major confusion about Buffett and inflation!

[scorpioncapital]

Watch this video 

 

around 6min 30 seconds he says best inflation protection is your own earning power and a great business. He says NOT business with huge capital investment as you will get killed in inflation!

Yet berkshire owns HUGE capital intensive railroads and utilities!

Isn't he afraid he will get killed if inflation hits?

He said it himself. you will get killed with high capex businesses!!

 

[adesigar]

30 minutes ago, scorpioncapital said:

Watch this video 

 

around 6min 30 seconds he says best inflation protection is your own earning power and a great business. He says NOT business with huge capital investment as you will get killed in inflation!

Yet berkshire owns HUGE capital intensive railroads and utilities!

Isn't he afraid he will get killed if inflation hits?

He said it himself. you will get killed with high capex businesses!!

 

Utilities have guaranteed returns. The more a utility is asked to spend the more it makes. Railroads are basically monopolies.

Edited December 15, 2021 by adesigar

[scorpioncapital]

do you mean his high capex investments are exceptions to the general rule?

[bizaro86]

I dont think inflation helps utilities at all. The primary source if value is the regulated rate base, which is denominated in USD and guaranteed a return. 

 

Inflation makes the real value of that regulated rate base smaller.

 

[LearningMachine]

Buffett explained in 2015 that utilities and railroads are poor businesses for inflation. 

 

See https://buffett.cnbc.com/video/2015/05/02/what-businesses-do-best-in-times-of-high-inflation.html.

 

Instead, he said that a strong brand is a wonderful thing to own in inflation.  See's chart in the other thread indeed shows how it did from 1972 to 1984. 

[scorpioncapital]

Ok, so why he owns such huge amount of high capex investments if inflation will clobber those businesses? Also is insurance considered high capex? For example, take something like Intel, a high capex business too but without government guarantees of profits. In the order of things I suppose utilities are better, or even telecom but just wondering why he owns these businesses at all if what he says about capex and inflation is true. Is it a case of he has set it up to win as exceptions to the rule due to some special ways he has figured out to go around this idea? I read he said inflation is a tapeworm that consumes capital just to maintain flat earning power. Doesn't sound like its something he would want to own.

Edited December 16, 2021 by scorpioncapital

[Parsad]

2 hours ago, scorpioncapital said:

Ok, so why he owns such huge amount of high capex investments if inflation will clobber those businesses? Also is insurance considered high capex? For example, take something like Intel, a high capex business too but without government guarantees of profits. In the order of things I suppose utilities are better, or even telecom but just wondering why he owns these businesses at all if what he says about capex and inflation is true. Is it a case of he has set it up to win as exceptions to the rule due to some special ways he has figured out to go around this idea? I read he said inflation is a tapeworm that consumes capital just to maintain flat earning power. Doesn't sound like its something he would want to own.

 

 

While Berkshire owns several high capex businesses, remember that they also own huge stakes in businesses that benefit from inflation or can price their products with inflation...think Apple, Coca-Cola, See's, retail businesses, etc.  Unlike many other companies, Berkshire's high capex businesses are 1st or 2nd generally in their respective lines of business...that provides some ability to absorb cost and pass it on.  Also, insurance is a business that can price policies with inflationary pressure and insurance is by far Berkshire's largest business and always will be.  Cheers!

[kab60]

8 hours ago, scorpioncapital said:

Ok, so why he owns such huge amount of high capex investments if inflation will clobber those businesses? Also is insurance considered high capex? For example, take something like Intel, a high capex business too but without government guarantees of profits. In the order of things I suppose utilities are better, or even telecom but just wondering why he owns these businesses at all if what he says about capex and inflation is true. Is it a case of he has set it up to win as exceptions to the rule due to some special ways he has figured out to go around this idea? I read he said inflation is a tapeworm that consumes capital just to maintain flat earning power. Doesn't sound like its something he would want to own.

I think he's positioned for everything. I generally think rates will stay low for long, and I love Berkshire for their holdings in BNSF and BHE. It gives them an outlet for internal investments at attractive returns. The more I follow Berkshire, the more I love what the old dude has assembled. It's pretty genius and in a 0 rate environment it is pretty crazy to pick up a ~10% return with so little risk.

[ValueArb]

I don't understand the question. He owns some businesses that will do well in inflationary times, and some that won't do quite as well. Do we expect him to build an inflation safe portfolio in 2010 and just wait for it? Or do we expect him to have dumped BNSF and Berkshire Energy earlier in the year when it became evident inflation was on the rise?

 

Buffett is the captain of a mighty battleship sailing in a tiny lake. Any decisions he makes he's frequently stuck with for very long periods without the liquidity to suddenly reverse.

[CorpRaider]

Thankfully he's not going to rejigger the portfolio based on some macro view of inflation for a decade or something.  

[MarioP]

For the insurances business I think inflation is good. Each year premium is adjusted based on replacement value of the good insured. So earned premium will rose with no investment other than regulatory capital required, which we already have plenty.

[gfp]

2 minutes ago, MarioP said:

For the insurances business I think inflation is good. Each year premium is adjusted based on replacement value of the good insured. So earned premium will rose with no investment other than regulatory capital required, which we already have plenty.

 

Except for the enormous section of Berkshire's insurance business where they have taken on long-tail liabilities for fixed up-front premiums.

[spartansaver]

2 hours ago, MarioP said:

For the insurances business I think inflation is good. Each year premium is adjusted based on replacement value of the good insured. So earned premium will rose with no investment other than regulatory capital required, which we already have plenty.

Go through the 70's letters. Inflation wasn't great for insurers. From what I remember, they had a tough time keeping pricing up with claims. 

[scorpioncapital]

18 hours ago, spartansaver said:

Go through the 70's letters. Inflation wasn't great for insurers. From what I remember, they had a tough time keeping pricing up with claims. 

 

I've read some articles that suggest it is sudden, unexpected inflation that is the problem for insurers. If the inflation is gradual, then the companies can price properly. A fast inflation increase can even bankrupt an insurer. But I do not know how rapid...for example is the current increase very rapid? Also it depends I suppose how long you've fixed your investment assets (duration of bond portfolio) and how much inflation you factored into your underwriting as a potential surprise.

[MCR]

2 hours ago, scorpioncapital said:

 

I've read some articles that suggest it is sudden, unexpected inflation that is the problem for insurers. If the inflation is gradual, then the companies can price properly. A fast inflation increase can even bankrupt an insurer. But I do not know how rapid...for example is the current increase very rapid? Also it depends I suppose how long you've fixed your investment assets (duration of bond portfolio) and how much inflation you factored into your underwriting as a potential surprise.

I wonder if this is an example of the potential benefit of BRK as a conglomerate? BRK has the advantage of getting info (close to real-time or with some reasonable lag) on cost increases across an array of businesses/industries, which in theory could be used to inform writing new insurance contracts. The Q3 report never used the word "inflation" but mentioned cost increases many times -- generally attributed to supply chain disruption, the pandemic, increase in cost of raw materials, and increase in personnel costs.  A standalone insurance enterprise (e.g. Progressive, State Farm, etc.) presumably would not have this type of first-hand information across an array of industries. The hope is that the extreme decentralization of BRK does not inhibit front running of this type of intel to provide insights to Ajit and the rest of the insurance crew. My guess is that they've got the incentives right for the insurance group to proactively look for this type of information across the BRK subsidiaries...

Edited December 18, 2021 by MCR

[Munger_Disciple]

On 12/17/2021 at 6:23 AM, gfp said:

 

Except for the enormous section of Berkshire's insurance business where they have taken on long-tail liabilities for fixed up-front premiums.

 

As I understand this business, Ajit always insists on a maximum cap on the total liabilities. So the inflation risk is significantly mitigated if not completely eliminated. 

[omagh]

Buffett is on point in the video.

Let's not forget that rail assets are depreciated over a fixed number of years but have asset life that extends well beyond the depreciation period.  Most of BNSF's capex in this cycle is done.  Furthermore, most of these assets aren't replicable and in an inflationary period, their replicability becomes an even larger hurdle.

 

BHE as a regulated provider can earn a regulated margin above cost which is passed on to the consumer.  BHE has ready access to capital (from its parent) and won't be starved out should capital become scarcer (inflation) and will continue to have a lower cost of capital than its competitors (borrows from parent's credit rating).

 

Most of BRK's companies are franchises with moats and provide necessary goods/services.  They have some degree of pricing power that will become more evident in an inflationary period.

 

I sleep well.

[Spekulatius]

On 12/17/2021 at 12:12 PM, spartansaver said:

Go through the 70's letters. Inflation wasn't great for insurers. From what I remember, they had a tough time keeping pricing up with claims. 

Yes, inflation and especially accelerating inflation is a really bad thing for insurers. It is even worse I’d interest rates remain suppressed and they can’t make up for more expensive (due to inflation) claims with higher investment income.

[scorpioncapital]

14 hours ago, Spekulatius said:

Yes, inflation and especially accelerating inflation is a really bad thing for insurers. It is even worse I’d interest rates remain suppressed and they can’t make up for more expensive (due to inflation) claims with higher investment income.

 

Perhaps it differs with the insurer strategy? I know for example AIG has some equity and real estate and non government bonds in their portfolio. The majority is however government bonds which are leveraged say 2-3:1.  I imagine this means that to pay their claims the net levered investment income must be equal to the inflation rate but considering also the leverage and cost of float. 

Edited December 20, 2021 by scorpioncapital

[RadMan24]

On 12/16/2021 at 3:11 AM, scorpioncapital said:

Ok, so why he owns such huge amount of high capex investments if inflation will clobber those businesses? Also is insurance considered high capex? For example, take something like Intel, a high capex business too but without government guarantees of profits. In the order of things I suppose utilities are better, or even telecom but just wondering why he owns these businesses at all if what he says about capex and inflation is true. Is it a case of he has set it up to win as exceptions to the rule due to some special ways he has figured out to go around this idea? I read he said inflation is a tapeworm that consumes capital just to maintain flat earning power. Doesn't sound like its something he would want to own.

Intel is high capex, and will be above historical capex in the future, but in prior times, the Intel strategy of fully depreciating its assets and then moving on to a new node would become difficult in a period of high inflation. TSMC uses its prior nodes for all sorts of chips and that is the strategy Intel is embarking on, which would help it retain earnings power and recoup its investment even during periods of moderate to high inflation. Of course, in order to get to that stage, Intel is at the mercy of current inflation trends, but longer term, the business model should be more adapt than it is today. 

 

Nevertheless, it ain't going to be easy navigating inflationary trends, interest rates, economic growth, etc. in a post covid-19 alpha world.

[scorpioncapital]

They say commodities do well in inflation because the commodity sale price goes up. Thinking oil. However I never see a discussion of the capex to get it out of the ground. Is the cost of the commodity going up so much higher than production costs? If not, all the claims that commodities do well in inflation seem misguided. I wonder if this is the case for all high capex businesses. It does seem to be true that commodities , metals, etc.. did well in the 70s-80s high inflation but did low capex stocks in fact do even better? Perhaps the issue is the price paid. Commodity stocks always seem to be cheap, so the risk is small to buy them even if they are bad businesses almost always. low capex stocks while superior might have been so expensive that no amount of buying them at a high p/e when p/e was compressing would give you a return? I see such a risk today. Great businesses but can't get into them so as to ensure a return. So maybe cheap high capex stocks are the next best thing?

[SharperDingaan]

Companies bitch because inflation raises costs immediately, but a company can only respond after a time lag, and not in full. 4% inflation today on a constant sales volume, offset by a 3% increase 9-months from now. When inflation spikes, the higher cost typically impacts EPS today; and tomorrow, by reducing future sales volume (higher price = less volume). Hence, inflation sucks! Yet when inflation spikes down? and the headwind is now a tailwind ? nobody screams inflation rocks 

 

O/G companies announce planned capex well ahead of time, most investors just don't know how to use it.

If no M&A and write downs are planned, the inflation impact is just (capex announced - depreciation - depletion)/(prior year depreciation + depletion). Invest in the O/G space and you have a pretty good idea as to what the number should be - anything above that is planned M&A, When inflation is rapid, you don't drill - you buy, especially when 2PNPV10 reserves are widely available at cents on the dollar, and majors are being forced into ESG related transactions 

 

There is a reason why the investment community isn't crazed about commodities businesses, and why operators love them. 

 

SD

 

Edited December 21, 2021 by SharperDingaan

[scorpioncapital]

is it true that insurance companies have less regulatory restrictions to price premiums for inflation than banks can add a lending premium to customers because it's based off of fed rate ?

[longterminvestor]

Insurance Companies have lots of tools to get more premium in both regulated and non-regulated markets.  If a carrier wants to get an increase, they will find a way to do it.  And the smart one get off the risk if they can't get the rate they want for the account.  

 

Insurers "rates" are regulated by individual state insurance commissioners - this is called the "Admitted Market" or standard market.  Carriers can get rate in other ways if regulators do not approve increase in rate.  They can increase the insured values on property for "inflation" and then the "approved rate" is based on an inflated property value = higher premium even though the rate stayed the same.  

 

However there is another market that is growing fast - Excess & Surplus Lines Market - known as E&S or non-admitted market.  Same game here with inflating values to get more premium.  I have seen carriers increasing building values due to increased cost of construction.  this is helping the insurance market get more premium in an already very hard market.  "Double Whammy" for insureds.  The rate is up AND the value of building is up.  I have seen 60%-75%-100% increases in property premiums where we do business - Florida.  Everyone is complaining about no capacity available in marketplace.

 

and personal lines in Florida is as bad as I have ever seen.  Clients are getting crushed.  

 

[scorpioncapital]

Thank you. That is really inside intelligence!

I guess in the USA and some European countries there are 20-30 year mortgages. I know in Canada they don't have it. Smart..because in a way the bank is a major loser if they have to fix by law 20-30 year mortgages. I do not know in the USA if a bank can do the same 'you do not qualify' gimmick..but then you have no loan volume growth and as I understand it banks in inflationary environment are somehow eager to lend? not sure why since they will get clobbered if they fix in a 20-30 year rate not knowing where things are heading.