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Barrons / Biz - Money

Berkshire Hathaway: Tax Reform’s Big Winner?

Warren Buffett’s conglomerate would be a quadruple beneficiary if the federal corporate tax rate falls to 20%.
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Berkshire Hathaway could be America’s single biggest winner from lower corporate taxes.

The massive conglomerate controlled and headed by Warren Buffett, 87, would be a quadruple beneficiary if the federal corporate tax rate falls to 20%, or something just above 20%, from the current 35%.

Berkshire could see a $27 billion drop in its deferred tax liabilities that mostly stem from gains on its equity portfolio. The decline would lift its book value. The company already is benefitting from a strong stock market, given its $185 billion equity portfolio that includes big stakes in Apple (ticker: AAPL), Bank of America (BAC), Wells Fargo (WFC), American Express (AXP), and Kraft Heinz (KHC).

Berkshire would pay lower corporate taxes under the proposed Republican tax plan; its current tax rate is in the high-20% area. A slew of economically sensitive businesses owned by Berkshire, including the Burlington Northern railroad, and industrial and retail operations, are being helped by a stronger U.S. economy.

Berkshire class A shares ( BRK.A ) are up about 5% this week to $288,500, including a 1.2% rise today. The shares hit a record $290,000 earlier in the session. There could be more upside in Berkshire as Wall Street recognizes the tailwinds helping the company, whose market value is around $475 billion. The stock has roughly matched the 18% advance of the Standard & Poor’s 500 in 2017. Berkshire’s class B shares ( BRK.B ) are up 1.4% today to $192.50.

The stock trades for 1.5 times Berkshire’s book value of $187,435 as of Sept. 30. That is at the upper end of its range in the past few years. But book-value growth should be strong in the fourth quarter due to the stock market’s advance and the company’s operating earnings, now running at about $15 billion annually.

Profit growth could accelerate in 2018 from all of the company’s U.S.-focused industrial businesses. Property and casualty insurance, long the dominant unit inside Berkshire, now accounts for 25% of its profit. And P&C insurance is improving, particularly in auto insurance, where Berkshire’s Geico unit is the No. 2 company in the U.S. behind State Farm. Rival auto insurer Progressive (PGR) has seen its shares surge 50% this year, to $53.

Berkshire’s book could rise by $27 billion, or about $16,000 per class A share, if the corporate tax rate falls to 20% because of reduced deferred tax liabilities, Barclays analyst Jay Gelb estimated in a client note earlier this month.

That would lift book by 9% to around $203,000 per class A share. Use that figure, and Berkshire’s price to book ratio falls to 1.4 times. Berkshire has a balance-sheet liability of $77 billion, mostly for taxes that would be paid if it sold its huge equity portfolio and realized profits from those holdings. A lower corporate tax rate reduces that liability.

In his early November note, Gelb reiterated an Outperform rating on Berkshire with a price target of $322,500. “Berkshire is well positioned, in our view, to benefit from an improving economy and higher short-term interest rates. In addition, the potential benefits of a lower U.S. tax rate as well as potential future accretive acquisitions are not included in our estimates,” he wrote.

Berkshire has more than $100 billion of cash. Buffett is searching for what he has called an elephant-sized acquisition.

The company is stronger than ever, and its many attributes – including its tax situation – don’t appear to be fully reflected in the stock market.

Email: editors@barrons.com

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