Many would consider Berkshire Hathaway to be the model company, but the company has a problem in the form of its founder.
Warren Buffett has achieved staggering returns for shareholders over the years but the billionaire sage is not getting any younger, and neither is his right-hand man, Charlie Munger. The age of Warren Buffett and Charlie Munger presents a problem for Berkshire’s shareholders, as well as those investors who want to become Berkshire shareholders but are afraid of what will happen to the conglomerate after Warren Buffett.
According to Morningstar, concerns about what will happen to Berkshire after Buffett departs are overblown. Last week, Morningstar published its latest 100 plus page Financial Services Observer, “Berkshire Hathaway Will Survive the Departure of Buffett and Munger.” Within the Observer, Morningstar equity analysts consider what is in store for the powerhouse after the departure of its founder and list the reasons why the firm is in a good position to succeed despite undergoing an impactful change in management.
Berkshire Hathaway is well positioned to survive after Buffett
Morningstar analysts explore the Berkshire case across 140 pages giving plenty of food for thought. At the end of this mammoth business analysis the research outfit concludes that after Buffett, Berkshire will continue on its current path thanks to the business discipline and skill for capital allocation Buffett has instilled in his managers over the past five decades.
Morningstar boils down the investment case for Berkshire after Buffett to five main points:
- Berkshire Hathawaywill survive the departure of Buffett and Munger.
- Stakeholders keep two big concerns top-of-mind: The company’s size will prevent it from growing at a decent clip in the future and Buffett’s departure may cause a drop in the company’s stock price.
- A decentralized structure and efficient capital allocation will drive Berkshire’s future success.
- Berkshire Hathaway will eventually focus on returning more cash to shareholders.
- Insurance will continue to fuel Berkshire's future investments even as float growth slows.
The points above show the main reason why Berkshire will continue on its current path after Buffett’s the company’s decentralised nature. To answer the question of who will replace Buffett, Morningstar analysts see two strong candidates—Ajit Jain, who runs Berkshire's reinsurance operations; and Greg Abel, who leads Berkshire Hathaway Energy. But the most part, it’s not so much who the manager’s that takes over Berkshire but the size Berkshire itself.
- Charlie Munger on Investing, Wall Street and Berkshire
- A Response To The Economist’s Hatchet Job On Warren Buffett
During the past three calendar years, the company has generated an average of $16.3 billion annually in free cash flow.
With investment opportunities few and far between, the company continues to hold a large amount of cash on its balance sheet. The incoming manager will be presented with a dilemma even they use this cash to acquire new bolt-on businesses, which is unlikely as Buffett will choose only those who are disciplined in capital allocation to follow him. (The Berkshire's conglomerate model has worked primarily because Buffett and vice chairman Charlie Munger have invested in businesses with identifiable economic moats, or sustainable competitive advantages, trading at fair prices that have solid management teams and a culture dedicated to management autonomy and entrepreneurship.) Or the new management team will eventually focus on returning more cash to shareholders. Berkshire’s size means the group will have to acquire larger and larger businesses in order to achieve any sort of reasonable growth and sooner or later it’s reasonable to believe that the business will choose cash returns to shareholders rather than overpaying for a business while chasing growth.
- Berkshire’s Blemishes: Lessons For Buffett’s Successors, Peers, And Policy
- Hiring Untested Ajit Jain Paid Off For Berkshire
- Warren Buffett: How Berkshire Differs From 3G
Still, while Morningstar analysts believe that Berkshire’s growth will generally slow in the medium to long-term, they are confident that the group’s insurance business will continue to report growth for the next four years. Despite the fact the insurance industry is currently facing headwinds from low interest rates, Morningstar analysts envision earned premium growth of 6% to 8% percent annually during 2016 to 2020, with the firm’s overall combined ratio on par with the past five years. This growth will materialise even without Buffett at the helm.
What does this all mean for current and future Berkshire Hathaway shareholders? It looks as if business at Berkshire will continue on as normal after Buffett. The decentralised operating model of the group, coupled with steady growth in the insurance business will help keep revenues growing. The only difference between Berkshire’s operating model now and in several years time, when Buffett steps down will be the group’s cash return policy. As the number of reinvestment opportunities falls shareholders will see more cash return to them via dividends and buybacks.