Why More Big Buyouts Could Harm Buffett and Berkshire Hathaway Credit Ratings

March 10, 2016 by Jon C. Ogg

When investors and the public think of Warren Buffett, chances are high that they think of his company or Mr. Buffett very positively. Berkshire Hathaway Inc. (NYSE: BRK-A) has become one of the most powerful companies in the world in recent years.

After having moved from being considered an insurance holding company to a truly diversified conglomerate at S&P, now Buffett’s empire has expanded handily with the acquisitions of Precision Castparts ($37 billion) and BNSF ($26 billion) in rail.

With all of the hoopla about Buffett, most investors might just assume that Berkshire Hathaway has a full on AAA rating. Not so. In fact, it is down at A+, according to Fitch — with the possibility of a credit pressure ahead.

Fitch Ratings assigned A+ ratings to seven new traunches of senior notes issued by Berkshire Hathaway and by its wholly owned finance subsidiary Berkshire Hathaway Finance Corporation. The total offering was right at $9 billion.

It turns out that $5.5 billion of the notes are senior unsecured notes issued by Berkshire Hathaway itself, with the other $3.5 billion of senior notes having been issued by the Berkshire Hathaway Finance Corporation subsidiary, which were said to be fully and unconditionally guaranteed by the parent.

24/7 Wall St actively follows the moves of Buffett and Berkshire Hathaway. On top of the new changes for Buffett’s 2016 top stock holdings, here are several issues to consider of late (with links to more detail):

Berkshire Hathaway was using these funds to repay a $10 billion bank loan that was part of the $37.2 billion purchase price for Precision Castparts. The company also was using part of the proceeds to refinance $300 million of 2.2% senior notes that matured and were repaid on February 11, 2016.

As far as why the offering was given an A+ rating, Fitch Ratings credit report said:

Berkshire Hathaway’s consolidated financial leverage ratio remained under 30% after the $9 billion debt issuance and the assumptions of $5 billion in Precision Castparts debt obligations. This level of financial leverage would not trigger any rating sensitivities, however, Berkshire Hathaway is approaching Fitch’s limits on financial leverage and interest coverage. Consequently, another material acquisition funded with significant amounts of debt would place downward pressure on Berkshire Hathaway ratings.

Fitch’s report further said:

Precision Castparts represents a noteworthy acquisition for Berkshire Hathaway, but does not materially change the profile of the conglomerate. Precision Castparts’ trailing 12 month consolidated revenue as of September 27, 2015 was $9.7 billion, which would amount to roughly 5% of Berkshire Hathaway’s total revenue. Further, Precision Castparts’ near-term sales could be negatively impacted by challenges in the energy sector.

Berkshire Hathaway’s consolidated financial leverage ratio was 24.6% as of December 31, 2015. Pro-forma financial leverage including the $9 billion of new senior notes and $5 billion of Precision Castparts net debt that was assumed in the acquisition was 27.6% at year-end 2015. Consolidated interest coverage in 2015 was 8.0 times excluding realized investment gains, which is below Fitch’s expectations of 12 times for companies at Berkshire Hathaway’s rating level. An alternate calculation of interest coverage, excluding railroad, utilities and energy, was 18.3 times in 2015 and is consistent with the current rating category.

Keep in mind that laying out a strategy for future credit rating pressure is one thing. Downgrading a company’s credit rating is far worse, as is putting the credit on negative credit watch alerts. Neither of the worse cases were made here.

The additional risks noted at Fitch did actually specify what capital requirements and capital ratios need to be kept. Fitch said:

  • A consolidated run-rate debt-to-total capital ratio that exceeds 30% or a run-rate debt-to-total capital ratio from the holding company, insurance and finance operations (including debt issued or guaranteed by the holding company) that exceeds 25%.
  • Acquisitions or other actions that reduce outstanding cash below $10 billion or approximately 5x consolidated interest expense.

Berkshire Hathaway investors likely have very little to worry about here for now. Buffett said that he will always try to keep about $20 billion in capital on hand as dry powder. At $209,100 for the A shares, Berkshire Hathaway has a 52-week trading range of $186,900 to 223,011.

As far as how the $37 billion for Precision Castparts and the $26 billion for BNSF rank, Berkshire Hathaway’s market cap is $344 billion. In short, Buffett is growing the empire, but not with such mega-changes that investors should panic. That being said, the warning of potential downward pressure should not be ignored by Buffett — nor by his investors. Still, Berkshire Hathaway owns a large stake of almost 24.7 million shares of Fitch’s credit ratings rival Moody’s.