For years, Berkshire investors have been “worried” of the growing cash pile. The company has + $100bn in cash, and more of it is coming in every day that needs to be redeployed. Some investors have argued that Buffett should return some of that cash as it is becoming a “drag” on returns.
I think there is some hope. Specially, for investors like me, that would prefer if Buffett is able to redeploy the cash into attractive opportunities or via buybacks. The preference of buybacks over dividends is due to tax efficiency.
The challenge is that at Berkshire´s current size, there are a limited number of opportunities that can move the needle. So, deploying all the cash has not been easy. It is also important to note that Buffett is very disciplined. He will only act when there are decent opportunities.
Another good “problem” has been that the insurance division has been able to grow float at a CAGR of 8% in the past decade. Buffett has been saying throughout this period that “further gains in float will be tough to achieve”. Well, the division has been able to surprise him on the upside. And the most important aspect is that this growth has been achieved while maintaining underwriting discipline and generating an attractive combined ratio, well below 100.
The issue with this success is that float went from $63bn in 2009 to current levels of $123bn. That is an additional $60bn in float that needed to be redeployed during that period. Not an easy task in a low rate environment.
But we also need to add the cash flow from operating businesses, etc. So, the task for Mr. Buffett has been even “tougher”.
In the past 10 years Berkshire has generated $282bn in operating cash flow!!
Fortunately, not all that amount gets back to headquarters in Omaha since $110bn was invested in capex by the subsidiaries.
After capex, we are left with $172bn, which is still a big task but better than the original figure.
With that cash Buffett has been able to acquire companies, invest in public equities, do special deals, etc.
To be specific, $102bn has been spent in business acquisitions which include BNSF, Precision Castparts, Kraft Heinz, etc. That is a pretty significant number.
After these acquisitions, we are left with $70bn of cash flow that had to be deployed. A portion of that has obviously gone into public equities like Apple, JP Morgan, etc. But the figure is very low, at least compared to what I expected before looking into the numbers. Net purchases have “only” been $28bn in the last 10 years. If we take away the Apple investment, which was significant and done in the last couple of years, the net amount might have been close to zero. I know it is a big “IF”, but still…
This was a surprise to me. Of course, he has found opportunities, but he has sold shares in some of the holdings as they became expensive or reached the 10% threshold. Point is, public equities has not been a field that has consumed a large pile of Berkshire´s cash. That of course might change if the market hits a rough patch, etc.
Going back to our $282bn operating cash flow number, Berkshire has been able to deploy most of it through capex, acquisitions and public equities. To be exact, Berkshire deployed $240bn in these 3 fields.
We can conclude then that the company was able to deploy most of the cash flow, except $42bn which just built up. On top of that, there were some bond maturities, redemptions, etc. that increased the cash amount.
Not bad Warren.
Back to our original topic, why am I optimistic that Berkshire will find ways to efficiently allocate cash going forward?
Of course, the modification to the repurchase policy is a major change. Now, the company will repurchase shares whenever it considers the price attractive for remaining shareholders. That provides flexibility considering that for years the mandate was that repurchases could only occur below 1.2x book value. This proved ineffective and too restrictive, making repurchases difficult to execute.
In the past decade, repurchases were close to insignificant. I predict going forward, this will change for the better. This will be a relief for Mr. Buffett and Berkshire shareholders as this will consume some of the cash (hopefully).
I am not a fan of financial models since they are usually wrong and there is much more to investment than only looking at the “projections” but let´s play with some numbers.
I believe operating cash flow for the next couple of years should be close to $35bn. I get that figure assuming float grows by 3% a year (much lower than the past decade) and cash flow from “non-float” sources stands close to $30bn.
Capex in the last 5 years has averaged close to $14bn. So, let´s assume that cash flow after capex currently stands at $20bn.
We are looking at $20bn per year that needs to be deployed. Options include repurchases, public equities, acquisitions, special deals, etc.
Looking at repurchases, there is a possibility (slim though) that in a given year, Berkshire can spend $20bn in its own stock. That figure is achievable by buying close to 10% of daily trading volume. Of course, we would need to assume that the stock remains undervalued throughout the year and that Berkshire remains “very” active in this department for almost 12 months in a row. Not easy. But there is also the possibility of a tender or a large “estate” transaction like the one that occurred some years ago.
There is a possibility that all of the free cash flow is consumed by repurchases. That would be great for long term shareholders. If there is a company Buffett knows well, that is Berkshire. He is only buying below a conservative estimate of value. These are value generating repurchases that also reduce the famous “cash” drag and provide relief to headquarters.
Buffett might also get the opportunity to deploy large amounts of cash if there is a large decline in the stock market. Or people will go to him looking for special deals, “a home for their business”, or the need for large, quick financing (Occidental Petroleum 8% prefs is an example), etc…
I am optimistic that returns will be satisfactory going forward and that there won´t be a need to do a large special dividend. Hopefully, the stock remains slightly undervalued for years and Buffett can direct the $20bn in annual free cash flow to repurchases.