Monthly Archives: May 2015

Warren Buffett High on Germany

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Warren Buffett’s admiration for the German economy was on full display at the Berkshire Hathaway annual meeting on May 2, 2015.

This past February, Berkshire Hathaway struck a deal to acquire Devlet Louis Motorradvertriebs, a mail-order and retail chain selling motorbike clothing, helmets, leisurewear, add-on parts, and spare parts. The acquisition price was just over 400 million euros. The Hamburg, German-based retailer has 1,600 staff in their Europe-wide mail order business and at 70 retail stores in Germany and Austria.

Buffett likes Germany for a Variety of Reasons

“Germany is a terrific market, lots of people, lots of buying power, productive, it’s got a legal system we feel very good with, it’s got a regulatory system we feel very good with, it’s got people we feel very good with—and customers,” Warren Buffett explained back in February in an interview in German newspaper Handelsblatt.

The Three Ps

Buffett likes Germany because it has lots of people, they are productive, and they have lots of purchasing power.

While there was nothing formal to announce at the annual meeting, Buffett was emphatic that German companies are on Berkshire’s radar.

“I would be very surprised if we do not acquire at least one more company in Germany in the next 5 years,” he said, emphasizing that the euro’s recent plunge against the dollar makes European companies all the more attractive. “We’re far more on the radar screen than we were five years ago.”

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Derivatives Bring Huge First-Quarter Gains for Berkshire

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While derivative contracts were viewed by many analysts as ticking time bombs that exploded with devastating consequences during the 2009 recession, Berkshire Hathaway has used them to book huge financial gains over the past three years.

The use of the phrase “time bombs” comes directly from Warren Buffett, who said in Berkshire’s Hathaway’s 2002 annual report that “I view derivatives as time bombs, both for the parties that deal in them and the economic system.”

This has led some investors to have the false impression that Berkshire does not use derivatives, credit default swaps, or other financial instruments.

Not only does Berkshire use them, but it has been using them to add billions of dollars to Berkshire’s coffers.

1st Quarter Billion Dollar Bounty

During Berkshire’s 2015 first quarter, derivative contracts produced pre-tax gains of approximately $1.3 billion. This compares to just $236 million in 2014. In 2015, the gains were primarily related to equity index put option contracts, while 2014 reflected gains from credit default contract exposures, partially offset by losses under the equity index put option contracts. The company notes that the 2015 gains were from equity index put option contracts, and the gains reflected increased index values and the favorable impact of a stronger U.S. Dollar, which reduced liabilities of contracts denominated in foreign currencies.

For all of 2014, derivative contracts produced pre-tax gains of $506 million, and the change in the fair value of their credit default contract during 2014 produced a pre-tax gain of $397 million.

In addition, equity index put option contracts produced pre-tax gains of $108 million in 2014.

As Berkshire has powered out of the recession, its various bets on the U.S. economy, which included the 2009 acquisition of BNSF Railways, have proven savvy. The purchase of BNSF at a time when others were running for financial cover was touted by Buffett as an “all-in wager on the economic future of the United States,” and has proven to be so.

Buffett’s Use of Derivatives Has Paid off

As the economy and the stock market have gained momentum, Berkshire’s various derivatives, options and other financial instruments have made the company bushels of money. For example, in 2013, derivative contracts generated a pre-tax gain of $2.6 billion, including a $2.8 billion gain from equity index put option contracts.

Deactivating the Time Bombs

Berkshire has significantly reduced its total derivatives exposure, reducing it to just$ 3.5 billion at the end of the first quarter. The amount is less than a quarter of Berkshire’s $15 billion derivatives exposure in 2009.

The lesson is that when used prudently, these financial instruments are useful tools. However, like all future promises to pay, you have to have the means to back them up.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

McDonald’s Discovers Dairy Queen’s Secret to Success

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As McDonald’s continues to battle slumping sales, it is turning to Dairy Queen’s winning formula as a key part of its just announced turnaround plan.

McDonald’s announced it will be selling off half of its company owned stores, turning them over to franchisees.

In a similar move, Wendy’s is selling 640 restaurants in the U.S. and Canada to franchisees.

Reducing the number of corporate owned locations was a big part of Burger King’s turnaround when 3G Capital’s partner Daniel Schwartz took the helm as the Chief Executive Officer and a Director of the company. He quickly put the Burger Kings where they belonged, in the hands of more motivated franchisees.

Fortunately for Berkshire Hathaway’s Dairy Queen System, they already knew that franchisees are highly motivated, hard-working people motivated by the ultimate incentive, ownership.

A Winning Formula

Dairy Queen, which has 6,400+ locations worldwide, may be smaller than McDonald’s or Burger King, but to its advantage it has only three company owned stores. The cost of the bricks and mortar are born by the franchisees, and Dairy Queen makes its money from franchise fees and a percentage of the sales.

Each franchise pays a $35,000 franchise fee, a royalty fee of 4%, and a marketing fee of 5% – 6%.

In the aggregate the franchises net Berkshire hundreds of millions a year on its investment of only $585 million.

That’s a sweet formula indeed.

For more information read a Mazor’sEdge special report on Dairy Queen.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Why Coca-Cola is one of Buffett’s “Forever Stocks”

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Berkshire Hathaway’s ownership of 400 million shares of the Coca-Cola Company (9.3%) is impressive, but what’s even more impressive is Berkshire’s annual return on its investment.

In 2014, Berkshire received $518 million in annual dividends on its Coca-Cola holdings, which brought its annual return, excluding unrealized gain, to over 40%.

Speaking of unrealized gain, the cost basis of the shares he purchased in 1988 and 1989 was $1.29 billion, a stake that is now worth a whopping $16.39 billion.

What was Warren Buffett’s Secret?

The key was buying Coca-Cola at the right price. An important lesson for any investor.

Buffett, who admired Coca-Cola all the way back to his boyhood days in Omaha, waited until 1988 to start amassing shares. At the time, the company was out of favor with Wall Street, but Buffett believed in the durability of the brand.

“I like wonderful brands,” Buffett explained at the 2013 Coca-Cola annual shareholders meeting. “If you take care of a great brand, it’s forever.”

At the same meeting he also gave insight into his investment philosophy.

“I’m the kind of guy who likes to bet on sure things,” Buffett said. “No business has ever failed with happy customers… and you’re selling happiness.”

Buffett, who drinks five Cokes a day, and recently proclaimed that he is “one quarter Coca-Cola,” is still high on the company. In fact, he played his ukulele and sang a version of Coke’s famous jingle I’d like to teach the world to sing in the film shown at the 2015 Berkshire Hathaway annual meeting.

Setting Your Sights on Forever

Not all stocks can be held forever. It certainly wouldn’t have been a good decision with RadioShack, but that’s where evaluating the quality of the company comes into play.

In Buffett‘s 1988 letter to shareholders, he forecast his long term goal for Berkshire’s new Coca-Cola stake, noting that “when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”

That “forever” holding period in the case of Coca-Cola continues to pay huge dividends to Buffett and all of Berkshire’s shareholders.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Warren Buffett’s Advice for Chinese Investors

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With Chinese stocks having soared in recent years, often fueled more by rumor than earnings, the question of whether value investing has any place in such an environment is a natural one to ask.

In Comes Warren Buffett With His Answer

“Investment principles do not stop at borders,” Buffett told a Chinese investor, who had made the pilgrimage from mainland China to Omaha, Nebraska, for the Berkshire annual meeting.

Buffett, who has put Berkshire Hathaway directly into Chinese equities as a minority owner in BYD Co Ltd, a Chinese manufacturer of automobiles and rechargeable batteries, also has a growing presence in China through Berkshire’s global companies.

Quick-service-restaurant franchisor Dairy Queen International has 600+ franchises in China, and ISCAR, a global manufacturer of precision carbide metalworking tools, maintains eight branch offices in provinces throughout the country, to name just two examples.

Still, speculative fever often appears to leave value investors, who focus on a company’s fundamentals, shaking their heads in disgust.

What should be remembered is that all speculative bubbles eventually burst, leaving all the stocks that are more hot air than substance to evaporate.

The recent tightening of the margin lending requirements in Chinese stock markets are just the first steps that could turn gamblers into paupers.

As economist John Kenneth Galbraith chronicled in The Great Crash 1929.

“That afternoon and evening thousands of speculators decided to get out while – as they mistakenly supposed – the getting was good. Other thousands were told they had no choice but to get out unless they posted more collateral, for as the day’s business came to an end an unprecedented volume of margin calls went out.”

That’s Not Buffett’s Only Advice

Or, as Buffett also has been known to say, “Only when the tide goes out do you discover who’s been swimming naked.”

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Warren Buffett Downplays Global Warming’s Impact on Insurers

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Despite nonstop alarm bells from the media about the future costs of global warming, Warren Buffett downplayed its impact on Berkshire Hathaway’s insurance units during his 5-hour question and answer period at the Berkshire Hathaway annual meeting on May 2, 2015.

It’s not that Buffett thinks that climate change isn’t real, it’s just that its long term impacts are not an immediate concern in the insurance business because prices reset annually, and can always be adjusted upward after a bad year.

“We set it one year at a time. I find nothing on a yearly basis that makes me change my prices,” Buffett noted.

No 50-Year Policies

“That doesn’t mean it isn’t a threat to humanity and isn’t terribly important,” he added. “If I was writing a 50-year windstorm policy in Florida…”

What is of more immediate impact to insurers is the quality of the policyholders. It’s something that insurance companies can’t ignore just to rack great sales figures.

“You insure “Marvin the Torch,” you are going to have a lot more risk than global warming,” Buffett explained. “That building’s going to go!”

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Buffett and Munger Defend 3G Capital’s Aggressive Lay-Offs

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Questions about Brazil-based 3G Capital were much on the minds of Berkshire Hathaway shareholders at Berkshire’s annual meeting on May 2. Warren Buffett defended 3G’s cost-cutting methods as necessary to bring complacent century-old companies into the modern age.

“3G has been buying businesses that have too many people,” Buffett explained.

Over the past year, Berkshire and 3G went in together on two major deals.

On December 14, 2014, Berkshire provided key financing for the combining of Burger King International with the Tim Horton’s chain. The move was a merger that created a new company, Restaurant Brands International (QSR), one of the world’s largest quick service restaurant companies with more than $23 billion in system sales and over 19,000 restaurants in nearly 100 countries and U.S. territories.

3G Capital ended up owning 51% of the combined company and quickly installed 3G’s partner Daniel Schwartz as the Chief Executive Officer and a Director of the company.

Berkshire came out of the deal owning 68,530,939 Class A 9.00% Cumulative Compounding Perpetual Preferred Shares, and warrants to purchase 8,438,225 shares of Common Stock for a penny a piece. Berkshire later exercised those warrants for a modest 354,000% paper profit on its money.

On March 25, 2015, 3G and Berkshire announced the merger of their jointly-owned H.J. Heinz Company with Kraft Foods Group. The combined Kraft Heinz will be 51 percent owned by 3G Capital and Berkshire Hathaway. Kraft shareholders will own the remaining 49 percent. 3G partner Alex Behring will become the Chairman of Kraft Heinz. Berkshire will be the largest shareholder in Kraft Heinz.

In its growing partnership with 3G Capital, Berkshire Hathaway has found an aggressive partner that is looking to own major brands, and most importantly, to “right-size” them in the words of Charlie Munger.

Right-sizing refers to ruthless cost-cutting that cuts expenses in all areas, including laying off employees.

It’s the laying off of employees that drew questions at this year’s Berkshire annual meeting.

Counter to the Berkshire Ethos?

While some may mistakenly think Warren Buffett’s folksy persona might make him a softie when it comes to the management of companies, cost-cutting clearly is not just on the minds of 3G’s partners.

“You will have never found a statement from Charlie or me saying that a business should have more people than needed,” Buffett said at the meeting.

Charlie Munger compared the employment of excess personnel to the full employment guarantees in the former Soviet Union, where, as he quoted the old Russian saying, “We pretended to work, they pretended to pay us.”

Buffett went on to point out that Berkshire’s own strategy is to make sure its companies do not have excess employees, and as he joked about companies in general, “Any company that employs an economist has one employee too many!”

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

Buffett Quells Talk of Big Insurance Takeovers

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As Berkshire continues to expand its insurance empire, including just last week adding a new Australasia Region to Berkshire Hathaway Specialty Insurance, rumors have swelled that the company might be ready to put some of its $30 billion in cash to work through a major insurance company acquisition.

At the Berkshire Hathaway annual meeting on May 2, Buffett dismissed such speculation. He noted that it is “almost certain that we will not take over a large commercial insurance company.”

A SIFI?

Berkshire’s continued growth in the insurance industry, which in addition to Berkshire Hathaway Specialty Insurance includes GEICO, National Indemnity, and Berkshire Hathaway Reinsurance Group, has brought questions as to whether Berkshire is now a Systematically Important Financial Institution (SIFI).

“There is no reason, in logic or in terms of what we’ve heard, to think that Berkshire would be designated as a SIFI,” Buffett noted. “I do not think Berkshire comes within miles of qualifying as a SIFI.”

While Berkshire Hathaway continues to build its own insurance companies, including bringing on board four former AIG executives for its new Australia-based unit, Buffett notes that insurance is only about 30-percent of Berkshire’s total business, with business units, such as BNSF Railway, being much larger.

The insurance and transportation units helped propel Berkshire’s 2015 first quarter earnings up almost 10% over first quarter 2014, with lower fuel costs for BNSF a particular factor.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

5 Things You Probably Didn’t Hear at the Berkshire Hathaway Annual Meeting, Even if You Were There

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Here are five things gleaned from the Berkshire Hathaway Annual meeting in Omaha, Nebraska, that you might not have learned, even if you were there.

1. That new DOT tank car standards will lower tank car capacity from 31,800 gallons to 30,300 gallons, but BNSF can maintain capacity by adding three extra cars per train.

2. That Berkshire’s HomeServices Lending is now originating $250 million in mortgages a month.

3. That Nebraska Furniture Mart currently has no plans to follow-up its new mega-store in The Colony, Texas; with new stores in other markets.

4. That Dairy Queen’s overseas growth is bypassing Western Europe to focus on Eastern Europe and other emerging markets.

5. That even with new federal tank car standards coming, Union Tank Car is not making the manufacture of new oil tank cars its biggest priority, because they recognize that new pipelines will get built.

And One Thing You Probably Did Hear

“If other people weren’t so often wrong, we wouldn’t be so rich!”—Charlie Munger.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.

BHE Renewables to Build 440-Megawatt Wind Farm

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BHE Renewables, a subsidiary of Berkshire Hathaway Energy, will add to its wind generating capacity with the acquisition of the Grande Prairie project from Geronimo Energy.

The 400-megawatt wind farm will be located about 12 miles northeast of O’Neill, Nebraska, and will begin construction this summer. The completion date will be in 2016. The new wind farm will be the largest in the state and will increase Nebraska’s wind energy capacity by nearly 50 percent.

BHE Renewables currently owns and operates a number of wind farm projects, including the 300-megawatt Jumbo Road project near Hereford, Texas; 168-megawatt Pinyon Pines I and 132-megawatt Pinyon Pines II projects, located near Tehachapi, California; and the 81-megawatt Bishop Hill II project in Henry County, Illinois.

“We are excited to be constructing this wind farm in Holt County, our first project in the state,” said Bill Fehrman, president and CEO of BHE Renewables. “The Grande Prairie project will have a major impact on Nebraska’s economy and energy future while helping our customer, Omaha Public Power District, meet its long-term renewable goals.”

BHE Renewables also acquired the 225-megawatt Walnut Ridge Project in Illinois, and plans to begin construction in 2016.

Founded in 2011, BHE Renewables owns and operates more than 3,400 megawatts of wind, solar, geothermal and hydro resources that produce energy for customers under long-term power purchase agreements. The company has invested more than $10 billion in renewable energy resources and will have more than 1,300 megawatts of wind generation capacity in operation when recent acquisitions are complete.

In addition to its investments in wind generation, BHE Renewables owns 1,271 megawatts of solar-powered generation in Arizona and California, 10 geothermal facilities in California’s Imperial Valley, and two hydroelectric facilities, one in Hawaii and one in the Philippines.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.