petec

I seldom disagree with you strongly SJ but I do on this. They’ve literally given the minorities the choice. Entirely reasonable.

This is my take too, but with two caveats: they also issued a TON of shares, which has really impaired EPS growth, and while it is probably the best-managed shipping company in the long run, the fact is that the massive spike in short term rates, which ATCO chose not to capture, has completely recapitalised their previously crippled competitors. I take that as a significant negative.

This board makes me smile. COBF when Prem bought at $6.50: oh FFS. Why can’t he just pay up for quality growth like everyone else? COBF when Prem offers $14.45 to minorities: Stop! Thief! He’s stealing the company! 7x future earnings is a perfectly reasonable multiple for a ship leasing company, especially when that multiple might reflect peak earnings (it’s quite possible when contracts roll in 4/5 years they’ll roll onto similar or lower rates, and it’s quite likely the cost of capital rises). ATCO is basically a specialist bank: it applies leverage to a narrow spread between the cost at which it sources and the price at which it supplies capital. It just isn’t worth a high P/E. The reason ATCO is going to be worth more than $14.45 in the future is because Sokol will allocate capital brilliantly, but capital allocation isn’t and shouldn’t be capitalized before it happens. Asking buyers to pay for it up front is nuts. (That’s actually why I liked it - I felt the value would compound nicely for years without it ever getting too expensive.) So, although ATCO is 7% of my portfolio and I’d hoped to own it for 20 years, I don’t think this is a crazy cheap price for the current business and I won’t feel cheated if my minority peers vote to sell. Genuine question, SJ: did you think ATCO was cheap enough to own at $11 a few weeks ago? And if you didn’t, why do you think Prem buying it at $14.45 (but only if the sellers approve) proves that he can’t be trusted?

https://www.fairfax.ca/news/press-releases/press-release-details/2022/Chairman-of-Atlas-Corp.-Fairfax-Financial-Holdings-Limited-and-the-Washington-Family-Partner-With-Ocean-Network-Express-Pte.-Ltd.-To-Jointly-Propose-Acquiring-All-Common-Shares-of-Atlas-Corp.-Not-Controlled-by-Its-Majority-Shareholders-for-14.45-per-/default.aspx

You don’t, but over the long term the change between two currencies should approximate the difference in inflation. If you assume FIH’s assets are real assets - which you’d very much hope good equities should be - then their intrinsic value should rise to offset the currency fall. However this is only over the long term, and in my experience slowing GDP in an inflationary environment can wreak havoc because corporate earnings can be compressed (it’s far easier to overcome inflationary cost pressures in a strong economy than a weak one, but inflation usually creates a weak one) and multiples fall. So there is a multiyear risk of a triple whammy: lower fx, lower earnings, and lower multiples. I’ve lived this in Latin America over the last decade. India’s issue in the current environment is that it is an energy importer. If they can drill enough oil and gas at home to change this it would be a huge boon for them.

Personally not something I worry about much given the JAB deal and the underwriting profits, which give the subs more dividend capacity. I also think the reduced leverage and the increasingly “hard” book value (not long ago a lot of it was intangible) means there’s space to issue a bond if needed. There might be a risk of rising leverage, but I don’t think there’s a liquidity risk brewing.

I think this is a dangerous assumption. There’s no reason to believe the liabilities and the bonds are a great hedge, especially when inflation (which impacts claims) might well run ahead of rates for a good while. What is the duration of their liabilities?

Exactly.

+1

I’m agnostic here. I don’t really think they should be aiming to trade short/medium term moves and I don’t have a really strong view on whether rates are higher or lower in 5/10 years.

I think Prem has already said they don't see the need to add capital to subs to fund premium growth so that's probably out. I very much doubt they will reduce equity down to tangible capital and I am not at all sure they should or need to. The obvious uses (for me) is a buyback - either of FFH shares or of the stubs in Odyssey, Brit, or Allied. And I would imagine the choice will be driven by the price of FFH shares because I imagine the buyback prices for the subsidiaries are fixed.

I’m tempted to say it may well not be, but I think JAB are quite smart. I think Fairfax has spent 25 years turning Crum from a commoditised junkyard into a cluster of niche specialties, so I’m not entirely surprised that there is a jewel in there (and perhaps more). But I’m delighted by the number!

This month to date 20+ year treasuries (TLT) are down 5.3% and 1-3y treasuries (SHY) are down 1.4%. (Data from Koyfin.) The loss differential in 14 days is nearly 10x the annual yield differential that was available at the start of the month. In other words there is absolutely no way people were being paid to take this duration risk. Going long when the yield curve is flat is a macro bet. The only way it works is if yields fall. Staying short when the curve is flat is macro agnostic.

Yes - Exco and Ensign might be little gems for FFH this year.

I think we are talking about different timeframes. To the extent Atlas owns ships on short contracts it is fairly inflation-proof in the short term. If that’s what you’re saying then I agree. However: 1. Every single ship, always, ends up being worth scrap value. Ships depreciate. At that point, you’ve got to replace it with a new one, the cost of which will have inflated. That’s not an inflation hedge. In fact it’s exactly the kind of business with high ongoing capital costs that Buffett warned against owning in an inflationary environment. 2. To the extent Atlas has *fixed* long term contracts it is not an inflation hedge. I can’t for the life of me see how that statement can be contested!

I find this tempting too although I worry that fundraising & deployment has been slow since the deal closed. Maybe I am just impatient, or have missed some news.

I think you are right on both counts, but I disagree Atlas missed the boom. It has nearly doubled its fleet, including newbuilds, and its earnings power. It just captured the boom a different way. It's on 6x 2024 earnings. I think it should probably trade on 8-10x. That's a good return in 2-3 years. But amidst a generalised selloff with epic pain in certain areas and deep value in others, there are a lot of things that appear more interesting than they did a few months ago. I am still sifting through! No, it won't - it will grow, but is largely mature. Atlas's argument is/was that this would make it less cyclical. Clearly that hasn't been the case during covid but it makes sense long term - more predictable demand = less likely to overbuild. Also the industry is much more consolidated which should lead to rationality. This probably isn't a huge issue. Demand would usually be 2-3% and scrappage 3-4%, so you usually need an order book of around 6% per year. In 2008/9 the orderbook hit 60% of fleet and clearly we are nowhere near that. I think demand would have to come in at 0% for the orderbook to be a big issue, and even then capacity can be regulated by steaming slower (which is likely to happen anyway given fuel costs and environmental regulations). No. Didn't happen in 2008-2018 and the industry is *far* better capitalised now. I have no intention of taking anyone's word for it It also blew up! But I take your point about 10-12x. I am not sure that stands in a more inflationary environment for the reasons I have given but, I doubt we will settle it here. Time will tell! That is a terrible analogy. Ships depreciate. Real estate appreciates. Atlas buys ships at a fixed price and leases them at a fixed rate, earning a FIXED spread for as long as the initial contract lasts. There is no inflation link until the initial contract rolls. If the initial contract is 1 year then earnings are inflation linked. If it is 12 or 15 years then there is significant risk to the real value of the contracted cash flows in the later years of the contract. Yes, there will be a nice boost when the contract rolls, but in a high inflation environment that will be more than offset by the increase in the cost of replacement ships.

I'm sceptical that the market doesn't understand that Atlas is a lessor. Atlas trades at a huge premium to other lessors. So it should: it is a better operator, it has longer contracts, it is not over-earning in the short term markets the way the others are, and it has Sokol. But Sokol has attracted a hell of a lot of attention and I think the market knows what this business is. I am also sceptical that a lessor should trade at 12x. I wouldn't capitalise long term contracted cash flows at 8% unless they were inflation-linked. BAM-style assets are infinitely more attractive than ATCO style assets, given they are largely inflation-linked cash flows that can be financed fixed. I do think the market is disappointed that they failed to grow earnings much in the best market in history. Short term rates are set by the marginal buyer, and can therefore spike to incredible levels in an unbalanced market; long term rates are set by the cost of new ships, so they stay much more stable. Normally, high short term rates don't last, so Atlas' strategy of locking in long term cash flows is normally smart, and they may yet look smart if the market normalises soon. But this spike in short rates has lasted 18 months now. Companies at the short end have earned vast percentages of their enterprise values in a few months. If that continues for another year or two, Atlas will look dumb, and worse, their competitors will be exceptionally well-capitalised. I also think there is confusion about the diversification strategy is and whether it will succeed. The market won't assume that's a success before it is one. The only way I think this gets to 12x is if Atlas successfully develops 2-3 other earnings streams at good returns, and that'll take a decade. Anyway, I agree it is cheap, and I would have been adding at $12 6 months ago. I just think the market might be offering better opportunities now.

Out of interest, why? I have slightly cooled on it, although I haven't sold a share. $2 of earnings puts it on 6x 2024. I suspect EPS might be understated and I think the right PE is probably 8-10x, so it's certainly cheap - but then a lot of things have got a lot cheaper recently, including things that have far better pricing power in an inflationary environment than Atlas does give its long term contracts. I'm not sure Atlas looks better relative to other things than it did at $16. What are your thoughts and how do you value it? (Sorry if this should be on the ATCO thread.)

Thanks!

This. I think there are only two ways you can prefer the 10y here: 1) you think rates will fall. This is a macro bet. 2) your liability is a perfect hedge for a treasury bond, and therefore the extra 27bps comes free. Insurance liabilities are far from a perfect hedge. Absent one of these factors, the prudent thing to do is to buy the 2y. That's risk-reward analysis, not a macro bet.

That's good news given what's happening to tech valuations at the moment.

I’ve said this before, so at the risk of sounding like a broken record: why is the cash position a macro bet rather than a risk-reward bet? When curves are as flat as they’ve been, there simply isn’t enough interest rate reward to justify duration risk. The AGM deck is good on this - look how much higher the duration on a 30y treasury is compared to 30 years ago. Bond price risk is real. You guys are all focussed on the absolute level of rates, but how steep the curve is matters just as much. To invert, when the curve is flat, to go long you *must* believe rates are going to *fall*. *That’s* a macro bet. What Fairfax is currently doing is actually macro agnostic in my view.

Interesting point on the accounting. Do you know which applies to capital for solvency purposes? I’m half hoping that Fairfax can continue to outgrow peers because they’ve taken less of a capital hit. Is that possible?

Yes, I am well aware of the history. What I don't understand is why Fairfax don't muscle in and demand change to management, strategy, and/or capital allocation. Unless of course they disagree with your critique. Recipe is one of those businesses where I'd like to see buybacks stop and dividends start. Buybacks only make any sense if you have real belief in the terminal value of the business. Otherwise you want cash OUT. And if they can get free cash flow back to anything like pre-covid levels that would be quite a dividend.