I fear Warren Buffett is ignoring this major threat

Warren Buffett, CEO Berkshire Hathaway

Berkshire Hathaway (WKN:A0YJQ2) is one of my favorite companies and a stock I have generally expected to own for decades. Under the leadership of Warren Buffett and his underappreciated investment partner Charlie Munger, Berkshire has created life-changing wealth for scores of people over the past four decades.

But despite all these successes and a good chance Berkshire will remain a strong company in the years ahead, I have concerns about how well the company is preparing for two big changes that could affect cash flow in the years ahead: self-driving cars and alternative fuels. My biggest fear is that Buffett has a blind spot for these developments, and that could cause problems.

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Huge changes

One of Berkshire’s largest subsidiaries is auto insurer GEICO. According to Buffett’s letter to shareholders, GEICO’s insurance profit in 2016 was $462 million, or about 22% of Berkshire’s total insurance profit. Its safety cushion was $17.1 billion at year-end, representing 19% of total revenue. Buffett talked about GEICO’s competitive advantages and growth:

GEICO’s low costs create a competitive advantage that rivals don’t have. Year after year, this has allowed the company to increase its market share, ending 2016 with about 12% of industry volume. In 1995, we had 2.5% when Berkshire bought GEICO. The number of employees increased from 8.575 on 36.085.

GEICO’s growth accelerated dramatically in the second half of 2016. Claims costs across the auto insurance industry rose unexpectedly fast, and some competitors lost their enthusiasm for new customers. However, GEICO responded to the drop in profits by accelerating new business. We like to make hay while the sun is setting because we know it will surely rise again.

Sunset is the wrong analogy for self-driving cars. A lot is likely to change with auto insurance companies. GEICO’s scale should help it remain a dominant insurer, but fewer accidents and lower premiums seem destined to make it a smaller, less profitable industry in the future.

Here’s why I fear Buffett doesn’t get it

In October, Berkshire Hathaway announced it would buy a large stake in privately held Pilot Travel Centers LLC, the company behind Pilot and Flying J truck stops and travel centers. Berkshire will initially buy 39% of the company, but that stake will increase to 80% in 2023.

On the surface, this is a typical “Buffett” investment. Pilot Flying J is the leading operator of travel centers and truck stops in North America, with 750 locations and $20 billion in annual revenue. The company’s size is a big advantage because more locations means more truckers, motorcoach operators and other fleets will want to contract with the company to fuel them. That has also worked in attracting other retail and restaurant partners who will pay for access to the enormous customer traffic that flows through the company’s locations.

While Pilot Flying J should continue to be profitable in the near term due to these advantages, self-driving cars and alternative fuels will greatly change the commercial transportation landscape in the coming years. A significant portion of the company is focused on providing services to the professional drivers of the more than two million heavy- and medium-duty commercial vehicles in use today.

At the same time, alternative fuels are also poised to become a major player. Today, the company sells more diesel fuel than any other U.S. fuel retailer, although it has taken some steps to prepare for lower demand. Renewable energy sources such as electricity and hydrogen are not yet viable alternatives for a variety of reasons (primarily charging time, battery weight and access to fuel infrastructure), while natural gas is cheaper, cleaner and more abundant. Pilot Flying J today opened natural gas fueling stations at about 100 locations, made possible by a partnership with Clean Energy Fuels Corp.

The takeaway is that fuel and drivers are the two biggest expenses for fleet operators, and they will use technologies in the future to help them reduce these costs. Pilot Flying J will almost certainly lose business because the business is built on catering to truck drivers and fueling and servicing their vehicles. And it looks like Berkshire’s timing couldn’t have been worse, as the company will double its stake if autonomous driving technology gains widespread acceptance in the marketplace.

I’m not selling, but I better watch out.

Buffett once wrote, “The key to investing is not to judge how much an industry will impact society or how much it will grow, but rather to determine each company’s competitive advantage and, more importantly, the durability of that advantage”. His ability to do just that is the single most important reason Berkshire Hathaway has been a machine for decades, creating more and more wealth. Without this advantage, Berkshire loses its luster as a potential dominant investment.

If Buffett ignores or underestimates the impact of the self-driving cars and alternative fuels megatrend, that’s a major weakness in evaluating investments. I think Buffett overstated Pilot Flying J’s competitive advantages for this very reason.

I’m not selling Berkshire, but I will focus more on how Buffett is investing in the future. If I see an investment pattern that ignores the megatrend of alternative fuels and autonomous vehicles, I may decide to sell.

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The Motley Fool owns and recommends Berkshire Hathaway B and Clean Energy Fuels Corp.

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