Takeaways From the Berkshire Hathaway Annual Meeting

In this episode of MarketFoolery, Chris Hill and Motley Fool Chief Investment Officer Andy Cross take a look at some business headlines. Their topics include Berkshire Hathaway's (BRK.A -0.04%) (BRK.B -0.07%) airline moves, other things learned from Berkshire's annual meeting, and COVID-19's impact on retail.

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This video was recorded on May 4, 2020.

Chris Hill: It's Monday, May 4^th. Welcome to MarketFoolery. I'm Chris Hill, with me, Mr. Andy Cross. Good to see you.

Andy Cross: Chris, happy Monday to you.

Hill: Happy Monday. Happy Star Wars day for all the nerds out there.

Cross: Happy Star Wars day. Fantastic. I didn't think about that, but that's great.

Hill: [laughs] You know, may the fourth be with you. It is also the Monday after the Berkshire Hathaway meeting. And we're going to get into retail in a little bit, but we're going to start with the annual meeting.

And there are a few things we're going to get to, but the headline is the airlines, that, United (UAL 1.98%), American (AAL 1.24%), Southwest (LUV -7.03%), Delta (DAL 3.98%), he sold them all. Cut them all up. We knew he was selling some, and at the meeting we learned, they're all gone.

Cross: Yeah. Actually, in the Q1, which is the quarterly annual filing, he had talked about it and he listed that they sold $6.5 billion in equity sales in April, and so the assumption was that's, you know, a lot of the airlines, right? So, we knew he was selling them. We knew that he was concerned about them. And clearly, this was a sign that he lost faith. And he talked a little bit about the logic, Chris. He admitted a few times that it was a mistake and it was his mistake and they paid $7 billion to $8 billion for those four. Significant stakes obviously. And what he thought was $1 billion in equity earnings and thought that number was likely to grow over time.

And now, considering what has happened in the airline industry over the last few months that clearly the environment has shifted, he had recognized that and just had soured on the prospects of that investment, considering all of the help the airlines need, billions and billions of dollars from the Federal government to help them sustain through this time. And not just through this time, it'll probably be for a couple of years maybe, until we see some sign of normalcy. But who knows what that even looks like, Chris, so I think he saw that.

And you could see it, Warren Buffett, through Berkshire Hathaway, has not made a lot of investing mistakes. And when I say mistakes, I mean lost money. Some certainly haven't done as well as he had expected. Clearly, he kept Kraft Heinz, for example, and others. But even his first go with U.S. Air back in the 90s, which after that experience he had talked about having that 1-800 number that he can call when he has an airline idea, wants to buy another airline. Then lo-and-behold, decades later ended up buying four of them as an airlineaholic, as he called himself. I think that U.S. Air investment still made money. This was a loss. And now it's a real loss because they sold the airlines and they rung up that loss. And I think that just weighed on Warren because he does not like to lose money for shareholders and you could see that in some of his demeanor, I think, throughout the meeting.

Hill: Well, and this is a mistake he's made twice. Like, it's one thing to make a mistake in investing and learn from it, and the jokes about the 1-800 and that sort of thing, but the fact of the matter is, he actually -- you know, whether it was Ted and Todd or people on this team, but he actually said to himself, "You know what? I'm going to take another crack at this." And I think that has to make this sting even more. If it was some other -- like, if it was Burlington Northern that just took a bath or something like that, I don't think it would sting as much.

Cross: I think that's right, Chris. He clearly took the brunt of this, as he should. I mean, this was his investing decision, he mentioned that repeatedly and never talked about Ted and Todd when it comes to the airlines. So, I think he is feeling that sting more so than ever.

The airline industry before the COVID pandemic, Chris, was in much better shape, obviously, just not from a structural perspective, but they were operating much better. They had finally found religion about how to operate an airline and run it, I think, more properly. I think that was one of the encouragement of the last few years for him to invest in airlines. And he started this a few years ago. This just wasn't last year. So, he had been building up these positions.

And so, the airline industry was in better shape. Warren Buffett is a thinker in probabilities that his mind thinks in probabilities and he runs probability numbers in his mind. And he looked at the airline industry and said, hey, this is $7 billion to 48 billion of shareholder capital I can put to work and get a good, nice, healthy return. When he's dealing with very large significant sums of money and he has to be very careful about how he puts that to work to get some kind of return. So, he saw this as a higher probability event looking across the other investment opportunities. And clearly, with the COVID pandemic and the shutdown that just is no longer the case right now.

And like he said, he doesn't really nibble around the edges, win or go all out, and this one is in the go all out category.

Hill: Did it surprise you that he's basically not buying anything? That the other headline is he's still sitting on this massive pile of cash.

Cross: Chris, that wasn't a surprise for me. Now, as they disclosed it in the 10-Q, the activity was, in the first quarter they bought about $4 billion in equity purchases, $1.7 billion in Berkshire stock, and then $2.2 billion or so in equity sales. But if you look at the actual purchases of those over time and look through the quarter and how they bought those, that's what's really enlightening, because in January they were buying, they bought 582,000 of Class B shares. And then between that period of February 24^th and February 28^th, when the market first took its real big hit from the COVID pandemic, when the news really started to break, they bought $4.5 million worth of Berkshire B at an average price of $214 a share. But then in March, between the 2^nd and the 10^th, he only bought 320,000 or so of Berkshire B at $214.

But then here's the real surprise, Chris, when the market really took that dive on the 23^rd of March, and during that period, he didn't buy at all. And then he hasn't bought at all in April. So, that was a real surprise when the market took that real dip in March that I think he was not more active in buying back his share and wasn't really active in buying back any stock, and he still hasn't been. If you look at his April purchases, he's bought no Berkshire stock and they've only bought about $426 million in equities. And when asked about that at the meeting, Chris, Warren said, "I'm not even sure what that was, that's just small potatoes for us, it might have been a little bit of Todd and Ted," he was very nonchalant about those buys.

So, clearly he has not been as active in the market, and my opinion is, this goes back to how he is feeling about dealing with the airline situation, the loss for shareholders, maybe the stock didn't get quite as cheap as he thought, even though it got down to 1.25X tangible book value. I know he likes to see that below 1.2X tangible book. But the key for me is two things, Chris, for Berkshire buys is, one is that he is looking at the future and he is uncertain for maybe the first time in Berkshire Hathaway, considering the COVID pandemic and what that means for the next year or two of earnings power for Berkshire. So, not sure really of the intrinsic value considering -- he actually kind of said that and hinted at that during the annual meeting near the end, he kind of was like, "Listen, the intrinsic value has been hit because of what I did with the airline industry, that Berkshire is worth less now than it was before." So, I think there's some internal mind games he's playing with the intrinsic value.

And second of all is, capital and cash. And he just values cash so much in this situation, more so than ever that I think he'd rather hold on to it than buy back stock or make other equity purchases.

Hill: Well, and there are two signals in these two headlines. So, the signal for the airlines, and not surprisingly, the four airlines that Berkshire Hathaway owned, United, American, Southwest, Delta, all four of those are down today, all four of them are at or near five-year lows. And so, that's a clear signal for everyone out there who's asking, is it time to buy the airlines because they're cheap? That's a resounding "no."

And then the larger thing, to me, is just Buffett, one of the greatest investors ever, if not the greatest investor ever, is looking at the market and saying, "No, I'm not interested, not at these prices." And you may be right about maybe the ripple effect of what happened with his experience with the airlines the second time around. But put aside the airlines, the fact that Buffett's not buying anything is a little disconcerting to me. I honestly was hoping [laughs] for a little bit more encouragement out of uncle Warren.

Cross: Yeah, Chris, so was I. The tone of the meeting, Whitney Tilson had said it near the end that it was conservative, it wasn't like dour. At the very beginning of the meeting, Warren gave a little bit of a history lesson talking about the don't bet against America, buy America. He talked about the long tenure of time when stocks had really not done anything after he was born, he gave a kind of fun lesson about that during the period of '29 to '51, when stocks really had been flat and what they went through and then, obviously, what they have done since then and the wealth accumulation in America and just the value of investing in America over long periods of time. So, it wasn't dour per se, but it was conservative, it was that kind of thinking through, like, OK, this is a different market than he has ever seen and he talks a little bit about that reference about the fact that pandemics are almost, not the term he used, I don't think, but a black swan event, but you can see it playing into his mind, an uncertainty about what this means for equity prices in the near-term.

He continued to be bullish on investing in America and on stocks, in general, he said that repeatedly. But there was this a little bit of a right-hand and left-hand feeling to the meeting where it was like, well, you're not buying now, but you're kind of saying, like, don't bet against America, and you could see it just playing in his mind and I think shareholders had the same question about, as did I, expecting him to put some of that cash more aggressively to use, and he didn't.

So, there's a little bit of that cautious behavior that we see him taking that I think is catching the investors off guard and you see it in the stock price in Berkshire today.

Hill: Last thing and then we'll move on. And you are absolutely right about his tone, I think he was trying to strike as cleareyed and optimistic a tone as possible, and yet, I was struck by the fact that he just -- for the first time, he looked old. Like, he didn't look old a year ago because a year ago he was 88 and you see him at the meeting and I just remember thinking last year, "Man! He doesn't look 88 years old," he looks 89 now and maybe that's just, he loves this event and he missed it, he wasn't able to have it. I hope that was it. But that was part of what struck me too, because I was like, "Oh, man!" Like, I just want to give them a socially safe distant hug to, sort of, pick him up, because the man just looks down.

Cross: Yeah. He could probably use one. So, 99% of his wealth is tied into Berkshire. His whole life is tied into Berkshire Hathaway, essentially, he created the business. He missed his partner, I think, Charlie Munger, nothing against Greg Abel, another Vice Chairman who works on the operating side, and I think did an admirable job on speaking when he felt he had something to say and then letting Warren take the stage. But I think he missed Charlie Munger, his partner of, you know ... decades, since they really took over Berkshire Hathaway. And so that I think weighed on him.

He just loves this event, man! Like, it brings thousands and thousands of Berkshire shareholders to Omaha. By the way, he mentioned the concern of not having this event, how that will impact the economy of Omaha. I think that weighs on him, because he knows the importance that those businesses have, not just his own businesses, but the jewelry store and the furniture marts, but every small business, hotel around -- whatever it might be, is going to be impacted by not having the event. I think that weighed on him.

But I just think he loves getting people together, talking about Berkshire, celebrating the success, toss newspapers, have dilly bars, play ping-pong, all of those uncle Warren events and activities we're used to seeing, he loves that more than anybody.

And at 89 years old, the fact that he can still go, you know, three, four hours taking questions and trying to answer them as best he can in a situation that's very foreign to him.

He even used slides, Chris, he had mentioned that he had never used it. He hasn't really ever used slides over his decades of teaching investment advice and having all the meetings and he put together some slides for the first time ever, and you could see them, they are very simple slides, no Berkshire framing around them. So, that was kind of fun to see him try to use those. But it was just a different tone and I think you could see that in his demeanor. You know, he's 89 years old, so I don't know how many more Berkshire meetings he has left, I hope he has many more, but clearly at that age, he wants to have as many as he can, like, he wants to have them and this one was not like that.

Hill: J. Crew has filed for bankruptcy. 500 stores, just shy of 500 stores closed. And this was news at the end of last week, we sort of got a hint that this was coming. And I said to you right before we started recording today, this is the first, but this is not going to be the last that we see in 2020, and it's unfortunate but it's not a surprise to me that stocks like -- J. Crew is a private company, but it's not a surprise to me that stocks like American Eagle, Abercrombie & Fitch, Tapestry, VF Corp, which is the parent company of North Face, they're all down today.

Cross: Yeah, Chris, more evidence that the COVID pandemic and the quarantines and lockdowns that we're all facing is impacting the retail and, by the way, the commercial real estate space as well. And Warren Buffett had talked about both of those in the annual meeting.

So, J. Crew, yeah, they've filed for bankruptcy. I think the real, maybe nail in the coffin, to use -- perhaps maybe a bad metaphor, but a metaphor nonetheless -- was the fact that the IPO market had really shut down and they couldn't take their Madewell business and IPO that to help get a little bit of juice and some funding and some capital into the business. And when basically they couldn't do that, that was a troubling sign.

Like you said, they have hundreds of J. Crew stores, hundreds of outlet stores, like, 170 outlet stores, a 150 maybe Madewell stores around the country. And no one's going in those or very few. Now, they do have a little bit of an e-commerce business, but on the margin, it just can't make up for what is going on in the loss of revenues and then cash flow. And when you have $1.7 billion of debt on the balance sheet, that's just a very tricky situation to be in.

I will note from the public side, that it's interesting that in 2010-2011, TPG and Leonard Green took J. Crew private at about a $3 billion market valuation, and I can't imagine it's worth anywhere near that even before this, because the retail environment has been so challenging and competitive advantages are very faint in the retail space.

And so, like you said, a lot of them are struggling right now. And J. Crew filed Chapter 11, and now so the financing that they had to arrange basically just to be able to keep some of the lights on and some of the stores open.

Hill: It's going to be interesting to see if some of these, particularly in the apparel retail space, if some of them start to get proactive and look for buyout opportunities, because J. Crew has brand equity, like, you know, there is a universe in which [laughs] J. Crew continues, maybe it's part of a larger parent company, maybe a major retailer, like, Target or someone like that comes in and says alright, at this price American Eagle will be the exclusive retail location for you and take out some of your costs, and that sort of thing. But it wouldn't surprise me if some of them started to pick up the phone and hunt around for a buyer.

Cross: Yeah, maybe. I mean, J. Crew, Chris, they've struggled. It's been the last few years. I mean, Jan Singer, who is the CEO, comes over from -- I think she was President of Spanx, she has experience at Nike, Victoria's Secret, I mean, she has vast experience. Mickey Drexler was there, the famed retail executive for many, many years then he was out, then they had another CEO come in after Mickey Drexler for 16 months before he left and then Jan Singer joined. Very talented people, obviously, lots of insights and it's just a very tough environment. Even before this, the retail environment and we know what's happening with the likes of Amazon, the likes of, take Stitch Fix, for example. Just the competitive pressure that they are under is more fierce than ever before. And that's not going to change, that is just going to pass the pandemic and pass the quarantines. That is just going to continue to elevate and evolve and become more pronounced. And so, the retail space, you know, maybe it's acquisition, maybe it's mergers, maybe it's some kind of lifeline, but I don't know how many private equity firms are out there and start spending the capital to help some of these businesses.

Hill: Andy Cross, thanks for being here, man.

Cross: Hey, thanks, Chris, be safe, my man.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening, we'll see you tomorrow.