10 Questions That Should Be Asked at Berkshire's Annual Meeting(Part 1)

In a recent interview with The Wall Street Journal, it was put to Munger that in the current environment “hordes of corporate executives must [surely] be calling Berkshire begging for capital,” to which Munger replied, “[n]o, they aren’t…[t]he typical reaction is that people are frozen…[some, like the airlines, are] negotiating with the government, but they’re not calling Warren…[e]verybody’s just frozen…and the phone is not ringing off the hook.”

This goes back to a question we asked at least year’s meeting about Berkshire’s model perhaps being too “pull” oriented as opposed to “push.” With so much capital already out there in the hands of private equity and other larger investors in pursuit of the types of larger deals Berkshire would like to do, and the preferred process being to wait until sellers (or their representatives) call up Berkshire or drop by the offices, are there potential deals or investments that Berkshire is missing out on right now because the company is not close enough to (or informed enough about) the markets or companies in need of financial assistance or investment?

Question 2: How much cash and cash equivalents should we consider as being counted toward reserves?

Munger also told The Wall Street Journal that he regards this “as a time for caution rather than action” and that Berkshire right now is kind of “like the captain of a ship when the worst typhoon that’s ever happened comes…[w]e just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity…[w]e’re not playing, ‘Oh goody, goody, everything’s going to hell, let’s plunge 100% of the reserves [into buying businesses].’ ”

Our question here relates to how we should think of cash reserves. While Berkshire’s large equity investment portfolio and bond holdings have generally been far greater than the company’s required insurance loss reserves, Buffett has noted for years that he likes to keep around $20 billion in cash on hand as a backstop for the insurance business. Given that the size of the company’s insurance operations continues to expand, and that we are now seeing an unprecedented event that could require greater levels of liquidity to meet claims that may have been considered low probability in the past, is that an adequate level of dedicated cash reserves for Berkshire, or does that number need to be higher--say $25 billion or $30 billion?

Question 3: Has Berkshire ramped up its share repurchases?

When Berkshire changed its share-repurchase program at the end of July 2018, it said the new program would allow Berkshire to repurchase shares when Buffett and Munger believed “the repurchase price was below Berkshire’s intrinsic value, conservatively determined.” This effectively removed the floor that had existed under Berkshire’s shares and created a bit less certainty about where Berkshire might be willing to buy back stock. For example, in the back half of 2018, Berkshire bought back just over $1.3 billion of stock for 1.40 times trailing book value per share and 1.39 times pending book value per share. During 2019, the price paid was somewhat lower, as the more than $5.0 billion of stock that Berkshire repurchased was picked up for 1.36 times trailing book value per share and 1.29 times pending book value per share.

With the shares trading off meaningfully this year, we expect that Berkshire bought back a fair amount of stock during the first quarter and early part of the second quarter. If not, then why not? And if so, then what sort of run rate would Buffett be willing to commit to for share repurchases? Given the amount of cash Berkshire continues to hold, and the current regulatory approval to declare up to $21 billion as ordinary dividends during 2020, we believe that the company could easily buy back $1.5 billion-$2.5 billion of common stock per quarter.

Question 4: Can Berkshire increase its equity stakes in banks following the new Federal Reserve guidance?

At the beginning of the year, the Federal Reserve issued a final rule that would update and revise, to some degree, its framework for finding “control” under the Bank Holding Company Act of 1956. As we read it, the new rule clarified the existing rules and interpretations related to control determinations, which were ambiguous and not always transparent, and relaxed some previous presumptions of control. Overall, though, it still seems to be filled with a lot of gray area, requiring ongoing conversations between equity investors like Berkshire and the Fed when it comes to their investment stakes. Looking at some of Berkshire’s Form 4 filings since the end of January, when the Fed released its revised rule, it appears that the company has been adding to some of its bank holdings--picking up another 23 million shares of Bank of America (BAC), 9 million shares of Bank of New York Mellon (BK), 19 million shares of U.S. Bancorp (USB), and another 24 million shares of Wells Fargo (WFC)--with at least Bank of America creeping up above the old 10% threshold that in the past would have forced you to trim your position. We would like some insight into how the new rule will influence Berkshire’s ability to invest more heavily in the banks and whether the amount of business that it does with any of these banks would limit the stake that it could hold in that company.

Question 5: How does Berkshire feel about those stakes in the airlines now?

Several years ago, we asked a question related to Berkshire’s initiation of stakes in the four major U.S. airlines: American Airlines (AAL), Delta Air Lines (DAL), Southwest Airlines (LUV), and United (UAL). At that time, we pointed out that the airline industry seems to have few, if any, advantages--that even with the consolidation over the past 15-plus years, the barriers to entry for the airlines are few and the exit barriers are high, and the industry also suffers from low switching costs and intense pricing competition and is heavily exposed to fuel costs, with rising fuel prices being difficult to pass on and declining fuel prices leading to more intense pricing competition. While the industry, in our view, is only ever one giant oil price spike away from having serious problems, we weren’t surprised by the speed in which a black swan event like the COVID-19 pandemic brought the airlines to their knees.

With regard to Delta, it was interesting to see Berkshire acquire close to 1 million additional shares at the end of February only to turn around and dispose of 13 million shares (as well as 2.3 million shares of Southwest) at the start of April. We’re not sure if this is just portfolio reallocation, given the increased risk to the industry, or the start of a larger move to eliminate the airline holdings from the stock portfolio completely. That said, what are Berkshire’s options here? In past cycles, Berkshire has not had to compete so heavily with the government and other providers of capital to throw a lifeline to companies, taking high-single-digit coupon-paying preferred stock and warrants to buy common stock in lieu of a capital injection and the Buffett Seal of Approval.

In the Part 2, we'll discuss more on Berkshine's holdings and thhe strategies that to tackle the market colatility caused by Covid-19 pandemic.