Month: February 2016

Berkshire Hathway- Annual Report with Comments

It’s a pleasure to read Mr. Buffett. I have tried to build my understanding of the business based on the letter. Hopefully in a few years, I should be better positioned to understand the maestro.

A few highlights of the letter for a quick look at the business and some timeless advice.

  1. BH is truly diversified – in fact, the companies “Powerhouse Five” themselves are significantly diversified within their industries. There is a significant thrust in the infra space – BNSF is in railroads and BHE is a utility company, and BH does not shy from making large capex ($16 Bn in 2015 for the Five) to increase sustainability and profitability ($13.1 Bn) of the businesses.
  2. BH’s float grew to massive $88 Bn, a source of cheap capital for its investment wing. The sheer sizeof the float gives BH an unparalleled moat.
  3. I am uncertain of the Heinz business, where BH plans to redeem their holding for $8.32 Bn in June 2016, while maintaining it will be a bad news for BH and good news for Heinz. Anyone who understand this statement?
  4. Mungerism alert! “If you want to guarantee yourself a lifetime of misery, be sure to
    marry someone with the intent of changing their behavior.”
  5. Buffett’s investment in Coca-Cola, IBM, and Amex surprise me as he continues to see significant profitable growth in all of them.
  6. The power of compounding is fantastically presented using a simple example – even at a low growth rate of 2%, or equivalently a 1.2% per capita growth, in a generation (25 years), USA would see its per capita GDP grow from $56,000 to $76,000. Further, Mr.Buffett shows sensitivity to the fact that the growth may not benefit all uniformly, but would impact everyone positively.This lesson does not appear to sink in the minds of the Indian parliamentarians.
  7. BH’s blueprint for money-making:
    1. Constantly improving the basic earning power of our many subsidiaries;
    2. Further increasing their earnings through bolt-on acquisitions;
    3. Benefiting from the growth of our investees;
    4. Repurchasing Berkshire shares when they are available at a meaningful discount from intrinsic value; and
    5. making an occasional large acquisition.
  8. As Buffett points out, the insurance model is known to all but adhering all 4 points is what differentiates them from the rest. The model for insurance:
    1. Understand all exposures that might cause a policy to incur losses;
    2. Conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does;
    3. Set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and
    4. Be willing to walk away if the appropriate premium can’t be obtained.
  9. Buffett and team’s continuous focus is to lower costs (most of the subsidiaries are in the lowest decile in their sector) while maintaining a high level of product quality and service.Further financially, each entity is by itself pretty strong – just look at some of the interest cover numbers 8:1 (and that too compute at EBIT not EBITDA level)!
  10. It is in the self-interest of governments to treat capital providers
    in a manner that will ensure the continued flow of funds to essential projects. It is concomitantly in our self-interest to conduct our operations in a way that earns the approval of our regulators and the people they represent. Here Buffett explains how the Government and private can work in co-operation rather than in suspicion, an apt lesson for both Indian government and corporates.
  11. When large rewards can flow to investors from good decisions, these parties should not be spared the losses produced by wrong choice – and this to me summarizes capitalism! The Indian version, or indeed the version peddled by global banks where the upside is private and the downside is borne by the public, just negates the benefits that can be accrued by the larger public through capitalism.
  12. The finale!  These potentialities are just a few of the negative possibilities facing us – but even the most casual follower of business news has long been aware of them. None of these problems, however, is crucial to Berkshire’s long-term well-being. When we took over the company in 1965, its risks could have been encapsulated in a single sentence: “The northern textile business in which all of our capital resides is destined for recurring losses and will eventually disappear.” That development, however, was no death knell. We simply adapted. And we will continue to do so. The crux of a truly smart manager of capital – the ability to act on the risk at the right time and adapt in a manner that is overall favorable to the share holder.
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Weekly Report 22 Feb 2016 – 27 Feb 2016

Banks and Finance:
News (22Feb16): Indian Public Sector banks (PSU Banks) continue to be in a bad state as bad loans have ballooned to INR 4 Trillion (USD 80 Bn). Including overstressed assets, this could double. Gross NPA at SBI is INR 728 Bn, Bank of Baroda is 389 Bn. Private sector banks are better at gross NPAs of INR 460 Bn,of which INR 211 Bn is with ICICI Bank.
Impact: The actual NPA levels would be significantly higher due to “under-declaration” or cascading impact on ancillary sectors to which bank has exposure (If steel sector NPAs are being recorded, further loan book expansion for steel promoters with exposure in power would be reduced). The next capital cycle may take at least a couple of years to kick-off. Indian Government will have to infuse capital to meet the banks Basel 2/3 requirement.
News(24Feb16): The NPA crisis continues. According to Credit Suisse, there are still companies are using debt to fund their interest payments, without banks declaring them as NPAs.  Banks can keep funding the poorly structured assets and wait for the economy to gather momentum to get their money back, or recognise the loss of value and find another manager to run the company better and recover their dues. Morgan Stanley estimates  that Indian banks will need INR 2.5  Tr in capital by 2019 while the government’s estimate is at INR 1.8 Tr.
Impact: The crisis may actually be an opportunity for the government – privatize most of the PSU banks. Let an SBI function as a Govt. bank meant to cover the priority sector obligation. Modernization of these banks can be a turnaround opportunity, or a merger opportunity. Secondly, clearing the existing “bad assets” on the balance sheet, will allow a fresh round of capital cycle to begin, which can then focus on the long term capital formation.
EXIM and Currency Movement:
News(22Feb16): Crude oil imports may fall by 45%. India’s import in FY16 is expected to be USD 62 Bn from USD 113 in FY15. India’s crude oil production between April and January fell 1.2% from a year ago, pushing up import dependence to above 80%. Forex reserves up by 7% to USD 350 Bn, fuel subsidy down to INR 220 Bn from INR 760 Bn
Impact: The present low oil price era may last for a couple of years, but definitely in the long run it will start its upward trajectory. It is critical for India to move away from oil dependence – by substitution to non-oil products, development of its oil resources (assuming oil field development have a 3-5 year horizon) as it has a potential to derail its growth story.
News(24Feb16): Residency permits for Foreigner investing in India. Minimum investment by the company of USD 2 Bn. Foreign nationals to get perks, and smoother work permit process.
Impact: The floor for investment is set on the higher side, restricting it to large funds. Lowering it to, say USD 100 Mn, will allow multiple players to invest in Indian companies. While the security concern is valid, the present system is equally vulnerable (hawala routes, etc.). The bogeyman of East India Company is raised – but circumstances are different – EIC was allowed privileges and gross violations of contracts were tolerated too long. The fun quotient would come when Indians would want the same perks and benefits cribbing about foreigners being doled with preferential treatment.
Cement Industry:
News(22Feb16): Consolidation in an industry with over-capacity.  a third of the 375-mtpa industry capacity is with two entities, Lafarge-Holcim (70MTPA) and UltraTech(65MTPA). Jaypee is 3rd with (31MTPA)  needs to sell under lenders’ pressure, after defaulting on repayment of a non-convertible bond last year. Lafarge-Holcim  needs to sell 11 mt capacity of Lafarge India, to overcome local anti-trust laws. JSW cement has 6 MTPA, may expand, CRH has expansion plans in India
Impact: Cement industry will have winners who will benefit from the next round of construction growth.The crux is getting these assets at the right price
News update (23Feb16):KKR,Ultratech in race to buy Jaypee assets. Dalmia Cement also has put in a bid. Each bid pegs the Enterprise Value of the 21 MTPA plant above INR 180 Bn.
Power Sector:
News(23Feb16): Smart grid market to touch INR 500 Bn in 5 year.  Grid modernization will result in huge gains in efficiency which will pay back the investment in 3-4 years. Would cover 100 smart cities and 500 towns in the second phase.
Impact: Some of the steps planned under the project are critical – automating substation, load matching, while others would be useful to reduce leakage. The key concerns are the ability to translate the paper efficiencies to actuals, and the impact of increase in renewables on the overall grid stability
News(24Feb16): Tax free bonds to fund hydro power. The ministry is also considering altering bid documents to account for geological surprises,and action to reduce costs and time overruns.Issues like long construction period, lack of transport infrastructure, geological risks, land acquisition and environmental and religious concerns have slowed hydropower projects including 50,000 MW being allocated to private companies in north and northeast India. India has a potential for 148 GW of hydro. Large hydro also planned to be categorized under renewables.
Impact: While bonds are a fine idea to match bond duration with life of project, it is important to note that hydro,especially large hydro, is unlikely to pick up until land related issues are resolved. From an environmental perspective, it is critical to ensure that we do not take shortcuts just to achieve the potential.
Steel Industry:
Impact: Steel sector woes continue. Companies that have been with low levels of debt should emerge from this cycle with better market position. From a broad picture perspective, India should make the most of the bottom in the commodity cycle to push for capital asset formation.
Railways:
News(25Feb16): The railway budget for 2016. New category trains running at 130 kmph, double decker air conditioned trains, wifi at 100 stations this year, 44 projects covering 5,300 km,in-house entertainment, elevated corridor for Mumbai local, modernization of rail infra (INR 8.5 Tr),2 new loco factories with order book of INR 400 Bn
Impact: New projects and modernization plans are fine, but the devil lies in the details.The budget is continuation of previous budget – no change in passenger tariff, locomotives by PSU, etc. What I would like to see if a true transformation – split the behemoth into operations, marketing, and infra (platforms). Let the private guys set up factories and build locomotives in partnership with the best. Is 130 kmph peak speed? then it is pathetic in the face of modern times! We need peak speeds in 200+ range if we are to modernize with average speeds in 150-160 kmph range. The elevated corridor for Mumbai is coming too late, but lets see the plans before commenting.
Airlines:
News(25Feb16): GVK plans to sell MIAL and BIAL airport stake to JSW This is JSW’sfirst attempt in the aviation infra
Impact: JSW needs to be monitored for 2 aspects – how consolidation can positively impact its other stressed businesses (esp. steel), how would the group debt shape up.