Berkshire Profit Jumps to $3.1 Billion on Derivatives

Berkshire Profit Jumps to $3.1 Billion on Derivatives

Feb. 27 (Bloomberg) -- Warren Buffett’s Berkshire Hathaway Inc. said fourth-quarter profit jumped on the recovery of derivative bets tied to the world’s stock markets.

Net income rose to $3.06 billion, or $1,969 a share, from $117 million, or $76, in the same period a year earlier, the Omaha, Nebraska-based company said today in its annual report.

The profit increase, Berkshire’s third straight, helps rebuild a cash pile that diminished since 2007 as Buffett invested in financial firms bruised by the recession. Companies including Goldman Sachs Group Inc. that turned to Buffett for funding are paying Berkshire interest of 10 percent or more. The shopping spree culminated with the November agreement to buy railroad Burlington Northern Santa Fe for $27 billion.

“We’ve put a lot of money to work during the chaos of the last two years,” Buffett said in his letter to shareholders today. “It’s been an ideal period for investors: A climate of fear is their best friend.”

Berkshire had net income of $8.06 billion for all of 2009, a 61 percent gain from the year before. Rising stock prices helped boost book value to $131.1 billion, a 4 percent increase since Sept. 30. The figure climbed about 20 percent from the end of 2008. Buffett typically highlights book value, the measure of assets minus liabilities, in the first sentence of his annual letter to shareholders.

Derivative Gains

Derivatives added $1.05 billion to earnings in the quarter, compared with a loss of $4.61 billion a year earlier after the collapse of Lehman Brothers Holdings Inc. Liabilities on Buffett’s so-called equity-index puts narrow when four stock indexes, including the Standard & Poor’s 500, climb closer to the levels they were at when Buffett made the deals near the market’s peak in 2006 and 2007.

Berkshire’s own stock has gained 52 percent in the past year as derivatives rebounded and the value of the firm’s top stocks rose. The Class A shares closed yesterday at $119,800, their highest since Oct. 21, 2008.

The 20 largest holdings in its U.S. portfolio all increased in value in the past 12 months. Coca-Cola Co., Berkshire’s top holding, climbed 29 percent on the New York Stock Exchange. Wells Fargo & Co. doubled and American Express Co. tripled. The U.S. portfolio was valued at $57.9 billion at Dec. 31, a 12 percent rise from a year earlier.

NetJets Loss

The NetJets unit, which leases planes to corporate customers and individuals, posted a $180 million pretax loss for the quarter, bringing the full-year deficit to $711 million on asset writedowns and the cost of cutting staff.

“NetJets is likely to operate at a profit in 2010, assuming there is no further deterioration in the U.S. economy or negative actions directed at the ownership of private aircraft,” Berkshire said in today’s report. The unit earned $213 million in 2008.

Buffett cut jobs and reshuffled managers at Berkshire’s operating companies last year as retail and industrial demand suffered in the recession. He replaced the CEOs of NetJets and jeweler Helzberg Diamond Shops Inc. Earlier this month, Berkshire reported its workforce fell by 9.8 percent since the end of 2008 to 222,000 employees. The total is about 257,000 with the addition of railroad staff.

Buffett’s firm joined the S&P this month after completing the takeover of Fort Worth, Texas-based Burlington Northern and splitting Class B shares 50-for-1 to facilitate the deal. The move prompted managers of funds that attempt to recreate the returns of the index to add Berkshire to their portfolios.

Berkshire had $30.6 billion in cash as of Dec. 31, compared with $26.9 billion three months earlier. Buffett used about $8 billion of that cash this month to help fund the rail deal.

‘We Sleep Well’

“We pay a steep price to maintain our premier financial strength,” Buffett said in the letter. “The $20 billion-plus of cash-equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.”

Buffett spent $1.86 billion on fixed-maturity securities and $1.37 billion on equities in the quarter. Berkshire sold $1.12 billion in fixed maturities and $3.5 billion in equities to help fund the rail deal. In 2009, the company bought $10.8 billion in fixed-income maturities, compared with a $35.6 billion purchase in the previous year.

Buffett added a $2.6 billion investment in Swiss Reinsurance Co., completed in March, to a portfolio of financing deals that he struck during the credit freeze as other investors were withholding funds. The Swiss Re transaction pays a 12 percent coupon, while Berkshire gets 10 percent annually on its $5 billion injection in Goldman Sachs and its $3 billion of preferred shares in General Electric Co., investments from 2008.

Reinsurance

Investment income, which includes stock dividends and the interest payments from GE, Swiss Re and others, fell about 4 percent to $1.7 billion at Berkshire’s insurance and finance operations.

Berkshire, which owns National Indemnity, General Re and Geico, said profit from underwriting insurance policies fell 71 percent to $535 million. Net income from Berkshire Hathaway Reinsurance Group fell 80 percent to $270 million in the fourth quarter as Buffett scaled back sales.

Profit at Shaw, the world’s largest carpet manufacturer, fell 65 percent to $8 million as sales to residential customers declined in the fourth quarter. Profit at furniture stores, jewelry shops and the candy business advanced 24 percent to $113 million.

Marmon Holdings Inc., the collection of more than 100 businesses purchased by Berkshire from the Pritzker family last year, reported that profit declined 19 percent to $160 million. The unit’s operations include manufacturing, leasing railroad tank cars and making wire and cable products.

Derivative Bets

Buffett sold the equity derivatives to undisclosed buyers for $4.9 billion, according to the 2008 letter to shareholders, and can invest the cash and keep any profit even if he loses the bet. If the four indexes covered by the contracts are at zero when the agreements expire, the losses would be $38 billion, the firm said today, a figure that can change as currencies fluctuate. The total was $38.6 billion on Sept. 30.

The four indexes -- the S&P, the U.K.’s FTSE 100 Index, the Dow Jones Euro Stoxx 50 Index and Japan’s Nikkei 225 Stock Average -- rose in the fourth quarter.

Berkshire has also sold credit-default swaps on individual companies, and contracts that require the firm to pay when credit losses occur at borrowers included in high-yield bond indexes. The maximum Berkshire would still have to pay on agreements tied to the indexes is about $5.5 billion, the firm said today.

Sanofi-Aventis, Tesco

Buffett disclosed increased stakes in drugmaker Sanofi- Aventis SA and Tesco Plc, Britain’s largest retailer in the regulatory filing. Berkshire’s holdings of Sanofi-Aventis rose about 14 percent to 25.1 million shares and the stake in Tesco rose 3.1 percent to 234.2 million shares. Berkshire owned 1.9 percent of Sanofi and 3 percent of Tesco, as of Dec. 31.

Berkshire was stripped of its last remaining AAA credit grade from a major rating firm this month when Standard & Poor’s downgraded Berkshire. The cut, which followed reductions last year by Fitch Ratings and Moody’s Investors Service, came as Berkshire neared the completion of the Burlington Northern takeover.

source: bloomberg