While there are a lot of commentators out there commenting on Berkshire’s results, here is a short different take on it.
- In 2018, Berkshire took a pre-tax mark to market losses of $22.4B on investments and derivatives and $17.8B on a post tax basis
- Berkshire reinsurance group did not have a great year and lost $1.1B pre-tax driven by property casualty and retroactive reinsurance.
- Berkshire’s portion of the Kraft Heinz goodwill impairment was $2.7B in 2018
- $19.8B of Fixed Income securities compared to $172B of equities
- $109B in Cash and treasury bills
- Offset by strong earnings in the rest of the operating businesses and insurance companies resulting in a book value increase of 0.4% and net income of $4B for the year.
If on a year like this, Berkshire does not lose money, it talks a lot about the fortress balance sheet and the resiliency of the business model. I know that Buffett talks about not using BVPS any more. I look at it differently. It was an understated proxy for intrinsic value. Now, it is vastly understated for the intrinsic value.
It is often about return of capital before return on capital. There are a lot of commentary about Berkshire being an index fund. It might be but the risk profile is completely different.
About a week ago, Molycorp, the rare earth minerals manufacturer declared a chapter 11 bankruptcy.
From google finance,
Molycorp, Inc. is a rare earths producer. The Company operates in four business segments: Resources, Chemicals and Oxides, Magnetic Materials and Alloys and Rare Metals. The Resources segment includes its operations at the Mountain Pass facility. The Chemicals and Oxides segment includes the production of rare earths at Molycorp Silmet; production of separated heavy rare earth oxides and other engineered materials from its Molycorp Jiangyin facility, and production of rare earths, salts of rare earth elements (REEs), zirconium-based engineered materials and mixed rare earth/zirconium oxides from its Molycorp Zibo facility. The Magnetic Materials and Alloys segment includes the production of Neo Powders through its wholly owned manufacturing facilities. The Rare Metals segment produces, reclaims, refines and markets niche metals and their compounds.
Often companies get into bankruptcy as they are unable to absorb the burden of the debt that they have undertaken and go through the bankruptcy process and come out stronger with better negotiated debt on the other side. The market that Molycorp operates in is dominated by Chinese firms . When the economic behemoth tried to strong arm the world by controlling supplies, Molycorp and Lynas came up with supplies with some non-Chinese mines. These two companies at one point contributed to 10% of the global consumption. Since then the Chinese have backed down and the world has been more than willing to buy from them at rock bottom prices.
When one looks at the financials of Molycorp, attention needs to be paid to the income statement rather than the balance sheet as we usually do in distressed conditions.
The company has been reporting net negative gross margins. The company has been losing money just getting metal out of the ground. This is even before the sales force is paid, the corporate expenses are paid and even before the interest payments are serviced on the debt. The only time when the GP’s were positive was during the Chinese induced shortages which resulted in a huge price increased in the market. Just restructuring the debt with lower interests or better terms or financial engineering is not the solution to this problem.
The company has not outlined any measures that can make the investor comfortable that a margin of safety exists in the bond even under distress. Unless there is another attempt to strong arm the rare earth market from the Chinese or the US is determined to use only US made rare earth metals, or the Chinese crack down on the black market, financial engineering will only go far to stem this tide. A cautious investor will do well to sit this out and watch from the sideline!