Buffett's Berkshire poised for gains on rate hikes, countering slumps

(Bloomberg) –Berkshire Hathaway Inc. contended with rising prices, a troubled insurance market and a dearth of deals in the second quarter. But rate hikes and an expanded stake in Apple Inc. will likely help counter those woes.

Warren Buffett’s conglomerate reports second-quarter earnings on Saturday, offering investors a glimpse of how its group of railroad, utility, energy and insurance companies fared in a period dogged by higher costs, wavering demand and a jump in catastrophe losses.

Despite those tribulations, analysts expect Berkshire to benefit as the Federal Reserve’s continued interest rate hikes help drive up its investment income. In May, Buffett, 92, noted the increased yield generated by Berkshire’s holdings of Treasury bills after the company amassed more than $130 billion mostly in that paper at the end of March.

“Our investment income is going to be a lot larger this year than last year, and that’s built in,” Buffett said at the company’s annual general meeting this year.

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And Fitch Ratings’ surprise downgrade of US government debt hasn’t deterred Buffett from buying up Treasuries, he said in an interview with CNBC.

“Berkshire bought $10 billion in US Treasuries last Monday. We bought $10 billion in Treasuries this Monday. And the only question for next Monday is whether we will buy $10 billion in 3-month or 6-month” T-bills, Buffett said on Thursday.

Read More: Buffett Says He’s Not Worried About Fitch’s US Downgrade

Such gains — plus the buoyant share performance of its biggest holding Apple — may help offset any slumps across its sprawling business lines. The billionaire investor warned at its annual meeting in Omaha, Nebraska that earnings at the majority of its operations could fall this year as an “incredible period” for the US economy draws to an end. Berkshire’s results are closely watched as a proxy for economic health owing to the expansive nature of its businesses.

“The favorable impact of higher interest rates is offsetting some softness in areas with some other companies that are sensitive to interest rates,” Jim Shanahan, an analyst with Edward Jones, said.

Insurance Woes

Berkshire’s insurance businesses have weathered elevated costs tied to natural disasters with second-quarter catastrophe losses at their highest in over decade, according to a note from UBS Group AG analyst Brian Meredith.

But reinsurers, which can charge underwriters more to cover their risks, have benefited, likely translating to “strong premium growth and stable to improving profitability” at its reinsurance units, Meredith said. Results at the firm’s auto-insurer Geico, which swung to a profit in the first quarter after more than six straight quarters of losses, will also be closely watched following a difficult period for the underwriting business as inflation took its toll on the cost of materials and labor.

The company’s other operating businesses — which include manufacturers, apparel companies and the largest US commercial railroad — have taken hits in prior quarters as inflation similarly sapped demand. Taken together, Berkshire’s second-quarter earnings are unlikely to grow much from a year ago, though should remain strong at around $8.5 billion, according to Bloomberg Intelligence.

“Lower railroad volume coupled with higher compensation, auto-repair costs at Geico and drops in retail and building materials demand may hurt the year-over-year comparison,” analysts Matthew Palazola and Eric Bedell wrote. “Reinsurance premiums should jump, but catastrophes could hurt insurance.”

Apple Stake

Developments in Berkshire’s stock picks will also be closely scrutinized. The firm’s equities portfolio, which Buffett’s two investing deputies Todd Combs and Ted Weschler help run, might have increased about 10% largely because of its stake in Apple, according to UBS’s Meredith. Shares in the tech giant, which Buffett has called “a better business than any we own,” are up about 48% this year.

According to Bloomberg Intelligence, Berkshire’s position in Apple shares could add $26 billion to book value.

Buffett has also bulked up Berkshire’s exposure to the energy sector amid dips in commodity prices, steadily adding Occidental Petroleum Co., even though he has said he has no plans to buy it outright. Additionally, Berkshire Hathaway Energy agreed to buy Dominion Energy Inc.’s stake in a Maryland liquefied natural gas export project for $3.3 billion in July.

“They continue to add into their commodity-oriented businesses,” said Cole Smead, chief executive officer of Smead Capital Management, which manages $5.4 billion, including Berkshire and Occidental shares. “I think they’re looking and saying, ‘That’s the most attractive place to allocate capital.'”

Investors will likely also look out for details on Chevron Corp., after Berkshire cut its stake by about 21% in the first quarter. Buffett has also reworked the company’s financial-sector bets. It exited U.S. Bancorp and Bank of New York Mellon Corp. in the first quarter after trimming them in the previous months.

Buybacks

Berkshire bought back $4.4 billion of stock in the first quarter, an increase from the same period last year, as turbulent markets continued to offer fewer of the blockbuster deals he’s renowned for. That pace may be poised to decline in the second quarter, according to Bloomberg Intelligence, which calculated that Berkshire may have repurchased less than $1 billion in shares in the period, noting it might not have captured all the activity.

Berkshire has turned toward buybacks more often as valuations in public markets had made it more challenging for Buffett to identify promising acquisitions.