Berkshire Hathaway Could Be Facing a Double-Whammy

Between "too big to fail" and potential regulations on shipping oil by rail, Berkshire Hathaway has two threats that could impede its profits. Is American International Group a better long-term investment, with less complication as from Berkshire's non-insurance holdings?

Jan 29, 2014 at 3:45PM

Cert

Warren Buffett is kind of a big deal. But is his company too big to fail?

Recent reports that the Fed is considering naming Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), a "Systemically Important Financial Institution," the technical term for "too big to fail," come after a number of highly publicized accidents, fires, and explosions involving crude oil shipped by rail. Berkshire's subsidiary BNSF Railways is the largest shipper of oil by rail in North America, and increased standards and tighter regulations could impact the company's bottom line. 

The question is, how much could these two potential threats of government regulation hurt Berkshire's bottom line -- and CEO Warren Buffett's ability to reinvest the company's cash? Should investors should look to competitor American International Group (NYSE:AIG), with its substantial discount to book value, and business less complicated by dozens of other business units? 

Too big to fail not a fallback position
Buffett used those words in his letter to shareholders several years ago, and considering Berkshire was a paragon of strength during the recession, loaning billions to Bank of America and Goldman Sachs, among others, during the lowest moments stemming from the financial crisis, it seems absurd that Berkshire could even be considered a risk. 

But when a company has insurance holdings the size of Berkshire's, it's not folly for the Fed to at least take a hard look. After all, Peter Lynch said it best: "Go for a business that any idiot can run -- because sooner or later, any idiot is probably going to run it." 

Bnsf Gn

BNSF hauls more oil than any railway in North America. Source: Todd Murray.

Buffett's success has largely been about managing risk, but eventually, Buffett will be gone. The risk is that when the next inevitable financial crisis occurs, Berkshire sans-Buffett may not be run in the same conservative manner, and the lack of oversight could wreak havoc. Just because Buffett built Berkshire into a distinctly diverse business doesn't mean its massive insurance holdings need any less oversight than, say, AIG's. 

Benmosche agrees
"They say big companies that are in the insurance business should be regulated, but I guess somehow they're not. They're pretty big, the last time I looked," said AIG CEO Robert Benmosche in 2013. Since AIG and Berkshire compete in the reinsurance business, it's no surprise he would want to see Berkshire have more hoops to jump through.

Benmosche has done a remarkable job turning AIG into a lean and competitive business again, largely selling off assets outside of its core business, and using the proceeds, in addition to strong profits, to pay off the Fed loans that kept the company afloat over the recession. 

While not holding the diverse stock positions and dozens of non-insurance businesses that Berkshire does, AIG is a compelling investment in its own right, because the market is still applying a heavy discount to a company that's nothing like the bloated behemoth of 2008. While the turnaround in the business is essentially complete, Mr. Market hasn't yet caught up to its value, assigning a heavily discounted price to book value (P/B) ratio of 0.74, nearly half the company's historical multiple under former CEO Hank Greenberg. 

What kind of blown might BNSF be dealt?
BNSF generated a whopping $3.4 billion in earnings in 2012, almost one-quarter of Berkshire's total. But onerous regulations that cut into that earnings power could further limit Buffett's ability to invest, especially if the FSOC requires Berkshire to keep more cash on hand. 

The NTSB's recommendations to the Department of Transportation, which oversees the nations railways, include forcing trains hauling crude to avoid populated areas altogether, and to increase the number of audits of trains and equipment used. This would add significant costs, while also reducing the total number of deliveries BNSF is able to make if each shipment takes longer to complete. 

Nerv

Feeling nervous? Source: Freddie Peña.

Worst case unlikely; good news about BNSF
The worst-case scenario would be the Fed labelling Berkshire a SIFI and increasing capital requirements, while at the same time, DOT regulations hurt BNSF's earnings power. Combined, these two events could severely limit Buffett's ability to invest Berkshire's profits, or worse -- force selling of assets. But Berkshire has historically been risk-averse, so a SIFI labeling wouldn't likely change much, if anything, about how the company manages capital today. 

BNSF will probably have more regulation to deal with, but the market for oil and gas via rail is only going to expand. New safety measures will only serve the industry better, and the expansion in domestic shipments should more than make up for additional expense and longer routes. 

Still an amazing company with lots of life after Buffett
The reality is, this isn't about Buffett's Berkshire: It's about what may come years down the road. The good news is, Buffett has made efforts to prepare the company for his eventual departure. Executives like his investment managers Ted Weschler, 52, and Todd Combs, 42, and 29-year-old Tracy Britt Cool, chairperson of four of Berkshire's subsidiaries and maybe Buffett's closest assistant, will play important roles in the post-Buffett era. 

For long-term shareholders, it's Buffett's long-term focus and planning that will make it more likely that Berkshire remains a solid investment well into the future, whatever regulators throw its way. 

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Jason Hall owns shares of American International Group and Berkshire Hathaway. The Motley Fool recommends American International Group and Berkshire Hathaway. The Motley Fool owns shares of American International Group and Berkshire Hathaway and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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