With the naming of two co-vice chairmen this week, Warren Buffett appears to have set the Berkshire Hathaway (BRK.A) (BRK.B) succession plan in motion. Obviously, Buffett, a spry 87 years old, is not going anywhere, but with Ajit Jain and Gregory Abel now one rung below Buffett on the Berkshire ladder, the list of the Oracle's potential successors is effectively two.
So, for a company and its leader that are worshiped with near-deity status, it is fitting that the next leader of Berkshire will be either Jain or Abel. Those two are not found East of Eden in the Land of Nod, but just west of the Missouri River on Farnam Street.
Berkshire is a collection of mostly slow-growing, domestically-focused businesses with relatively strong cash flow margins and virtually no technological advantages to speak of. What companies benefit most from the move dictated in the Tax Cuts and Jobs Act (TCJA) to a 21% corporate tax rate? Well, you guessed it: businesses with a high proportion of domestic revenues, good margins and an accounting system that is much closer to cash-based than the practices used by tech giants, for instance, which rely heavily on non-GAAP adjustments for revenue recognition and timing of expenses.
The market has recognized this, and as of the close of trading on Jan. 10 Berkshire's A and B shares have outperformed the S&P 500 in the trailing one-month, three-month and one-year periods while still lagging over the three-year and 10-year periods. Berkshire shares are going to perform well in a rising market, and the Trump Jump is a bull market like none ever seen in the history of the U.S. stock market.
So, it's a great tailwind for Berkshire, but professional investors look for companies that can generate economic value over the course of a business cycle -- not just when things are really good -- and that points to Berkshire's existential problem. Berkshire is rife with companies that benefit most from the TCJA, but that legislation just adds to the company's most pressing financial problem -- too much cash -- and the fact that none of that cash is returned to shareholders. Berkshire has not bought back its own shares in more than five years and Buffett has always been adamantly opposed to paying a common dividend.
To keep up with the market, therefore, Berkshire must always put its cash to good use, and that has not been the rule of late. Berkshire's last major acquisition was Precision Castparts, which closed in January 2016, and, obviously, Berkshire's cash hoard grows, not dwindles, with each successive quarter.
How should Jain and Abel advise the Oracle to deploy Berkshire's capital? Well I can think of three places:
- I was tempted to be cute and list "Energy. Energy. Energy." as the three places Berkshire should invest, but, really, the lack of natural resource producers is a huge hole in Berkshire's portfolio. The U.S.-listed E&Ps have a strong bias toward domestic production and I would think any and all are good takeout candidates for Berkshire. The largest U.S. E&Ps by market cap are ConocoPhillips (COP) , EOG Resources (EOG) , Occidental Petroleum (OXY) Pioneer Natural Resources (PXD) , Anadarko Petroleum (APC) and Marathon Oil (MRO) . Any of those "second-tier" producers would fit well in Berkshire's portfolio, especially with oil prices in the midst of an upward re-rating by the markets, with West Texas Intermediate crude prices nearly hitting $65/barrel Thursday.
- I left out Phillips 66 (PSX) and Valero Energy (VLO) in the last bullet, because those companies operate as refiners and marketers, not crude producers, but they would also fit well in the Berkshire corporate structure.
- After using the first two bullets on energy, I reserve the third for a tech company. Any tech company, really. Berkshire is so bereft of companies that are disruptive and/or innovative that it is a true chore to read its quarterly filings. From the lack of growth in McLane's food distribution market to the endless balance sheet adjustments necessary in the insurance/reinsurance business, Berkshire just doesn't include any companies with any real pizzaz. Heinz ketchup is not going to change the world, but autonomous vehicles (especially with electric powertrains,) artificial intelligence, and, yes, despite Buffett's disdainful comments on CNBC yesterday, even blockchain/cryptocurrency companies will alter the global economic landscape in the next five years.
I think the best time to shake things up is when the economic scenario is positive, and things just look so good right now. So, perhaps Jain or Abel could score points in the race to determine the successor at Berkshire by doing just that with a transformational acquisition.
-- This commentary was originally published on Jan. 12.
