Berkshire profit plunges 96% on stock market bets

Berkshire profit plunges 96% on stock market bets

Tags: Berkshire Buffett Omaha

Written by Bloomberg
Monday, 02 March 2009 10:32

NEW YORK: Warren Buffett’s Berkshire Hathaway Inc posted a fifth-straight profit drop, the longest streak of quarterly declines in at least 17 years, on losses from derivative bets tied to stock markets.

Fourth-quarter net income fell 96% to US$117 million (RM433 million), or US$76 a share, from US$2.95 billion, or US$1,904 a share, in the same period a year earlier, the Omaha, Nebraska-based firm said in its annual report. Book value per share, a measure of assets minus liabilities that Buffett highlights in his yearly letter to shareholders, slipped 9.6% for all of 2008, the worst performance since Buffett took control in 1965.

“The credit crisis, coupled with tumbling home and stock prices, had produced a paralysing fear that engulfed the country” at the end of 2008, Buffett in his letter to shareholders yesterday. “A freefall in business activity ensued, accelerating at a pace that I have never before witnessed.”

Berkshire, where Buffett serves as chairman, chief executive officer and head of investing, suffered as the benchmark Standard & Poor’s 500 Index turned in its worst year since 1937. Liabilities on derivatives linked to world equity markets widened by 49% to US$10 billion in the three months ended Dec 31, though the contracts don’t require Berkshire to pay out until at least 2019, if at all.

Berkshire shares have fallen 44% in the past year as the value of the firm’s top equity holdings dropped and losses increased on the derivatives. Nineteen of the top 20 stocks in Berkshire’s US portfolio declined last year.

Coca-Cola Co, Berkshire’s top holding, dropped 26%.American Express Co plunged 64%. Oil producer ConocoPhillips fell 41%, and Buffett said in his shareholder letter that he made a “major mistake” in buying shares when oil and gas prices were near their peak.

The decline in book value per share, a figure Buffett provides in a chart at the start of his annual report, still outperformed the S&P. Berkshire’s only other annual decrease in book value during Buffett’s tenure was a 6.2% drop in 2001; the company outperformed the S&P in 38 of the 44 years he’s run the firm. Book value has dropped by about US$8 billion this year, from US$109.3 billion on Dec 31, the report said.

“You can call it the worst year ever if you want, but the fact is, the results compared to the 30% to 50% declines in the world stock markets show just how defensive Berkshire is,” said Tom Russo, a partner at Gardner Russo & Gardner, whose largest holding is Berkshire shares. “In the face of the maelstrom, he did alright.”

In his “owner’s manual” for Berkshire shareholders, Buffett says he considers book value to be an objective substitute for the best, albeit subjective, measure of a firm’s success: a metric he calls intrinsic value. Buffett doesn’t provide a number for intrinsic value.

Net income fell 62% to US$4.99 billion for all of 2008, with storm claims from Hurricanes Ike and Gustav contributing to a decline at Berkshire’s insurance operations.

Industrywide, insurers faced US$25.2 billion in claims on natural disasters in 2008, the most since the record storm season of 2005, a trade group said last month.

Berkshire, which owns National Indemnity Co, General Re Corp and Geico Corp, said fourth-quarter profit from underwriting policies more than doubled to US$1.18 billion.

Pretax underwriting profit at Berkshire Hathaway Reinsurance Group jumped four-fold, in part because Buffett booked US$224 million after winning a bet with the state of Florida. Berkshire had pocketed the fee with the agreement that the company would buy bonds from the state if a hurricane forced the state to issue debt. No storms hit.

Profit from selling policies at car insurer Geico rose 18% to US$186 million before taxes as premium revenue increased. The unit added about 206,000 new policyholders in the quarter and 665,000 for the year.

Earnings from Berkshire’s energy and utilities unit, which includes MidAmerican Energy Holdings Co. and PacifiCorp, more than tripled to US$856 million in part from a breakup fee earned when Constellation Energy Group Inc backed out of a deal to be acquired by Berkshire.

Berkshire’s equity derivatives were sold to undisclosed buyers for US$4.85 billion as of Sept 30. The derivatives are tied to four indexes — the S&P, the UK’s FTSE 100 Index, the Dow Jones Euro Stoxx 50 Index and Japan’s Nikkei 225 Stock Average. The indexes would all have to fall to zero for Berkshire to be liable for the entire amount at risk, which was US$37.1 billion as of Dec 31 and can fluctuate with currency valuations. Buffett previously identified only the S&P.

Under the agreements, Berkshire must pay out if, on specific dates starting in 2019, the four benchmarks are below the point where they were when he made the agreements. Buffett, recognised as one of the world’s pre-eminent investors, gets to use the money in the interim. The liabilities on the derivatives are accounting losses that reflect the falling value of the stock indexes, not cash Berkshire has paid out.

“Derivatives are dangerous,” Buffett said in the annual letter.

“Our expectation, though it is far from a sure thing, is that we will do better than break even and that the substantial investment income we earn on the funds will be frosting on the cake.”

The worldwide recession and global contraction of the credit markets are giving Buffett, 78, opportunities to invest some of the firm’s cash hoard, which was about US$25.5 billion at yearend, down from US$33.4 billion three months earlier.

Berkshire agreed in the past six months to purchase preferred shares of General Electric Co. and Goldman Sachs Group Inc, and made deals to buy debt in firms including motorcycle-maker Harley-Davidson Inc, luxury jeweler Tiffany & Co and Sealed Air Corp, the maker of Bubble Wrap shipping products.

Berkshire is commanding yields as high as 15% at a time when potential rivals are no longer able to make such investments. In his letter, Buffett described the 10%yield on the Goldman and GE investments as “more than satisfactory”. — Bloomberg