Warren Buffett’s Berkshire Hathaway wants to do a massive acquisition, says its insurance group can withstand a $US400 billion mega catastrophe that would ruin many of its competitors and picked up a $US29 billion gross boost to its bottom line in 2017 from the Trump tax cuts.
In his annual shareholder letter released at the weekend Mr Buffett made it clear his ambitions for a another big deal are being frustrated by high valuations for companies powered by cheap debt and the Trump tax cuts.
Mr Buffett admitted that finding things to buy at a “sensible purchase price” has become a challenge, and is a major reason Berkshire is sitting on $US116 billion of low-yielding cash and government bonds (the float in his insurance companies) in addition to $US170 billion in sharemarket investments as at the end of 2017.
Buffett said a “purchasing frenzy” binge by deal-hungry chief executives employing cheap debt has made that task difficult. Berkshire mostly pays cash for its acquisitions. It has been more than two years since Berkshire made a major purchase, the $US32.1 billion takeover of aircraft parts maker Precision Castparts Corp.
It did a number of smaller deals in 2017, for example spending $US2.7 billion on a group of smaller deals, or what Berkshire said were “bolt ons” to existing businesses.
“In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price," he wrote.
"That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high."
Berkshire Hathaway’s cash pile jumped to $US116 billion in cash and short-term Treasury bills at the end of 2017 compared to $US86.4 billion at the end of 2016. A major reason for the boost was a $US10.2 billion payment involved in a retroactive re-insurance deal Berkshire did with insurer, AIG.
"Berkshire’s goal is to substantially increase the earnings of its non-insurance group. For that to happen, we will need to make one or more huge acquisitions. We certainly have the resources to do so,” Buffett wrote.
In his annual letter to shareholders of Berkshire Buffett said no one else to his conglomerate in its ability to financially withstand even a mega-catastrophe that causes $400 billion of insurance losses.
"No company comes close to Berkshire in being financially prepared for a $400 billion mega-cat. Our share of such a loss might be $12 billion or so, an amount far below the annual earnings we expect from our non-insurance activities.
"Concurrently, much – indeed, perhaps most – of the p/c world would be out of business. Our unparalleled financial strength explains why other p/c insurers come to Berkshire – and only Berkshire – when they, themselves, need to purchase huge reinsurance coverages for large payments they may have to make in the far future,” Mr Buffett wrote.
Buffett said the odds of such a catastrophe in any year is just 2%, but that Berkshire would lose only about $US12 billion, a sum more than offset by annual profits from its non-insurance businesses.
“Concurrently, much – indeed, perhaps most – of the p/c world would be out of business,” he wrote, referring to rival property and casualty insurers. “Our unparalleled financial strength explains why other p/c insurers come to Berkshire – and only Berkshire – when they, themselves, need to purchase huge reinsurance coverages for large payments they may have to make in the far future.”
Last year was difficult for Berkshire in insurance underwriting, where it lost $3.24 billion before taxes and $2.22 billion after taxes, its first full-year loss since 2002.
Hurricanes Harvey, Irma and Maria, as well as California wildfires and Cyclone Debbie in Australia and earthquakes in Mexico, were key culprits, and the $US3 billion pretax cost.
The $US29 billion gain from the changes to US tax laws boosted Berkshire’s annual earnings by around 87% for the year to December 31 to $US44.9 billion.
It would have been more had Berkshire’s core insurance and reinsurance operations not been hit by the impact of the Californian fires late in the year as well as hurricanes, cyclones, earthquakes and other storms in the US, Mexico and Australia.
Those events saw the group take pre-tax underwriting losses of around $US3 billion. Losses from Cyclone Debbie in Australia last March and April were estimated at more than $US152 million.
Berkshire’s net worth increased by more than $US65 billion in 2017 thanks to the tax cuts impact.
Fourth-quarter net income increased roughly fivefold to $US32.55 billion because of the tax cut impact, from $US6.29 billion.
Those increases, however, masked a fall in operating profit, which Buffett considers a better gauge of overall performance, and which fell 18% last year to $14.46 billion.
A major reason for that decline was a $US2.22 billion after tax loss from insurance underwriting, Berkshire’s first full-year insurance deficit since 2002.