<THE BORING PORTFOLIO>
Responding to Sosnoff
Oil and Coke don't mix
By Dale Wettlaufer ([email protected])
Alexandria, VA (Jan. 4, 1999) -- Before we get into anything else today, a note on the transactions that were announced last week. The Boring port acquired six shares of Berkshire Hathaway (NYSE: BRK.B) "B" class shares at $2,295 per share. We also sold our 400 shares of TCBY Enterprises (NYSE: TBY) at $6 5/8, bottom-ticking it on Thursday morning. We'll update the portfolio's accounting as well as our published materials on the Bore port when we receive the trade confirmations.
Today I wanted to address a column on Berkshire published in this week's Forbes. It's written by Martin Sosnoff, a veteran money manager whose pieces in the magazine I always read. This one I thought was sort of a clunker, though. It starts off with the observation that a gallon of gasoline is cheaper than a liter of Coca-Cola, and that is "bad news for Coke, bearish for Berkshire Hathaway, specifically, and generally a worldwide depressant." Well, I'm going to disagree with all three of those, but I'd rather not bore the world with my view on the macroeconomic picture for the next year just as I wouldn't want to spend a whole lot of time trying to figure out where the S&P 500 will finish in 1999.
What we want to concentrate on with Berkshire Hathaway is what things will look like over a number of years. And when we look at Coca-Cola, the average price oil producers are receiving at the moment matters a whole lot less than the fact that literally billions have never tasted Coca-Cola. It matters a whole lot less than the fact that per-capita consumption in most countries is nowhere near the per-capita consumption in G-7 countries. Of course, global growth for Coca-Cola this year will not be as robust as in other years, but when you look at the progress the company has already made and the potential it can look forward to in markets such as China and Eastern Europe, the spot price of crude today is not that big a worrying point.
When you have a company that can generate returns of $0.30 to $0.50 on each dollar of capital invested in the business with similar returns on new investments available down the road, you worry less about the strength of the dollar in year one and the exact timing of the recovery of economies that are based on petro dollars. You basically want to worry about the how many servings of refreshment Coke can serve five and ten years down the line. By "refreshment," it's not just Coca-Cola the company is selling. It's any of the company's beverages, including the brand names that will come along in the Schweppes deal the company announced last month. Put the brand names together with the bottling system and you've got a defense with a lot of different looks and an offense that can run and shoot. In short, I don't think the world economy can be boiled down to an equation that sets economic turmoil inversely equal to oil prices.
While we're on that subject of growth opportunities, the growth of the global economy is a very good thing for General Re. As one of the top three reinsurers in the world (with the largest surplus of any publicly traded insurer), the growth in personal, corporate, and national wealth in new markets all represent opportunities for GenRe. With growth in emerging economies and a natural increase in private and corporate wealth that go along with that, the need for primary insurers and reinsurers grows as well.
As far as pricing goes and, as far as the macro picture goes for GenRe in 1999, no, the picture's not totally rosy. Sosnoff points out the salient philosophy of GenRe's refusal to throw out the franchise for short-term gains in market share. So he's right on there. The natural progression in this logic, though, is what can it do for us as owners of the company five years down the line? And how will that affect the company ten years down the line from that? The next logical question is not "How does that make GenRe's earnings look for 1999?"
I'll disagree on this point of Sosnoff's, too: "To get going, Buffett needs to make a timely entry into equities with as much as $10 billion to $15 billion of Gen Re's investment portfolio, plus $5 billion or more of Berkshire's cash." Buffett doesn't need to get into any asset class that doesn't offer good long-term returns on capital. If by "equities" Mr. Sosnoff also means privately held companies, I would agree with him more readily. There are more than a couple good private companies out there that are family-owned and that could be a great addition to the Berkshire family. One of the hallmarks of Berkshire is that its management has never felt the "need" to get into one asset class or another just because people are looking for near-term earnings growth.
One of Sosnoff's conclusions holds that Berkshire needs a worldwide reflation to kick-start Coke if Berkshire itself wants to get moving. Not this year, it doesn't. It doesn't need it next year, either. Growth needs to kick in at some point, but this is the best-managed consumer goods company in the world. Really. Bar none. You don't need the rosy scenario from day one to save Coca-Cola and Berkshire from the torpor Sosnoff says Coke has rained down on Berkshire. Having finished 1998 with gigantic gains in intrinsic value and shareholder value, Buffett and the people at Berkshire don't need to do anything other than what they have done to build this company.
Take all the company's specialty insurance companies, its global strengths in reinsurance, its position as one of the most dynamic growth companies in the U.S. auto insurance industry, its many cash cow manufacturing and services businesses, and you've got the picture of vitality. And we think it's still cheap relative to invested capital and the return on invested capital the company can generate over its lifetime. I personally don't believe you even need growth in the topline or cash flows to make a successful investment. It all depends upon the price you pay. I think that's what's missing from Mr. Sosnoff's observations.
Have a good Monday evening. And thanks to the Buffalo Bills for a great 1998 season.
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