Berkshire Hathaway reported results for the second quarter following the close of trading today. Operating earnings per share declined 21.7% to $1,147 per A share, down from $1,465 in the second quarter of 2008. Operating earnings per share for the first six months of 2009 declined 17.1% to $2,248 per A share, down from $2,713 for the first six months of 2008.
Net income per share for the second quarter was $2,123 per A share, up 14.2 percent from the second quarter of 2008. Because net income includes the effects of investment and derivative gains and losses, focusing on net income to gauge quarterly results is not particularly meaningful.
Book value per A share on June 30 was $73,806, which was up 11.4% for the quarter. Book value includes the impact of both realized and unrealized investment and derivative gains and losses. Given the advance in equity markets so far in the third quarter, Berkshire’s book value has no doubt advanced significantly from the reported second quarter figure.
“Headline Numbers” Are Still Misleading
As I pointed out in my analysis of Q1 results, Berkshire Hathaway reports operating earnings each quarter in addition to the GAAP presentation of net earnings. This is done in order to allow investors to focus on the underlying health of the operating companies without regard to the timing of realized gains and losses as well as the impact of mark to market accounting on Berkshire’s derivative positions.
By providing operating earnings, Berkshire is not attempting to suggest that investment gains and losses are not relevant to intrinsic value. Although long term investment and derivative gains and losses are extremely relevant, the timing of these gains and losses during a specific accounting period holds little special meaning because Berkshire management never attempts to time the realization of gains and losses in an attempt to manage earnings.
Investment and Derivative Gains and Losses
Berkshire’s Q2 net earnings include investment and derivative gains of $1,534 million. I have previously explained why I disregard the mark to market changes for derivative positions due to the long term nature of the derivatives as well as the fact that the equity put options are “European” options which cannot be exercised prior to the expiration date.
Just as the large derivative losses that were booked in the first quarter should be disregarded in terms of evaluating company performance, so should the large derivative gains that were booked in the second quarter. Neither are meaningful in terms of evaluating quarterly results. Just as first quarter derivative losses were not cause for despair, neither are second quarter derivative gains cause for exuberance.
Berkshire’s insurance businesses posted after tax underwriting gains of $83 million in the second quarter and $302 million year to date compared to $360 million and $541 million of underwriting gains in the second quarter and first half of 2008 respectively. GEICO, General Re, and Berkshire Hathaway primary group posted underwriting gains for the second quarter and first half while Berkshire Hathaway Reinsurance Group posted underwriting losses primarily due to foreign currency transaction losses attributed to the weakness of the US Dollar in the second quarter. GEICO posted lower underwriting profits compared to the prior year while the number of policies in force increased by 596,000 over the first half of the year. GEICO’s results were adversely impacted by higher loss ratios in 2009.
Net investment income increased by 31.1% to $1,159 million compared to $884 million for the second quarter of 2008. The improvement reflects Berkshire’s large investments in Goldman Sachs, General Electric, Wrigley, Swiss Re, and Dow Chemical which were made at various points over the past three quarters. The improvement due to acquiring these higher yielding securities was partially offset by lower earnings on cash equivalents due to declining interest rates and cash balances.
Utilities and Energy
The Utility and Energy group posted net earnings attributable to Berkshire of $253 million during the second quarter which is a 21.6% improvement over the prior year period. For the first half of 2009, the group posted net earnings of $456 million, a decline of 13% from the prior year period. The group was impacted by lower revenues due to the decline in average per-unit cost of natural gas sold along with declines in electricity demand at PacifiCorp due to the ongoing recession.
All things considered, both the Insurance and Utility and Energy groups have provided resilient results during the economic downturn. Which is more than we can say for …
Manufacturing, Service, and Retailing
Substantially all of Berkshire’s operating companies suffered revenue and profit declines during the second quarter which is not surprising given the impact of the global economic recession and the nature of many of the businesses. Berkshire does not expect significant improvement in overall economic conditions until at least the end of 2009. The group posted earnings of $239 million for the second quarter, a decline of 66.8% compared to the second quarter of 2008. For the first half of 2009, the group posted earnings of $497 million, a decline of 58.8% compared to the first half of 2008.
With the exception of McLane, which was able to wring out some one-time profits from a cigarette inventory valuation gain associated with the imposition of new Federal excise taxes, results for all of the reported business units were down from the prior year. The “Other Service” group posted a loss of $76 million which is primarily due to dismal results at NetJets where revenues declined by 42% over the first half of the year with pre-tax losses of $253 million for the second quarter and $349 million for the first half.
Government demagoguery over business use of private aviation obviously hurt results, which is particularly ironic in light of a special appropriation of $550 million intended to purchase eight planes for the use of members of Congress. Can we interest our public servants in fractional shares rather than outright purchases given the benefits and flexibility such a strategy would offer?
Solid Results in Difficult Times
While the “headline numbers” that the media will focus on are particularly compelling due to large gains on derivative positions during the quarter, alert investors should focus on operating earnings for the reasons mentioned earlier in this article. When operating earnings are examined, we can see that the insurance and utility groups are weathering the recession very well while the other operating companies are facing severe headwinds as one would expect in this environment. To expect positive results from a manufacturing or retail business over the first half of this year would be unrealistic. What should be examined is the degree to which these businesses are building upon their competitive advantages and positioning themselves for future growth once economic conditions improve. Fortunately, Berkshire subsidiaries are uniquely positioned to be run for the long term given the superior financial strength of the parent company.
Disclosure: The author owns shares of Berkshire Hathaway.