Investment guru Warren Buffett has often said that derivatives are akin to financial weapons of mass destruction, and the latest result from his conglomerate Berkshire Hathaway is proof. Net profit at the company fell 40% during the three months to June 30, with a $US1.8 billion loss on Berkshire’s derivative trading operators behind the fall.
However, the result is nowhere near as bad as it looks. The derivate investments are essentially long-term bets that the US sharemarket will rise over the next decade, and have been structured in such a way that Buffett does not have to actually provide collateral (that is, cash) when markets move against him.
In fact, cash won’t be required until 2018, by which time Buffett will be hoping a recovery in the US is well and truly underway.
Berkshire’s operating profit – which is considered a far better guide to how its various business in insurance, transport, retail and energy are performing – was impressive during the second quarter.
Total operating earnings increased a whopping 73% to $US3.07 billion, or $1,866 a share, well in from of analysts’ expectations of an operating profit of $1,360 a share.
The strong performance of the operating division was thanks in part to the strong performance of the railway business Burlington National which Berkshire acquired in February in a $US27 billion deal. In the second quarter, the railway business contributed $US603 million in net earnings.
Berkshire’s jet business NetJets swung from a pre-tax loss of $348.5 million in the first six months of 2009 to a pre-tax profit of $114.5 million this year, while premium revenues increased 5.8% during the quarter.
And in an encouraging sign for the wider US economy, profit more than doubled to $US671 million in the company’s manufacturing, service and retailing operations in the second quarter, with Berkshire saying in a statement it saw “some stabilisation of economic conditions”.
Berkshire also noted the introduction of new US laws to reform the financial services sector, but said it did not expect the laws to have a material effect on the company’s earnings.
But Buffett, who admitted last year that his acquisition of Burlington was akin to a giant bet on the future of the US economy, clearly remains confident in his gamble.
“We continue to believe that the economic franchises of our operating businesses remain intact. We are hopeful that recent economic improvements will continue over the remainder of 2010 and beyond.”
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
