Building Out Expectations at Berkshire
Buffett's company has been among the safest investments in history, growing by thousands of percent in the past 30 years at a relatively steady pace. Since 1964, Berkshire has posted a jaw-dropping 2.5 million percent gain on a per-share basis.
In the course of Buffett's tenure, the company that was built out of a beleaguered Massachusetts textile company has come to be a half a trillion-dollar giant made up of leading insurance agencies, utility providers, fast-food chains, real estate brokerages, and even major railroad companies.
"From lollipops to locomotives" in Buffett's parlance.
However, the reliable investment has lagged well behind the market and many of its major holdings as of late, challenging some of the traditional optimism that abounds on the octogenarian-led conglomerate.
Berkshire shares have been largely flat over the past six months, while the S&P 500 has posted roughly a 7% gain. The S&P has nearly tripled Berkshire's gains in 2019 as well.
It will be incumbent upon the fourth richest man in the world to build confidence in the ability of his company to continue its strength in the future, as Buffett will not be leading it forever.
He has implored investors to see the forest from the trees on Berkshire's sum-of-the-parts story for the long term, arranging the business into five "groves." The portfolio of non-insurance businesses was noted as the most valuable arrangement of trees in Buffett's forest enclosure, followed by its equities portfolio, then controlling interest in select companies, then fixed-income holdings and the company's fortress balance sheet, and lastly the property-and-casualty insurance business.
"Berkshire's value is maximized by our having assembled the five groves into a single entity. This arrangement allows us to seamlessly and objectively allocate major amounts of capital, eliminate enterprise risk, avoid insularity, fund assets at exceptionally low cost, occasionally take advantage of tax efficiencies, and minimize overhead," Buffett explained in a letter to shareholders in February. "At Berkshire, the whole is greater - considerably greater - than the sum of the parts."
History certainly backs up that claim, despite recently disappointing performance.
Given Buffett's advanced age, the company's succession plan is likely to be one of the most pressing issues investors will want to hear more about on Saturday.
Buffett will turn 89 years old on Aug. 30, and while he continues to credit his diet of Coca-Cola (KO) and See's candies for continued health, a successor will need to be named sooner rather than later.
Buffett's number two, Charlie Munger, is actually older than Buffett, closing quickly on centenarian status.
Ajit Jain, head of insurance activities, and Greg Abel, who is in charge of all other business areas, are seen as the most likely future leaders of the sprawling business. The moves to give each man a firmer hand in recent years have been seen as a sign that Buffett is gradually letting go of the reins.
"Berkshire is now far better managed than when I alone was supervising operations," Buffett wrote in a letter earlier this year. "Ajit and Greg have rare talents, and Berkshire blood flows through their veins."
Dark-horse picks among oddsmakers also include star investment managers Ted Weschler and Todd Combs,
Whether a pick is made to fill Buffett's shoes has been a question for some time. The shift in corporate structure in recent years suggests a firmer decision could be on the way.
Buffett will likely be called upon to answer for some of his more recent movements.
"We are thrilled to have Berkshire Hathaway's financial support of this exciting opportunity," Occidental CEO Vicki Hollub said in a statement.
Buffett's backing not only aids Occidental as it now needs to borrow less for its proposed massive buyout, but adds the clout of Buffett's name.
"Berkshire Hathaway is almost like an 800-pound gorilla in terms of financing power, and the tie up between them and Occidental shows how committed Occidental CEO Vicki Hollub is about getting this deal done," TheStreet's Action Alerts PLUS team said.
They concluded that the entrance of Buffett into the Anadarko buyout sweepstakes stacks the deck for Occidental and should allow them to beat out Chevron's initial $65 per share offer.
So, what's in it for Warren?
Occidental said Berkshire Hathaway would receive 100,000 shares of preferred Occidental stock that pay at an 8% dividend, above the 5% currently generated. Berkshire would also get a warrant to buy $5 billion of OXY stock at $62.50 per share, above its current market price.
"Although the market has largely viewed Berkshire Hathaway's entry as supportive for OXY's cause, signs of shareholder pushback highlights a potential risk," Piper Jaffray analyst Ryan Todd noted, expressing the concerns that remain on Buffett's plan. "T Rowe Price, OXY's 6th largest shareholder, is reported to have expressed opposition to the deal and worries that the BRK entry could allow OXY to avoid a shareholder vote."
He added that simply using Berkshire to avoid a full vote, as was initially anticipated, would be "ill advised."
"The terms are attractive for BRK, expensive for OXY," Morgan Stanley analyst Devin McDermott said.
As such, Buffett may be required to speak to Occidental shareholders about his surprise deal as much as he addresses the needs of Berkshire shareholder attendees.
The big headline from Friday morning is Buffett's announcement that Berkshire has bought in on Jeff Bezos', noting that a stake in Amazon (AMZN) will be reflected in the upcoming 13-F filing for the company.
More details on the investment and its size will be hotly anticipated, especially as Amazon continues to approach all-time highs above the $1 trillion market-cap threshold after a nearly 30% run to the upside this year.
"Undoubtedly, an investment in Amazon is a strong endorsement from Buffett and his team. The company's long track record of delivering investment returns speaks for itself, and there tends to be a giddiness whenever it is revealed what the firm's next stock pick is," Jim Cramer's Action Alerts PLUS team acknowledged. "But consider this: Does Berkshire's newfound investment in Amazon improve e-commerce margins, increase Amazon Web Service sales, or help the company gain market share in Advertising? Of course, the answer is no."
As such, more details on the upside Buffett foresees and how much of the stock he was willing to scoop up will be key details hopefully elaborated on Saturday.
As some question the Amazon investment, it is helpful to recall Buffett's big bet on Apple (AAPL) in recent years, one that many second-guessed upon his entrance into the name in 2016.
Apple is now Berkshire's largest holding, with the company holding more than 5% of the Cupertino, California-based smartphone manufacturer. Since the time of his initial investment of about 10 million shares, the stock has more than doubled.
The move to invest heavily in Apple was a quizzical one to many at the time, given Buffett's reticence to invest in tech names.
"We try not to get into things that we don't understand," Buffett said in the mid-90's, explaining that tech was not his forte, as evidence by IBM (IBM) remaining his lone tech investment for decades.
Nonetheless, Buffett later noted that he missed the boat early on with both Apple and fellow tech behemoth Alphabet (GOOGL) . It would appear that he is seeking to avoid a similar fate with Amazon.
Apple is likely going to be a favorable talking point for Buffett on Saturday as the stock has shown a remarkable recovery from a tumultuous 2018 that had the company taking heat for its over $50 billion holding.
"I was pleased with what they reported," Buffett told CNBC on Friday morning. "What they talked about and reported is consistent with the reason we own $50 billion-plus of Apple."
He added that the company has not changed its holdings in Apple in the first quarter to his knowledge, a positive sign given the stock has run nearly 50% since its bearish pre-announcement to start the year.
Tangentially, this again shows the more hands-off role that Buffett has now and as tech names increase in importance to each portfolio.
Every investor has a bad investment and Buffett is no exception to this rule. So far, Kraft Heinz (KHC) has been symbolic of that rule for Berkshire.
Shares of the consumer staples stock have lost one-third of their value since it reported its full-year earnings for 2018 in February, battered by shifting consumer trends, massive write-downs on Oscar Mayer and Kraft brands, the disclosure of an SEC investigation, and misguided cost-cutting initiatives.
"There is no question we are disappointed that profitability did not ramp up with consumption gains as anticipated. We were overly optimistic on delivering savings that did not materialize by year-end." CEO Bernardo Hees admitted to analysts during the stunning earnings earlier this year. "For that, we take full responsibility. And we have taken steps to ensure this does not happen again by touching planning process, procedures and organization structure."
Berkshire lost over $4 billion on the stock's slide.
"I was wrong in a couple of ways on Kraft Heinz," Buffett told CNBC in the aftermath. "We overpaid for Kraft."
Berkshire and Brazilian private equity firm 3G Capital merged Kraft Foods with H.J. Heinz in 2015, after purchasing the latter company in a joint effort in 2013. The stakes left both 3G and Berkshire with about 25% interest each in the new Kraft Heinz.
The parent has already taken steps to righting the ship, making the organizational changes he expected. It is unclear if he knew at the time that these changes would start at the top.
It was announced last month that long-time Anheuser Busch InBev (BUD) executive Miguel Patricio will succeed Hees as CEO.
"Miguel is a proven business leader with a distinguished track record of building iconic consumer brands around the globe, driving top-line revenue growth through a focus on consumer-first marketing, innovation, and people development," said Alex Behring, Chairman of Kraft Heinz's Board of Directors upon the announcement.
Marcel Herrmann Telles, another board director, added that Patricio's track record turning around AB InBev's Chinese business shows he has the mettle to help KHC recover and deleverage its balance sheet that couldn't be further from Berkshire's fortress state.
As Buffett's shareholder letter fell too close to the Kraft Heinz earnings catastrophe to be addressed, shareholders will likely be eager to hear his thoughts as he continues to hold firm on his large position.
At the very least, acknowledgement of mistakes let us know that even the Oracle of Omaha is human at the end of the day.
Shares of Berkshire Hathaway trended positively in midday trading on Friday, up about 1% on the eve of the shareholder meeting.
The event Saturday will be webcast by Yahoo, beginning at 9:45 a.m. ET. Click here to tune in tomorrow.