Warren Buffett turns 80 on the 30th of this month, and as an unwelcome advance present, his Berkshire Hathaway company has again underlined what a treacherous investment financial derivatives can be.
His propensity for what he sees as ‘no fail’ options over major stockmarket indices might have provided Berkshire with a lot of free and easy capital to invest, but as we saw in 2008, when derivatives go bad, they can damage the company’s credibility with big top line losses in the turbulent markets.
Last year saw a recovery as markets rebounded and the options performed positively, as they did again in the March quarter of this year.
But the second quarter saw markets in the US and offshore hit by worries over Europe, the euro, Greece, the health of the recovery in the US and fears about deflation, as the company revealed with its second quarter report.
Judging by the performance on major markets since the end of June, the options should be positive this quarter, meaning the full extent of Berkshire’s enormous financial strength and profitability should be seen in the next quarterly report.
But for the second quarter, the options were a blot on earnings which featured the first full quarterly contribution (and impressive) from the Burlington Northern Santa Fe Company.
Net income fell to $US1.97 billion from $US3.3 billion in the second quarter of 2009.
But excluding investments, operating profit surged to $US3.07 billion, from $US1.78 billion.
That was on a 7% rise in revenues to $US31.71 billion, indicating an improvement in profit margins in some businesses, especially insurance.
Berkshire said improved insurance underwriting included a tripling of pretax profit at the Geico Corp auto insurer (one of America’s largest) and a turnaround at the NetJets corporate plane business.
But Berkshire recorded $US1.41 billion in losses on derivatives, including long-term contracts tied to equity indexes, compared with a profit of $US1.53 billion a year ago.
Buffett has said in the past that these options are on the Standard & Poor’s 500, London’s FTSE 100, the Euro Stoxx 50 (the index of the top 50 companies in Europe) and the Nikkei 225 in Japan, all of which had rough quarters with falls from 11% to 15% in the three months to June.
These have an estimated value of around $US37 billion.
Burlington Northern contributed $US603 million in the first full quarter since Berkshire paid $US26.5 billion in February for the 77.5% of the company it did not already own.
Operating profit at Berkshire’s insurance operations, its biggest business, rose 23% to $US1.55 billion, while NetJets (fractional ownership of private airliners) posted a $57.5 million operating profit, in contrast to the $US252.5 million in the June quarter of last year.
Profit from utilities and energy fell 8% to $US233 million, while manufacturing, service and retailing businesses such as the Forest River RV unit and the Fruit of the Loom clothing unit saw profit nearly triple to $US671 million, as demand recovered from the broader economy.
Berkshire had cash on hand of $US27.95 billion as of June 30 from $US25.67 billion at March 31.
