Boring Portfolio

<THE BORING PORTFOLIO>
Berkshire Hathaway, Pt. 6
More on its retailers

by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (Dec. 21, 1998) -- We're coming to the conclusion of our look at Berkshire Hathaway (NYSE: BRK.A, BRK.B). Before we get back to looking at what the company is all about, a note on the price action in Berkshire's shares since the GenRe merger agreement was announced. The decline in Berkshire's and GenRe's price since then is not a concern. Upon the announcement of the merger earlier this year, I calculated what I thought was the fair price for the combined company and came out with an estimate not too far off from where the company was trading at the time. Now, we have gone about calculating the value of the company anew and will not necessarily come to the same conclusion. But we do believe this: That Internet stocks are advancing 30% a day while Berkshire and GenRe and other high quality companies are down since some randomly selected time period is not a problem.

As of this afternoon, Berkshire is up nearly 30% for the year, which seems small if your view of investing was formed exclusively this year and you only own Amazon.com (Nasdaq: AMZN) or something along those lines. If not, you realize what a a good performance a 30% annual return is. General Re is down slightly for the year as of this afternoon (the merger was completed after the bell today and GenRe shareholders will receive Berkshire shares or cash for fractional Berkshire shares), but that's in the face of very tough industry conditions for the property and casualty insurance markets. Early in November, I wrote about this subject (that's what the link above is). Here's how those companies have fared through today for the year (dividends reinvested)

Only one of these companies has seen its stock appreciate this year, and that's auto insurer Progressive Corp. Of the rest, there are some very good companies that succumbed to pricing pressure or perhaps overvaluation late last year. The point is, just because a group is down doesn't make it less attractive. Depending on the company, its stock being down increases its attractiveness if the value of the business has not declined. Too many investors confuse the terms "price" and "value." The Chairman of Berkshire Hathaway said, "Price is what you pay, value is what you get." While I try not to rely on Mr. Buffett's words to explain everything, this one economizes on the words and maximizes their value. You can't say it better.

GenRe's stock price was down further today as S&P 500 and closet indexers sold out their positions in the stock as GenRe was removed from the index at the end of trading today. For our view on how that does not affect the value of the company, click here. So the markdown of Berkshire here pleases us as prospective acquirers of the company's stock.

Other Berkshire Retailers

Perhaps one of the most interesting Berkshire retailers is Nebraska Furniture Mart. Founder Rose Blumkin, who died earlier this year at the age of around 105, was doing the "big box" category killer retail concepts before those phrases came along. Mrs. Blumkin, who did not have a formal education and who spoke no English when she fled Czarist Russia during World War I to come to the U.S, started the company in 1937. Nebraska Furniture Mart, a furniture, electronics, and flooring super-retailer in Omaha, had sales of $500 per square foot in its 200,000 square foot store when Berkshire Hathaway acquired its majority stake in the company in 1983. That was a big, big per square foot sales number in those days. Heck, it's big even today. Sam's Club doesn't even do that. So we know that Mrs. B was pricing low and turning inventory and keeping costs down long before everyone else tried to shoot for that concept. By the way, this disproves the notion that Berkshire only invests in high-margin enterprises.

R.C. Willey is the same sort of store as Nebraska Furniture Mart and reported about the same volume as NFM in 1995 (the year Berkshire acquired it) according to the 1995 Chairman's letter, but generated that volume in five stores, versus NFM's one store. R.C. Willey now has nine locations in Utah and is probably well over the 50% Utah market share Berkshire reported in 1995. Next stop for the company -- Idaho in 1999.

Star Furniture. This is another big-box retailer, this one in Texas. "But allow me to let Mr. Buffett explain, because this is another great story about how Berkshire does things:

"The Star transaction has an interesting history. Whenever we buy into an industry whose leading participants aren't known to me, I always ask our new partners, "Are there any more at home like you?" Upon our purchase of Nebraska Furniture Mart in 1983, therefore, the Blumkin family told me about three outstanding furniture retailers in other parts of the country. At the time, however, none was for sale.

"Many years later, Irv Blumkin learned that Bill Child, CEO of R.C. Willey -- one of the recommended three -- might be interested in merging, and we promptly made the deal described in the 1995 report. We have been delighted with that association -- Bill is the perfect partner. Furthermore, when we asked Bill about industry standouts, he came up with the remaining two names given me by the Blumkins, one of these being Star Furniture of Houston. But time went by without there being any indication that either of the two was available.

"On the Thursday before last year's annual meeting, however, Bob Denham of Salomon told me that Melvyn Wolff, the long-time controlling shareholder and CEO of Star, wanted to talk. At our invitation, Melvyn came to the meeting and spent his time in Omaha confirming his positive feelings about Berkshire. I, meanwhile, looked at Star's financials, and liked what I saw.

"A few days later, Melvyn and I met in New York and made a deal in a single, two-hour session. As was the case with the Blumkins and Bill Child, I had no need to check leases, work out employment contracts, etc. I knew I was dealing with a man of integrity and that's what counted.

"Though the Wolff family's association with Star dates back to 1924, the business struggled until Melvyn and his sister Shirley Toomin took over in 1962. Today Star operates 12 stores -- ten in Houston and one each in Austin and Bryan -- and will soon move into San Antonio as well. We won't be surprised if Star is many times its present size a decade from now.

"Here's a story illustrating what Melvyn and Shirley are like: When they told their associates of the sale, they also announced that Star would make large, special payments to those who had helped them succeed -- and then defined that group as everyone in the business. Under the terms of our deal, it was Melvyn and Shirley's money, not ours, that funded this distribution. Charlie and I love it when we become partners with people who behave like that."

See's Candies

See's Candies is better known to those who live west of the Mississippi, but it's working its way east and is available in a number of locations throughout the holidays. See's is a manufacturer and marketer of premium confections. Its traditional base of business is California, where the company has been building its brand equity since 1921. See's demonstrates a number of attractive attributes about Berkshire.

1. Buying intrinsic value. When Berkshire purchased See's, "value investors" probably would have said it was too expensive. Berkshire's view of value is more complex than the Paleolithic views of value still practiced by those who won't pay more than "X" times earnings and "Y" times book value. Charlie Munger and Warren Buffett recognized the value of the See's franchise in preserving pricing power and the excellent return on capital economics of the company. Since the company was purchased in 1972, pre-tax earnings have grown more than 11% per year while capital investment has grown at a far smaller pace.

2. Re-directing cash flow. If something like See's doesn't have to reinvest cash flow to perpetuate the franchise, then the cash flow can be used elsewhere. This is particularly helpful in market environments such as 1974 or 1981 when Berkshire could use See's cash flow to invest in enterprises where internal rates of return on capital were far greater than See's. See's is a blessed little cash pump that will likely spit out over $40 million in cash flow this year and will be able to maintain this cash flow rain or shine.

The other interesting aspect about See's was that it was purchased using the operating cash flow of Blue Chip Stamps, a company that generated lots of float, or cash inflows the company was able to use for a long period before required cash outflows. At the time of the See's purchase, Blue Chip stamps was near the peak of its business life, but it provided Berkshire with not only See's but also with Wesco Financial (AMEX: WSC), which is headed by Berkshire Vice-Chairman Charlie Munger. Wesco, in turn, has provided Berkshire with giant-sized positions in companies such as Freddie Mac (NYSE: FRE). These are all parts of the Berkshire's puzzle -- where rational allocators of capital send on earnings to Berkshire where the capital is then put to its highest and best use.

We're already running way too long here, so more on Wednesday.


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12/21/98 Close
Stock  Change    Bid
ANDW  -  1/16  17.38
BGP   +  1/16  18.38
CSL   +  5/16  45.63
CSCO  +4 1/4   94.69
FCH   +  11/16 23.19
PNR   +1 9/16  37.50
TBY   -  1/16  6.81

                   Day   Month    Year  History
        BORING   +2.09%   3.29%   1.15%  27.28%
        S&P:     +1.25%   3.37%  23.95%  93.50%
        NASDAQ:  +2.49%   9.67%  36.15% 105.39%

    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96     94.69   295.26%
  8/13/96  200 Carlisle C    26.32     45.63    73.31%
  2/28/96  400 Borders Gr    11.26     18.38    63.24%
  4/14/98  100 Pentair       43.74     37.50   -14.27%
  5/20/98  400 TCBY Enter    10.05      6.81   -32.18%
  1/21/98  200 Andrew Cor    26.09     17.38   -33.40%
  11/6/97  200 FelCor Sui    37.59     23.19   -38.31%

    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  21304.69 $15914.70
  8/13/96  200 Carlisle C  5264.99   9125.00  $3860.01
  2/28/96  400 Borders Gr  4502.49   7350.00  $2847.51
  4/14/98  100 Pentair     4374.25   3750.00  -$624.25
  5/20/98  400 TCBY Enter  4018.00   2725.00 -$1293.00
  1/21/98  200 Andrew Cor  5218.00   3475.00 -$1743.00
  11/6/97  200 FelCor Sui  7518.00   4637.50 -$2880.50

                             CASH  $11273.22
                            TOTAL  $63640.40

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