Motley Fool Hidden Gems Investing - Berkshire Is Back

Episode Date: August 7, 2023

Berkshire Hathaway bounced back from a recent loss with strong net income and billions in cash waiting for action. Jason Moser and Deidre Woollard discuss: - The value of solid insurance underwriting. - Why Berkshire sees a future in catering to truck drivers. - Finding the secret sauce in consumer businesses. Companies discussed: BRK.A, BRK.B, KHC, CPB, SOVO, SRG, KO, KNSL Host: Deidre Woollard Guest: Jason Moser Producer: Ricky Mulvey Engineer: Rick Engdahl       Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Berkshire is back and Campbell's keeps it saucy. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst Jason Moser. How are you today, Jason? Hey, doing great. How about you?

I'm doing great. Jason, it was a Berkshire weekend. It wasn't the Berkshire weekend because that's in the spring. That's, you know, when everyone goes to Omaha. But we did get the second quarter results, always on a Saturday, always pretty low-key. You just get the basics there. I mean, a lot of basics. But this was strong. This was a nice boost in net income, up to nearly $36 billion. Last quarter wasn't so great. Buffett's back, right? I mean, Buffett's never gone, but Buffett's back. Yeah, I mean, I think it's fair to say, I mean, he kind of went through a little bit

of a lull over the last several years, particularly the last few years, as we've seen tech take over so much of the conversation in regard to investing. And now it's AI. And it's easy to kind of forget about that old, boring business model of Berkshire Hathaway. But listen, I mean, you know, money is money, right? And they certainly do a very good job of making it over long stretches of time. I mean, in regard to the actual business, you know, I think they're benefiting from this interest rate environment, right? We saw insurance underwriting. They record a 74% increase benefiting from those higher interest rates, along with lower catastrophic losses. They did see a little weakness in railroad,

which is, again, to be expected. But I think when you look at the business overall, this is just the quintessential long-term buy-to-hold investment. I would say this is probably as close to buy-and-hold as you could get. For those who are wondering what the difference is, I just like to say buy-to-hold, because I think buy-and-hold sort of implies You just buy it, set it, and forget it. You always need to keep track of what you own and understand what's going on with them. So, with Berkshire Hathaway, I don't think it requires quite as much micromanagement. But when you look back to how the stock has performed over the last decade, it's up 205% vs. the market's 165%. If you go back to 1965,

It's recorded a compounded 19.8% annually versus 9.9% for the S&P 500. Generally speaking, you've got some ebbs and flows with this business, but when you look at it through that longer-term lens, his strategy is a bit more clear, and obviously it's working very well. Yeah. You never want to sell based on one earnings report, as long as you know the thesis is solid. With Berkshire, it always is. One of the things I thought was interesting about this is that you mentioned strong underwriting with Geico made a big difference here. I mean, we've seen this with companies like Kinsale Capitals. Strong underwriting in insurance, it seems to me to be a bit of an art and a science, but it definitely pays off.

It is a very difficult business. I think that's, you know, we've seen over the last few years new businesses coming in to try to disrupt the insurance industry. I think Lemonade stands out as one, and I'm not criticizing Lemonade because I think there is potential with a business like that. But I think what Lemonade demonstrated is that insurance is really hard. Writing that book is really difficult. You have to have some understanding of the markets and the risks, the actuarials that go into it. It is just a very difficult business. And they have a long, long history of doing it very well. It's one of those things that if you have a philosophy, if you have a process in place and it's working, you stick with it,

you keep it going, you can do it very well. But insurance is just a really difficult business to do well. Yeah, yeah, absolutely. And to do well over time. Well, there was talk from analysts over the weekend that, you know, Berkshire's sitting on a lot of cash, right? Over $147 billion. So, some analysts are saying, well, that means Buffett's not seeing opportunities, the market's overheated. Do you agree with that? I think in his world, it makes a lot of sense. I mean, you can see there are a lot of quality businesses out there. And I mean, this is an exercise I think we all go through every quarter is, we learn of Berkshire's cash horde that we sort of dream about. What's the ideal Berkshire acquisition this quarter? I think there are

a lot of businesses out there that he would love to own. I do think that they are not at valuations that really work for him, though. And so, he is patient, if nothing else. And so, for him, I mean, listen, he continues to buy Treasuries, right? He's not concerned with that Fitch downgrade whatsoever. He's holding close to $100 billion in Treasuries today. and has expressed his intent to keep buying them. Because essentially, that's pretty much risk-free money that he can keep on bringing in for the business. And when you have a cash pile that large, scale really does make a big difference. But yeah, I think valuations are just in a tough place right now. They seem high relative to the uncertainty that

persists in the economy right now. And then you add to that, I think, what's certain to be a bonkers election year coming up next year. Any which way you cut it, I think it's going to be nutty. There's going to be a lot of uncertainty that really comes from that. I feel like maybe he's just, you know how they say, measure twice, cut once? I think he's probably measuring even more than twice here before he makes any cuts at all. I think he's just being very thoughtful about how he puts his capital to work, which to me makes a lot of sense in his current state. Yeah. I've heard this called a sensitive bull market or a tentative bull market, there's definitely a feeling right now that this bull

market is on cold legs. Yeah. Again, it goes back to a lot of conflicting data. We've been talking for several quarters now, recession, recession, recession. It's not really materialized, so to speak, but you hear people talk about rolling recession. It's been a very awkward time over the last several years. It's difficult to make decisions when uncertainty is so high. Yeah. And one of the things I think contributes to uncertainty right now is real estate and what's happening with loans coming to an office and things like that. So I always look at Berkshire's real estate holdings. Nothing much to see on the manufactured and site-built home loan side. About 97% of those are current. So I'm

not too worried about that. But I'm also interested in, I'm not worried by it, but the largest commercial real estate loan they have, that's the Seritage Growth Properties. So that's the REIT that Eddie Lampert created that holds a lot of those former Sears properties. They were going to renovate those. That was going to be the future of the company. It's actually the other way now where it seems like they're unloading them. Berkshire invested heavily here, unpaid balance of around $550 million. They've repaid about $1.05 billion since 2021.

We're going to hear earnings from them tomorrow, which I'm interested in. But I feel like this actually, I was unsure for a while, but I think it's working out. the company's speeding up selling off those assets, they're paying things off, they're paying ahead of time. Did this turn out to be a smart move, even though it looked a little iffy at times? You got to call him Warren Soprano, right? You don't want to be skipping payments with this guy. Definitely not. The deal, the relationship dates back to 2018, I believe. Clearly, Seritage, along with everyone, has gone through an anomalous stretch over the last three years, particularly in real estate, as we see how companies are addressing this going

back to office, it definitely feels like the narrative is bringing more people back. And that should be good for that real estate market. But it does also look like they came to an agreement to extend through July 2025 this agreement, this arrangement that they have. So, it's bought Seritage some time. But, by the same token, I think they realized the priority, right? When you talk about lien holders, again, this is a gentleman in a company that, through Seritage, a lot of much-needed financial aid. So, to me, it would be that No. 1 priority is making Buffett & Berkshire whole there. And if they see, also if Seritage sees things improving in that real estate space, particularly commercial real estate,

then all the better. Yeah. And Berkshire's always tucking a few companies under its wing. They did that with a natural gas facility in Maryland and also with Pilot Travel Centers. It was a Berkshire investment for a while, now a Berkshire subsidiary. This is the company that operates trucking centers, around 850 of them in North America. They're spending about a billion dollars to renovate some of their centers. It seems like a very Buffett business to me. It's reliable. You've got a consistent income stream. They also put in a new CEO who's a long-term Buffett guy. Adam Wright seems very capable. It feels like there's a lot of, maybe, Buffett's never exciting, but there's some interest in making

this business bigger. Well, yeah. I mean, this is something where they initially invested back in 2017 with a minority investment. And I mean, you're right. This is just the typical Buffett-style investment, right? Easy business to understand. I mean, they're selling stuff to people, consumers and truckers alike. It's a family-founded and led business, which clearly is something that he appreciates. It serves as, really, a backbone to our nation's infrastructure and trucking. And I don't think that's poised to change anytime soon. As we see the electrification of our fleets around the country progress, that's great. That also is something that

to take a lot of time. That's something that's going to take a long time to really implement at scale. So, as it stands right now, this really seems like a very sensible Berkshire-style investment. Yeah, truckers still need to eat and sleep, even if their trucks are going longer. I don't think autonomous trucking is going to happen tomorrow. No, no, definitely not. No. So, we know about the biggest Berkshire Investments. So, there's Amex, there's Apple, of course, very famously Apple, Bank of America, Coca-Cola, and Chevron. But they're adding to another company I found kind of surprising, which is Kraft Heinz. Stock's down around 40% in the past five years. Their

recent earnings, only expecting sales growth of 4% to 6%. You do get a good dividend here. Is that what Buffett sees here? Or does he feel like it's maybe, I mean, it's hard to speculate what he's thinking, but why Kraft Heinz? Well, obviously, the initial investment, they own, I think, around 26%, a little bit more than 26% of the company today. He went into this one, I think his opinion probably has changed on the business a little bit. He went into this investment thinking that portfolio of brands was probably a little bit stronger than it is. And I think he said as much. He said that there were some brands in there that maybe weren't as resilient or

as strong as he originally anticipated. But that's not all of them. I mean, it is still a portfolio with a number of strong brands. Now, to your point, it is a business. It's not recording really very impressive growth. If you look at the five-year compound annual growth rate there on the revenue side, just 0.7%. Now, three-year is a little bit better at 2.7%, so that could indicate that maybe things are improving a little bit. It is cash low positive. The coverage ratio is no issue there. They can cover the debt that they owe. The dividend should be safe for the time being. I do think you're right there. The dividend is at least something that gives him more comfort in being patient. I would encourage

anyone listening, go back to Berkshire's most recent annual letter. You can just Google Berkshire letters. It'll take you right to it. Read in that letter. There's a section in that letter called The Secret Sauce. And I'll read an excerpt from that. It says, in August 1994, yes, 1994, Berkshire completed its seven-year purchase of the 400 million shares of Coca-Cola we now own. The total cost was $1.3 billion, then a very meaningful sum at Berkshire. The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million. Growth occurred every year, just as certain as birthdays. All Charlie and I were required to do was cash Koch's quarterly dividend checks. We expect that those

checks are highly likely to grow. And then he closes, I'd imagine if Heinz demonstrates that it's a bit more impaired. I'm sorry. I would say I'd imagine that if Heinz demonstrates down the road here, that it's a bit more impaired, right? If we do see that growth is really kind of not where he thought it would be, then he may revisit it. I think as it stands right now, that dividend gives him a little bit of a reason to be patient. But I'd say this is also one that's probably on his list to keep an eye on. Yeah. And he loves great brands. And I would not bet against the mac and cheese. You kind of teed me up because you said sauce. And I think of you as our sauce guy. And on Friday, you talked about mustard skittles. Today, we're going to talk about

another kind of flavor, spaghetti sauce. So Campbell's announced they're buying Sovos Brands, which if you haven't heard of, yeah, me neither. But that's the company behind Rouse, which I have heard of, and Michelangelo's, which is those frozen Italian dinners, and also Nussi Yogurt. One of those things is not like the other. They're paying $2.3 billion. It seems like it's going to round out some of their prepared meal segments. It goes in their meals and beverages segment. Do you like the deal, and do you like the sauce? Well, yeah, the deal, I think, makes sense. You made a point in our discussion beforehand that it really does seem like this is more about getting the Rouse brand, right?

The other one was Michelangelo and the, what is it? Noosa. Noosa Yogurt, yeah. Those are kind of freebies, I guess. Hopefully, they do well. But I don't know that's really what Campbell wanted from this deal. If you look at the company itself, it's very recent IPO from August 2021. $23 per share in cash. That represents a total enterprise value of around $2.7 billion. Now, Campbell's going to issue some debt to get this done. That's not a problem. The coverage ratio there today is at $7. That essentially is just telling you the net interest expense vs. the operating income the company is bringing in. Pretty

reliable business there in Campbell's in the consumer goods that they're sending. So, I I think they can afford this with no problem. The trouble with Campbell is, these consumer goods companies, growth starts slowing down, then you have to figure out how to go from there. What's the next act? If you look at the track record, this has not been a very good investment. From a three-, five-, 10-year timeline, it's not an investment that's beaten the market. I think investors have made a little money from it, but it's nothing to write home about. But generally speaking, it does make sense if they're looking to expand their portfolio and figure out a way to stoke growth. We see it all the time. Then it really just boils

down to the price that they're paying. In this case, it seems at least fair. But yeah, if you look at the penetration of Rouse Sauce, I found in the 10-K that the household penetration of Rouse Sauce has increased from 1.3% in the 52 weeks ended January 3rd, 2016, to 11.9% in the 52 weeks into December 25th, 2022. So, clearly, the Rouse brand is growing a little bit. I mean, it's not impressive growth by any means, but it's gaining some share, and I think that's encouraging. Plugging it into the Campbell's business model there would likely give them exceptionally greater distribution there, which could have a nice impact, and perhaps with the other brands as well. So, it makes a lot of sense from that perspective.

Yeah, it's a little more expensive than some of the other brands that you might see on the shelf, I think, which is an interesting move for Campbell's to see if they're going to keep that price premium. I think so. I mean, I can't speak to the sauce. I don't actually know that I've ever had it personally. I'm a little bit of a sauce snob, maybe, Deidre. I suspected you might be. I'm going to go ahead and admit this.

I make my own sauce. Of course you do. I am a Cento San Marzano tomato guy. I mean, I feel like any time I'm going to make pizza or pasta, I mean, to me, I would much rather just start with those tomatoes and season it however I like it. I find that those jarred and canned sauces just are too sweet for me. It feels like they add a lot of sugar to them that just takes away from the flavor of the sauces. But you can't beat the convenience.

They're certainly very convenient. It's not like they're bad. If I had my druthers, I mean, I would make my own. But if I'm caught in a pinch, maybe I'll have to give that Rao sauce a try. Sounds like you're inviting me over to dinner. Well, thank you for your time today, Jason. Thank you. as always people on the program may have interest in the stocks they talk about

and the motley fool may have formal recommendations for or against so don't buy or sell stocks based solely on what you hear i'm deidre woolard thanks for listening we'll see you tomorrow