Buffett’s Berkshire hit with US$3.8 billion Kraft Heinz charge

WARREN Buffett’s Berkshire Hathaway took a US$3.8 billion impairment on its Kraft Heinz stake, the latest hit to a bet that’s weighed on the billionaire investor’s company in recent years.

On Saturday (Aug 2), Berkshire marked down the carrying value of its Kraft Heinz investment to US$8.4 billion, down from more than US$17 billion at the end of 2017. It’s a rare disappointment for Buffett, 94, who was an instrumental force in the merger of both Kraft and Heinz about a decade ago.

While the billionaire is still in the black on his bet, the stock of the packaged foods giant has fallen 62 per cent since then. During the same period, the S&P 500 has risen 202 per cent. Berkshire’s Kraft Heinz stake is now marked at its fair value as of the end of June.

The writedown was “overdue”, said Kyle Sanders, an analyst at Edward Jones. “You could argue they should have done it a couple of years ago.”

Kraft Heinz is now contemplating a spinoff of part of its business as it grapples with headwinds including inflation weighing on consumers’ spending and people seeking healthier alternatives to its products. Last month, the company posted a decline in sales that wasn’t as bad as analysts had predicted, in part thanks to higher prices.

In recent months, Berkshire has signalled that it’s taking a slight step back with its ties to Kraft Heinz. In May, Kraft Heinz announced that Berkshire gave up seats on the packaged foods company’s board. And because Buffett’s company is now limited to what Kraft Heinz discloses publicly, Berkshire said it would start reporting its share of Kraft Heinz’s earnings on a one-quarter lag.

The writedown, disclosed Saturday in a regulatory filing, was driven in part by the sustained decline in fair value. But the company also said it considered its relinquishing of those board seats and Kraft Heinz’s push to evaluate strategic transactions when determining how much of a charge to take.

“Given these factors, as well as prevailing economic and other uncertainties, we concluded that the unrealised loss, represented by the difference between the carrying value of our investment and its fair value, was other-than-temporary,” Berkshire said in the filing.

While Buffett’s conglomerate said it owns 27.4 per cent of Kraft Heinz stock at the end of June, the writedown could ease the path to a reduction of that holding in the future, according to Edward Jones’s Sanders. 

“I think they’re giving themselves more flexibility to potentially exit their position in the future,” he said. “This is one of Warren’s largest missteps in the past couple of decades. It might just be time to move on from it.”

Cash hoard

Buffett’s cash pile ended up dropping 1 per cent in the three months through June, to US$344 billion, the first time in three years that the war chest has shrunk. Those funds had previously kept soaring to all-time highs as he struggled to find opportunities to invest.

Buffett ended up taking a cautious approach to the stock market in the second quarter. He was a net seller of other companies’ shares during the period, offloading about US$3 billion of equities.

He even steered clear of Berkshire’s own stock, forgoing any buybacks. He’s been on the sidelines for repurchases for roughly a year now, despite the stock falling 12 per cent after Buffett announced in May that he would step down as chief executive officer at the end of the year.

Buffett’s perceived cautious stance towards the market, including his own stock, may weigh on Berkshire’s share performance compared with the market, according to Sanders.

“The things that they need to do to get the stock working, they’re just not willing to pull the trigger on yet,” he said.

Operating profit

Berkshire had a weaker second quarter at its operating businesses. Profit dropped 3.8 per cent to US$11.16 billion, driven by a decline in underwriting earnings at its insurers.

Its auto insurer, Geico, posted pretax underwriting earnings that rose 2 per cent to US$1.8 billion in the second quarter. The unit’s underwriting expenses surged 40 per cent in the period, as the company spent more to increase its policy count.

“They were behind their peers, they lost market share and it took a couple of years to turn the ship,” Sanders said. “That comeback is finally on solid footing.”

Berkshire’s utility business, which runs Pacificorp, MidAmerican and NV Energy, posted a 7 per cent increase in operating earnings. The company said it is currently evaluating the impact of President Donald Trump’s tax law as it accelerates the phase-out of clean energy production.

At its railroad network operator, BNSF, operating earnings rose 19 per cent to about US$1.5 billion, an increase Berkshire attributes to increased productivity and a lower tax rate.

The unit, which Berkshire acquired in 2010, has been caught up in dealmaking speculation in recent weeks. Two major competitors, Union Pacific and Norfolk Southern, struck a US$72 billion deal to create the first transcontinental railroad operator.

BNSF’s strong performance in the second quarter calls into question the necessity for the railroad to do its own deal to remain relevant, according to Cathy Seifert, an analyst at CFRA Research.   

“We just came out of a quarter where they’ve had to write down a deal that didn’t work out very well,” she said. “So there’s really a hesitancy to pay up when you’ve got a potential target that’s been bid up in anticipation of you making a deal.” BLOOMBERG