The Buffett effect
Australian banks have had a good run this week, apparently on the back of some comments made by Warren Buffett in a media briefing relating to Berkshire Hathaway’s investment in Insurance Australia Group (ASX: IAG).
Buffett’s track record needs no introduction, and it is perhaps natural to think that there may be investment merit in any business he is interested in. However, before you go increasing your weighting to Australian banks, let’s consider what was actually said. According to the Australian Financial Review, the relevant words were: “In looking at banks, I would say there is a good chance that that five years from now, we will have bought one or more positions in Australian banks”.
There are a few points worth making in relation to this. The first is that Buffett is looking to acquire Australian assets to match the A$ liabilities that arise from the IAG deal. Under that deal, Berkshire is on the hook for 20 per cent of IAG’s losses, and the desire to own some Australian assets is a natural consequence of that – it doesn’t necessarily mean that the Australian assets are attractive in the absence of that deal.
Secondly, if you need to own sizeable assets in Australia, and you don’t have a taste for resources businesses, then the banks are a large part of what you have to look at. The Australian market doesn’t offer a great deal of choice in terms of large, liquid companies.
Thirdly, Buffett points to the likelihood that five years from now Berkshire Hathaway will own one or more Australian banks. In that timeframe, it seems reasonable to expect that bank share prices will at some point be good value, and on that basis it is reasonable to expect that Berkshire would invest within that timeframe.
This does not add up to a case to say that Australian banks are good value today. An analysis of bank earnings and risks may lead you to that conclusion, but to my mind, nothing Buffett has said should make you want to own more of the Australian banks.
Especially when you probably own too much of them already.
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To learn more about our funds please click here.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Colin Petersen
:
Tim – any view on whether IFL represents a buying opportunity, or does the difficulty forecasting the earnings impact of the reputation damage make it too much of a punt?
Tim Kelley
:
We haven’t studied IFL in detail, so can’t comment with any authority. It may be worth spending some time on, but you’ve spotted an important issue – gauging the impact of reputation damage, even if the underlying business is sound.
Brett Edgerton
:
LOL… Fairfax today is running a survey “Warren Buffett this week flagged interest in Australian banks. If you could recommend just one bank stock, which one would it be?”
Of course there is no option “NONE – I’ll assess the lay of the land in a few years when we see what happens with the bubble, thanks”
caseyjtan
:
Warren is a genius.
He is my hero.
Pity though about this deal; tarnished my view.
Existing IAG shareholders just got ripped off; 20% of the profit from revenue stream for next 10 years seized by Warren; without payment for that 20% share of biz.
Actually better than owning 20% of biz. Getting 20% of revenue stream. Not exposed to risks of owning shares.
Will ASIC allow this?
Too big/powerful to investigate?
Gaveen Jayarajan
:
Just wondering why you still hold ANZ if your general view is that banks are not good value? Is there anything particular about ANZ you think makes them worth holding compared to other banks?
Tim Kelley
:
Hi Gaveen,
I’m not arguing here that the all banks are bad value. Rather, I’m arguing that Buffet’s comments don’t lead you to a conclusion that they are all good value. Analysing each bank on its merits is a better way of coming to a view, and when we do that it supports holding a position in ANZ, albeit not a large position relative to ANZ’s weight in the ASX300.
Gaveen Jayarajan
:
Thanks Tim.
Robert Summers
:
“In looking at banks, I would say there is a good chance that that five years from now, we will have bought one or more positions in Australian banks”
Don’t be surprised if, when that transaction comes, it is in a form not available to other investors, and is on very favourable terms for BH. Think the Goldman warrants they bought in 2008. Buffett likes to be the provider of liquidity when no-one else is and he has a history of formulating sophisticated white-knight deals in companies with strong competitive positions.
Brett Edgerton
:
Thanks for that Tim… your thoughts are fairly much in line with what I was thinking and wrote on Macrobusiness (partly reproduced below)… (Perhaps I, too, will be an investor in Australian bank equity in 5 years, but right now I am short as a hedge against the Australian economy deteriorating significantly over the next few years and thus impacting heavily on my family’s financial plans)…
I note that Berkshire has around $60 Billion in cash to deploy right now, plus almost $30 Billion in bonds, and $1.4 Billion in free cash flows each and every month. So AUD$500 MIllion represents around just 8 days of that free cash flow at Buffet’s disposal.
Clearly for a man who hunts elephants, this is barely a mouse!
Still, having read with much enjoyment of the exchange between Buffet and Munger over “indefensible”, the private jet on which Munger felt Buffet was profligately wasting his money, we can be certain that Buffett would scrutinise the deal prior to progressing.
Not surprisingly, as even brokers are pointing out today, it has not taken a great amount of thought to calculate that this deal, on a purely financial basis, is very favourable to Berkshire Hathaway (which is great for me as an investor in BH through my SMSF).
For this reason I believe that the payoff [for major IAG investors] for the deal is more related to the feel good factor of Buffett’s apparent optimism towards the Australian financial services industry. However, while I am in no doubt that Buffet scrutinised the deal itself, I would be surprised if he has yet given a great deal of serious thought to how he will invest his float in Australia, and any comments on such were more likely off the cuff than a result of analysis.
How he decides to invest these cash flows will only be seen over the years ahead. However, at this very early stage, I would say that anybody who has read his comments about house price movements in the US prior to it’s bubble collapsing would find it seriously difficult to believe that he would not have misgivings about investing in our major banks at today’s valuations when he learns that fully 65% of their assets are Australian mortgages, a world leading figure by around 50%