Earnings from Burlington Northern Santa Fe and MidAmerican Energy Holdings accounted for $1.46 billion, or 40 percent, of operating income in the third quarter, Omaha, Nebraska-based Berkshire said in a Nov. 1 regulatory filing. The two businesses have generated at least 30 percent of profit every year since 2010, when BNSF was acquired.
The railroad and utility are “the bond-like underpinning” of earnings, said Tom Russo, a partner at Lancaster, Pennsylvania-based Gardner Russo & Gardner who oversees more than $7 billion, including Berkshire shares.
Buffett’s deal in 1999 to purchase MidAmerican marked a shift into regulated businesses that require large amounts of capital spending. Before then, Berkshire had been dominated by insurance operations, which provided the billionaire with money for takeovers and stock picks in exchange for shouldering risks that could erase earnings in some quarters.
Underwriting profit at the insurance businesses fell 57 percent to $170 million in the three months ended Sept. 30 from a year earlier. Costs from hailstorms in Europe pressured results at General Re, and the frequency and severity of payouts at auto insurer Geico increased.
Berkshire’s results also have swung in the past decade because of changes in valuation on insurance-like derivatives that Buffett sold. The strategy allowed him to bet on long-term gains in stocks and the creditworthiness of borrowers.
Plunging markets in 2008 boosted liabilities on the contracts and were partly responsible for Berkshire losing its top credit grades from Moody’s Investors Service and Fitch Ratings in 2009. In the three months ended Sept. 30, equity-linked derivatives added $519 million to earnings, compared with a loss of $534 million a year earlier.
Buffett, 83, has said the fluctuations are meaningless because the contracts won’t be settled for years, don’t require collateral posting and have given Berkshire money to invest. The changes in value aren’t included in operating income.
“In our catastrophe insurance business, we are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run,” he wrote to shareholders in a 2008 letter. “That is our philosophy in derivatives as well.”
Third-quarter net income rose to $5.05 billion from $3.92 billion a year earlier, fueled by gains on holdings tied to Goldman Sachs Group Inc., General Electric Co. and Mars Inc. Operating earnings, which exclude some investment results, were $2,228 a share, missing the $2,403 average estimate of three analysts surveyed by Bloomberg, as insurance underwriting results deteriorated.
Berkshire increasingly has been putting money to work in MidAmerican and BNSF. The two businesses will spend about $8.7 billion on capital projects this year, according to the filing. That compares with $6.9 billion in 2012.
Profit rose at the energy business as it won approvals for rate increases at its largest units, which sell power in states including Iowa, Oregon and Utah. The firm also struck a deal in May to buy Nevada’s largest electric utility for $5.6 billion.
BNSF has benefited as new drilling technologies boosted oil production in states such as North Dakota and Montana. Volume increased 12 percent for industrial goods in the first nine months of the year because of “significantly higher petroleum products” moving by the company’s rail network, according to the filing. Buffett didn’t respond to a request for comment sent to an assistant outside normal business hours.
Part of the reason Buffett may be investing so heavily in the utilities and railroad is that bonds yield so little, said David Sims, co-manager of Eagle Capital Growth Fund. While other insurers primarily hold fixed-income securities to back obligations to policyholders and generate earnings, Berkshire has opted to put money in capital-intensive businesses, he said.
“They’re very complementary to the insurance business,” said Sims, whose fund counts Berkshire among its biggest holdings. “They’re a very reliable source of income.”
The businesses also allow Berkshire to deploy large amounts of cash consistently. That’s important because it’s harder for Buffett to make meaningful investments now that his company is much larger than when he took over as chief executive officer more than four decades ago, said Richard Cook, co-founder of Cook & Bynum Capital Management LLC in Birmingham, Alabama.
Berkshire’s book value, a measure of assets minus liabilities, was $126,766 per Class A share as of Sept. 30. When Buffett took control in the 1960s, it was $19.
The stock slipped 0.6 percent to $172,089 at 4:01 p.m. in New York and has gained 28 percent since Dec. 31. Berkshire’s largest investment this year was the $12.3 billion Buffett spent to help take ketchup maker HJ Heinz Co. private. The billionaire’s company got half the common equity, and preferred stock paying a 9 percent dividend.
“People’s expectations should not be that returns are going to be as good as they have been, because there’s so much capital to put to work,” said Cook, who oversees about $295 million, including Berkshire shares. “That’s not a change in Buffett’s skill. It’s a change in the capital base.”
Investing in the railroad and utilities also may have an element of “estate planning,” Russo said. Predictable profits will be helpful in ensuring payouts to the foundations to which the billionaire CEO is leaving almost all his wealth and a boon to his eventual successor, the Berkshire investor said.
Buffett is “starting to play more toward the middle of the tennis court,” Russo said. “The model is changing.”
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