Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) is one of the largest conglomerates in the world with a market capitalization of ~$450 billion. The company and its CEO Warren Buffett have been sitting on a growing cash pile of more than $100 billion. The company recently made one of its largest investments in years, a $10 billion investment in Dominion Energy’s (NYSE:D) transmission rights.
Berkshire Hathaway Dominion Energy Investment
Berkshire Hathaway made a $10 billion investment in Dominion Energy to acquire 7700 miles of natural gas transmission and storage assets along with 900 billion cubic feet of gas storage. The deal costs $4 billion along with the assumption of $5.7 billion of debt and some associated taxes with the deal as it was made.
The deal represents an expansion of Berkshire Hathaway’s energy assets, not surprising in a market where value is cheap to buy. Specifically, the offered assets are as follows:
Assets covered by the sale agreement include the company’s ownership interests in Dominion Energy Transmission, Questar Pipeline (including Overthrust and White River Hub), Carolina Gas Transmission, Iroquois Gas Transmission System (50 percent interest), legacy gathering and processing operations, farmout acreage, as well as a 25 percent operating interest in Cove Point. These assets will be reclassified as discontinued operations for GAAP reporting and excluded from operating earnings for full-year 2020. The company’s interest in the Atlantic Coast Pipeline is not included in the transaction.
These assets, as we’ll discuss, represent a major investment opportunity for Berkshire Hathaway.
Berkshire Hathaway Investment Opportunity
Specifically, the opportunity and cash flow from these assets can be determined from the forecast cash flow.
Dominion Energy revised its operating earnings forecast from a midpoint of $4.43 per share to $3.50 per share. For a company with 851 million shares outstanding, that means a predicted $791 million reduction in operating earnings. That’s for an asset that cost $4 billion and included the assumption of $5.7 billion in debt.
We don’t know the exact yield of this debt. However, we assume that Berkshire Hathaway Energy can finance them in line with their existing debt. The company has 4.5% 2045 bonds currently trading at roughly $1.3 on the dollar. That means a yield to maturity of sub 3% on the investment. Let’s assume that the company can get a 3% coupon on the $5.7 billion in debt.
That means a $171 million annual interest rate. Subtracting that from the operating earnings gets us to roughly $620 million in annualized operating earnings for a $4 billion cash investment. That’s a more than 15% operating earnings yield, a great yield, especially in an expensive and uncertain market like today’s markets.
Dominion Energy framed it as a move away to cleaner energy sources. Warren Buffett got quality assets at a great 15% yield. The investment opportunity for Warren Buffett is clear here, and it shows the benefits of having a large cash pile ready to deploy.
Berkshire Hathaway Oil Investment Portfolio
The investment here is part of a rapidly growing oil and energy investment portfolio that Berkshire Hathaway is undertaking.
Publicly, this comes on the back of Warren Buffett’s investment in Occidental Petroleum (NYSE:OXY) through $10 billion of preferred shares that will provide $800 million in annualized cash flow. Additionally, the company has warrants to purchase 80 million shares at $62.5/share. Lastly, the company owns 36 million common stock of Occidental Petroleum.
Now, the cash flow from the shares varies because Occidental Petroleum has been choosing to pay Berkshire Hathaway in stock at a 10% premium. At the current share price, that’s roughly 52.7 million new shares/year. Given that Occidental Petroleum has less than a billion shares outstanding, that’s quickly becoming a significant stake worth billions.
Additionally, the company has a significant stake in Berkshire Hathaway Energy. The stock price has grown roughly 8-10% annualized and was valued at just over $50 billion in 2019. That implies $55 billion today. Berkshire Hathaway’s 90.9% stake would be worth just over $50 billion. Berkshire Hathaway Energy is a major renewable energy provider.
Putting this all together, Berkshire Hathaway’s energy investments total is approaching $75 billion, a significant part of a $450 billion company. The company’s significant cash position, combined with the collapse in oil prices, means that energy represents one of the largest components and largest opportunities in the company’s portfolio.
Berkshire Hathaway Overall Opportunity
However, at the same time, it’s worth noting that Berkshire Hathaway’s overall portfolio is incredibly well valued, given the overall overvalued nature of the market.
Berkshire Hathaway’s earnings fluctuate heavily because of GAAP rules requiring the company to account for stock price fluctuations. However, with that said, it’s important to keep a close eye on the company’s core operating earnings. The company earned almost $24 billion here, down from $24.8 billion in 2018.
In the meantime, the company had a $130 billion float, a portfolio worth $220 billion, and $137 billion in cash. Given the company’s $443 billion market capitalization, subtracting cash and stock holdings but adding back the float, we get $216 billion. Balancing that off of the $24 billion in annualized earnings, that means a high single-digit P/E ratio.
This highlights how undervalued the company is in an environment where the SPY P/E ratio is more than 27, and the NASDAQ’s P/E ratio is almost 23. Even ignoring the value of the company’s cash and holdings, its P/E ratio off of operating earnings is just over 18. More goes into a valuation than this. However, it highlights the overall undervalued nature of the company.
Berkshire Hathaway Investment Risk
There is some investment risk worth paying attention to for Berkshire Hathaway, with its recent investments in Dominion Energy. The majority of U.S. adults now acknowledge that climate change is a serious issue. The scientific consensus is that the human-caused climate change is a significant issue.
With Joe Biden predicted to win the 2020 presidential election and Democratic efforts to stop climate change, there is a risk of significant new regulation in the natural gas space. That could place significant pressure on the new assets that Berkshire Hathaway has purchased, like the issues experienced by Energy Transfer (NYSE:ET) recently.
Fortunately, Berkshire Hathaway has a strong, and overall, very diversified portfolio. However, these are risks that shareholders should pay close attention to.
Berkshire Hathaway has recently gotten what’s unarguably a steal from Dominion Energy, effectively gaining a >15% return on invested capital at a time when a 5% return is difficult. Energy, through other investments like Berkshire Hathaway Energy and Occidental Petroleum, is quickly become a more significant part of Warren Buffett’s portfolio.
Additionally, Berkshire Hathaway overall, at this time, is incredibly undervalued. The company is trading at a single-digit P/E ratio if you count its investments, or even at a double-digit P/E ratio if you value its investments as not being worth anything. Putting that together, Berkshire Hathaway is a quality investment at this time.
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Disclosure: I am/we are long BRK.A, BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.