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A better use for Buffett's billions

Five South African Citywire-rated managers give their views on what they would do with Berkshire Hathaway's enormous pile of cash.

Berkshire Hathaway is holding more than $130bn in cash on its balance sheet. That is almost a third of its market capitalisation.

During the company’s first ever virtual annual general meeting earlier this month, chairman and CEO Warren Buffett defended the value of holding so much cash at the moment:

‘We really want to be prepared for anything,” he said. ‘We never want to be dependent, not only on the kindness of strangers, but the kindness of friends.’

Most of this cash is held in US Treasuries.

‘Those treasury bills are paying us virtually nothing,’ said Buffett. ‘They’re a terrible investment over time, but they are the one thing that, when opportunity arises, [we can use] to pay for those opportunities.’

Given that this is such a poor use of the company’s cash pile, we asked five Citywire-rated managers to give us their best views on what Buffett should be doing with the money instead. Their answers, which you can read over the following slides, were surprising, innovative, and delightful.

 

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Berkshire Hathaway is holding more than $130bn in cash on its balance sheet. That is almost a third of its market capitalisation.

During the company’s first ever virtual annual general meeting earlier this month, chairman and CEO Warren Buffett defended the value of holding so much cash at the moment:

‘We really want to be prepared for anything,” he said. ‘We never want to be dependent, not only on the kindness of strangers, but the kindness of friends.’

Most of this cash is held in US Treasuries.

‘Those treasury bills are paying us virtually nothing,’ said Buffett. ‘They’re a terrible investment over time, but they are the one thing that, when opportunity arises, [we can use] to pay for those opportunities.’

Given that this is such a poor use of the company’s cash pile, we asked five Citywire-rated managers to give us their best views on what Buffett should be doing with the money instead. Their answers, which you can read over the following slides, were surprising, innovative, and delightful.

 

Citywire A-rated Richard Pitt – CEO and portfolio manager at BlueAlpha Investment Management

For those agonising over missing the 30%-odd rally in global markets over the last eight weeks – fear not, for you are in excellent company. Even the ‘Oracle of Omaha’ apparently failed to catch this one.

Berkshire Hathaway has more than $130bn in cash on its balance sheet – a number which has grown by a factor of six times over the last 10 years. To many people’s surprise, and the consternation of some, Buffett engaged in only modest share purchases in the first quarter of 2020 and nothing during the March sell-off.

So what to do with Buffett’s Berkshire billions?

Let’s immediately knock off $20bn for risk outcomes that the company must always be prepared for, given their risk-underwriting activities. Let’s also keep a further $20bn in cash, given a very uncertain path ahead for the economy, and the likelihood that good businesses may well become cheaper as the economy slows and the consumer struggles.

That leaves just under US$100bn for investment – hardly a trivial sum. The challenge with investing such vast amounts of capital is that it requires, in the parlance of Buffett, an ‘elephant-sized’ acquisition. We think we might have found that elephant.

Berkshire recently sold all of its investments in four US airlines – and good riddance to them. Howver, along the lines of ‘in a gold rush, sell shovels’, may we be so bold as to suggest that an appropriate ‘elephant’ for Berkshire may be Boeing?

Operating in a duopoly market with an endless list of barriers to entry, Boeing now trades 70% off its high and has lagged the market by 50% over the last five years.

It has, admittedly, had its fair share of serious issues. There were fatal plane crashes that seem directly linked to its own safety technology; and, secondly, its customer base is literally grounded. What value is an order backlog of 5,000 planes if no one is flying?

The result of these challenges is that Boeing is now valued at only twice the enterprise value of Zoom and about half that of Netflix. The barriers to entry of both businesses (I think quite low) are fertile ground for debate. What is hardly up for debate is whether or not we will eventually get off the couch, turn off Netflix, ‘Zoom’ out and get back to living. And surely that means travelling once again.

Boeing has the potential to be Buffett’s next American Express, which he purchased during crisis in 1964. Even in the unlikely event of acquiring the whole company at a 10% premium, he would still have change of about $20bn.

 

Citywire A-rated Rory Spangenberg – Director of global equities at Northstar Asset Management

Shareholders of Berkshire Hathaway are fortunate to have an unrivalled repository of their Chairman’s thought process, in the form of Warren Buffett’s annual letter. The latest edition is a little over a week old.

The invitation extended on page 14 of this letter to shareholders with $20m or more in A or B class shares to have their broker contact Berkshire if they are ready to sell, is hard to ignore. It offers a very clear indication of Buffett’s likely use of some of Berkshire’s ever-growing cash pile.

Buffett used his 2018 shareholder letter to address the diminished relevance of book value per share. He highlighting a greater reliance on his estimate of intrinsic value, owing to the shift in Berkshire’s portfolio from marketable securities, carried at market value, to operating businesses, carried at their original cost.

This point was made in the context of Buffett’s assertion that: 'over time – Berkshire would be a significant repurchaser of its shares'. We believe the shift to intrinsic value, designed to compensate for accounting rules which fail to recognise economic reality, is long overdue.

Buffett is on record as saying his cash-pile allows him to go 'elephant hunting', and the expectation has been for him to conclude a mega private market deal. But perhaps the elephant is, in fact, Berkshire itself.

And why not? Conservatively valued, Berkshire is trading at its lowest price-to-book ratio of the past 10 years, and by our estimates, the largest discount to Intrinsic value observed over the past five years.

 

Citywire + rated Philip Bradford – Chief investment officer at Sasfin Asset Managers

Warren Buffet and Berkshire Hathaway are currently holding record amounts of cash, and despite the recent corona crash, are struggling to find good investment ideas. There are a few reasons for this:

  • Global growth is weak and the outlook is very uncertain;
  • Interest rates are likely to remain at record lows for a long time in an attempt to stimulate economic growth;
  • Quality risk assets like US equities are more expensive now than before the crash;
  • Defensive, low-risk assets like developed market bonds are only offering very low and even negative returns.

In a weak economic environment like this, equities would normally be cheap. Buffett would be buying up good companies and assets at attractive prices.

However, central banks are pumping record stimulus into economies, companies and markets across the globe. This is artificially forcing interest rates even lower than they should be, and investors are almost forced to buy equities. Therefore, Buffett would rather earn almost zero on cash than potentially make negative returns on equities.

But surely there are investments out there that are cheap and offer better returns than cash? The good news is there are. Emerging market bonds were sold off viciously during the initial market crash and are now at very cheap levels compared to their equivalents in the US, Europe and Japan.

South African government bonds are a great example of this. In February, South African offshore bonds were offering around 2.5% in US dollars. They are now at over 6%, and that is without any currency risk.

Local South African government bonds are still offering over 11%. That is very attractive to global investors that are getting almost zero on their cash in euros, dollars and sterling.

Buffett is famous for “being fearful when others are greedy, and greedy when others are fearful”. He should consider South African bonds when everyone else is fearful.

Citywire AAA-rated Gerrit Smit – Head of equity management at Stonehage Fleming

We have been surprised by Berkshire Hathaway’s low level of investment activity over many years. The recent collapse in share prices provides an ideal opportunity for such a long-term orientated investor, and it was therefore a huge surprise when the company stopped buying back its own shares in March at such low prices.

Contrary to some perceptions, it does not have a stock market liquidity challenge. The average total value traded on the US stock market has been $374tn a day, which is many multiples of Berkshire’s total ‘cash problem’. To illustrate, Microsoft’s share liquidity implies that its entire market capitalisation is traded every year. All of Berkshire’s cash pile represents only about six weeks’ share liquidity.

We believe Covid-19 may have a dampening effect on the global economy for quite some time, and that some industries may struggle for years to regain their former glory. These are predominantly the more cyclical types of industries that need higher and accelerating economic growth to come to fruition and flourish again.

We estimate that around two-thirds of Berkshire’s portfolio is of a more cyclical nature and we will not be surprised if some of them may currently need capital injections. These issues may explain some of Berkshire’s thinking behind selling all of their airlines and suspending their buy-back programme.

The more positive element of the ‘new normal’ economic environment triggered by the GVC (great virus crisis) is a likely acceleration of technological advances in many forms, especially in software, communication and some hardware applications. Along with this, we expect the renewed focus on improving healthcare and scientific research services to lead to further structural growth in related industries for a long time.

Berkshire is in a fortunate position with its huge cash pile, but unfortunately it is overexposed to those cyclical industries, and underexposed to the ‘new normal’. Further to this, the market is already in a process of repricing stocks for their sustainability in this new world.

Berkshire could consider building out the more defensive portion of its portfolio materially. It has vast choice amongst numerous outstanding quality technology and healthcare related businesses that have excellent cash flow and balance sheets.

Further to this, on a tactical basis, we believe Covid-19 has kept way too many health procedures out of hospital and postponed treatment. This will cause weak immediate results for many businesses in this context, but the pent-up demand keeps growing every day and could cause exceptional results in the not too distant future.

Berkshire Hathaway has always rushed very slowly. Covid-19 may urge it to start with some structural portfolio rebalancing for a changing economic and business order.

 

Citywire A-rated Gail Daniel – Portfolio manager at Ninety One

As a South African, the thought of $130bn, or about R2.4tn, is somewhat mind blowing.

Firstly, let’s get rid of Eskom’s debt. At last count it was R450bn, but given how things have gone since we last counted, let’s make that R500bn. That would be a real contrarian trade. Eskom has new management, which I think Buffett would prefer to the last bunch (and we might prefer him as a shareholder).

Next off, it would be nice to balance the South African budget. In February, the government went unfunded to the tune of R60bn, but (again) given how things have gone, the new number is more like R200bn. Add in the R60bn and let’s call it R300bn.

Then Sasol needs some help, and it would be nice to have some fuel, assuming we are allowed to drive again. Sasol has $20bn of debt. Of course, they don’t need the whole amount. Rights issue estimates are around R40bn.

SAA has a reported R13bn in debt. That will also have grown, so let’s invest $1bn there. (We might need a functional airline to buy a one-way ticket out of here for some politicians!)

I feel sorry for companies like City Lodge and Spur, that have run great businesses and are now struggling, not to mention all the unlisted small and medium size enterprises in South Africa. With a bit of cash help, a lot of them could very well be classic value buys.

Even after all this, there is still a lot left over. It would be kind to throw a bit at the government bond market – why should our government not also have zero interest rates? The Greeks do. The Greeks might have the Germans behind them, but we will have Buffet. Zero bond yields in SA – there is a thought! A value convergence trade second only to the Greeks.

And if that takes less than R1 trillion, I am sure Zimbabwe would also appreciate some help. If only…

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Rory Spangenberg
Rory Spangenberg Average Total Return:
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2/91 in Mixed Assets - Flexible ZAR (Performance over 3 years)
Gail Daniel
Gail Daniel Average Total Return:
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Philip Bradford
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