasing after yields. Unlike executives at Duke, Entergy (ETR) and Pepco Holdings (POM), MidAmerican's execs are not threatened by payout ratios.

But if analysts such as Real Money Pro's Doug Kass are looking for alpha, they will not find it in Berkshire's energy companies. MidAmerican's revenue is regulated to provide prudent but not excessive margins.

MidAmerican represents a small portion of Berkshire's portfolio. In 2012, it contributed only 7.3% to Berkshire's top line and 9% to its bottom line. Worse, those contributions have been declining over the last three years.  

Nevertheless, MidAmerican's operations are substantial. It owns $50 billion of assets. Its implied market capitalization is about $20 billion (assuming a P/E ratio of 15). These metrics suggest that MidAmerican is comparable to Edison International (EIX) Sempra Energy (SRE), FirstEnergy (FE), PPL (PPL) and American Electric Power (AEP).

MidAmerican's assets serve 7 million retail energy consumers. It distributed 118 billion kilowatt-hours of electricity over 177,000 miles of distribution lines. It distributed 1.84 billion decatherms of natural gas over 38,600 miles of distribution systems. It owns or contracts 22,000 megawatts of power.

MidAmerican owns several subsidiaries, including MidAmerican Energy, which provides regulated electric and natural gas service to 1.4 million customers in Iowa, Illinois, South Dakota and Nebraska.

MidAmerican owns solar, wind, geothermal and hydro energy assets in California, Arizona, Illinois and Hawaii. It sells most of its production to regulated utilities.

MidAmerican owns Electric Transmission Texas. It has indirect ownership of Prairie Wind Transmission. It is engaged in various joint ventures to develop, own and operate transmission assets in several regions in North America. MidAmerican Transmission competes against ITC Holdings (ITC) and AEP.

MidAmerican owns PacifiCorp. It operates as Pacific Power in Oregon, Washington and California, and as Rocky Mountain Power in Wyoming, Utah and Idaho. PacifiCorp's generating plants have a net owned capacity of 13,853 megawatts.

MidAmerican owns Northern Powergrid, which, like PPL, is one of the largest distribution companies in the U.K. Northern Powergrid serves 3.9 million customers in an area covering about 10,000 square miles.

MidAmerican owns Kern River and Northern Natural Gas; both are interstate natural-gas pipelines regulated by the Federal Energy Regulatory Commission. Kern River's system extends from Wyoming through Utah and Nevada to California. Northern Natural Gas' system extends from Texas to Michigan. With access to access to six major gas supply basins, Northern provides cross-haul and grid transportation between other interstate and intrastate pipelines.

While MidAmerican is large and diverse, it is not a wholly owned subsidiary of Berkshire Hathaway. Slightly more than 10% is owned by others, and Warren Buffett has a personal stake. The Walter Scott Jr. family and CEO Gregory Abel own 4,695,940 shares. The balance is owned by subsidiary directors and officers.

This provides background for Doug Kass, who was the "credentialed bear" at Berkshire Hathaway's annual meeting Saturday. He joined two other analysts to ask about one-third of the questions at the meeting, which included Berkshire's non-insurance subsidiaries.

If I were Kass, I'd have considered asking several questions about MidAmerican. Specifically, how does Berkshire plan to grow MidAmerican? How do subsidiaries such as rail, energy and derivatives work together to deliver unique value for shareholders?

It seems that MidAmerican owns disparate assets on the electric power and natural gas value chains. How do those assets work together? Does Berkshire have a wellhead-to-burner-tip vision for its energy businesses? If so, what is that vision?

Does MidAmerican have a "rank and yank" system to dispose of low-yielding assets? What are Berkshire and MidAmerican's low-yielding assets, and why are they retained? Finally, since $50 billion of shareholders' assets produce only $1.3 billion in earnings, how does MidAmerican help Berkshire take advantage of growth opportunities?

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