Why did Berkshire Hathaway buy the Japanese trading firms?

So far, 2020 has not been the best year for Warren Buffett’s Berkshire Hathaway, as the market plunged in March many of his positions were hit hard. To add insult to injury, the US Federal Reserve’s quick and steadfast support of the capital markets jeopardised any potential capital allocation opportunities afforded to Berkshire, as the lender of last resort.

In the business’ second quarter earnings, Precision Castparts (PCC), a 2015 Berkshire acquisition, incurred a $10 billion write-down. PCC had already been performing sub-optimally, however, as a major supplier of US airplane manufacturers, it had now become materially impaired as its key customers battled potential bankruptcy. Things have clearly not been too bright.

On August 31, Berkshire Hathaway disclosed the acquisition of more than 5 per cent stakes in Itochu Corp, Marubeni Corp, Mitsubishi Corp, Mitsui & Co and Sumitomo Corp, a group of Japanese trading houses referred to as “Sogo Shosha.” The positions are estimated to total approximately US$ 6 billion, less than 5 per cent of the approximate US$130 billion of cash and cash equivalents sitting on Berkshire Hathaway’s balance sheet.

Source: Morgan Stanley Research

Together, these five companies trade at less than 1.0x price-to-book and offer dividend yields, above 3.5 per cent. Whilst a yield of 3.5-5 per cent may not be considered attractive to investors like the team at Montaka, one must consider this yield in-reference with Berkshire Hathaway’s cost of capital, or opportunity cost. In September 2019, the firm issued US$4 billion of bonds into the Japanese bond market (see this news article here about this), at an average coupon rate of less than 70 basis points. If these trading house investments were made using the borrowed funds, then it becomes more apparent that this could be a clever trade.

There is further reason to believe that this investment is more than simply a low-cost leverage bet, given the nature of the firms that were purchased. Like their prior investment, Barrick Gold, these Japanese trading houses are highly exposed to changes in commodity prices including oil, metals, and grains.  Perhaps this investment could be interpreted as Berkshire Hathaway’s hedge against potential inflation arising from global central bank response to COVID-19.

Berkshire Hathaway recently disclosed the acquisition of more than 5% stakes in a group of Japanese trading houses. Is this investment Berkshire’s hedge against potential inflation arising from global central bank response to COVID-19?
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The Montgomery Global Funds and Montaka own shares in Berkshire Hathaway. This article was prepared 10 September with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Berkshire Hathaway you should seek financial advice.