Cardboard
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Good catch Roger!
Wow! I never thought and had never seen that this could have such influence. At least not on the exact day that the rebalancing is occuring.
I picked randomly some names in the additions: AHCI, MITI, MLR, RBI, UVE and they all showed dramatic increases in trading volume Friday. Most did go up by a fair amount, but not like ATSG.
Cardboard
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Something seems up with this puppy. Almost 9 million shares traded today with the stock up 25% and significant trading after-hours with well over 1 million.
Can't find any news.
Cardboard
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I agree Al,
No one is still valuing Fairfax using March 31 book value. Everyone can go on the SEC website and pull the 13F to see what is going on with their major U.S. holdings. They also disclosed that book value on April 24 was north of $285 and things have gotten better for sure since then. If people are waiting for mid-August to understand what book value will be on June 30 they have blinds on.
Cardboard
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The stock was down for the day and did pop about $3.50 U.S. on the news. Still quite disappointing to see Fairfax trading where it is at.
Personally, I was not really optimistic following the November announcement that all hedges had been removed. Disclosure: I had no position. I thought that they were doing exactly the right thing, but that the market would react negatively since the company was seen as a strong defensive name in what was a killing zone. So I was really surprised to see the strength in the stock in January and early February, but then everything unravelled in late February.
Since mid-March they have made a killing in the market, so this lack of hedges fear should have abated, but it did not work that way. I have a really hard time explaining why Fairfax share price is still not reflecting any of their gains. I truly hope that Prem is buying back a lot of shares at this price since they still have plenty of cash at holdco. Do we really need to carry more than $500 million in liquid assets at holdco with no debt due until 2012? Half a billion is quite a cushion especially when you consider that pretty much all of our insurance subsidiaries are over-capitalized.
The only explanation I can come up with it is that Fairfax is now seen as boring. Traders and fund managers are trying to squeeze returns so they are buying the volatile names: commodity plays, emerging markets, big U.S. financials. The pattern since mid-March in other P&C insurers is also quite similar.
The above could be a decent explanation for FFH recent trading pattern. However, I think that Fairfax and Prem should really question why we are still trading well below book. This made sense before in the dark days, but now that the issues are fixed, I see no reason why we should be trading at any less than peers.
Cardboard
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Thanks a lot for the information on Klarman and Robertson guys. :) I had gone through the 13F from Baupost to try to understand what Seth was using to protect from inflation and could not really find anything.
Wow! This is getting really interesting. Roberston is another one that did make a fortune betting heavily on CDS. We have a lot of players who anticipated the previous crisis now protecting themselves from something nasty occuring in the not too distant future:
John Paulson (CDS now into gold), Kyle Bass (CDS now into gold), David Einhorn (short financials now into gold), Julian Robertson (CDS now I assume into these CMS), Seth Klarman (heavy in cash now into these interest rate caps), Prem Watsa (CDS now into ?).
I am sure that I am missing quite a few more. Buffett is definitely another one that was prepared for the crisis with a mountain of cash and has now mentioned many times that he is worried about inflation.
These are all pretty level headed guys unlike Sprott and they all seem to come to the same conclusion or the need for some protection. Although, Sprott has been right on many things and I don't want to discredit him, he strikes me as a gold bug or one that will have a very hard time leaving the table at the right time.
On a related topic, I read this article yesterday.
http://money.cnn.com/2009/06/22/news/economy/derivatives_regulation_risks.fortune/index.htm
It makes me wonder about all these interest rate derivatives and the risk of some "miscalculation" by a player to hedge risk properly that could lead to some kind of domino effect. If interest rates spike a bit for any reason I wonder who is going to be left out there holding the bag? There must be another AIG or Bear Stearns in this world who is simply praying that this does not happen.
Cardboard
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Is the situation as described by Sprott really that simple? Is there any hole in his analysis? I mean, if it is that simple and the timing is truly before the end of 2009 then why is it that the market is not panicking yet?
While I believe that the situation is very difficult and that something could easily go wrong, I am not 100% certain of it. It would be nice if we could find a security that would provide a hedge against such event at a very small cost. For example, Prem was able to buy credit default swaps to hedge against the credit bubble at a very small cost relative to Fairfax portfolio, but with tremendous upside. The downside was also limited to the cost of the CDS.
Essentially, you need something to bet against long term treasuries or the dollar, but that something needs to be cheap or not recognized yet as of much value to the marketplace. Calls on TBT? Some kind of interest rate derivative? A call on silver? Any other idea?
Cardboard
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SD,
For arbitrage, I had in mind that some NA players would buy and store gas, buy a put future 12 months out at a 50% premium price to spot and then deliver the gas next year pocketing the difference. Their cost is storage and premium on the contract. I would imagine that their is quite a bit of money to be made. The impact of their action should be to shrink the gap between spot and future prices.
The issue is that storage is getting full in NA and at that point pricing could drop in theory to $0 if supply remains much greater than demand. As you mentioned export/import don't work so well for nat gas. However, with lower and lower spot prices, producers will at least stop new drilling and possibly close the tap bringing supply in line with demand and eventually less than demand depleting inventories.
My point in general is that something is out of whack here. Either spot is wrong, future prices are wrong or a combination of both. This cannot last forever, something has to give and I am trying to find out if there is something in it for me.
Cardboard
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I was just reading this article from Andy Xie posted on a different thread and it reminded me to check into the crude futures curve.
Early this year, there was a huge disconnect between spot prices and future prices for oil. This corrected pretty quickly with oil for short delivery now at around $70. The inverse happened last July when spot prices were quite a bit higher than future prices. Again the spot price moved lower to stabilize the curve.
I am not saying that this is a 100% reliable indicator for the direction of spot prices since the entire price curve moves up and down over time, but when the price of spot is way above or way below the long term prices, arbitrageurs and producers will try to profit from it which will tend to close the gap. It did work perfectly to bet against oil in July of 08 and for oil at the beginning of this year.
Currently, there is a very large contango between natural gas prices for today's delivery vs next year or 50%. For oil it is now down to only 8%. Then if you look at the compounded rate between June 2010 and June 2017 for both natural gas and oil it is about exactly the same at around 3% a year. So market forces should move higher the spot price of natural gas to a level closer to its future price at some point. It also seems to make sense for future prices to be where they are based on regular demand and the now much higher cost to produce natural gas.
I found this article which I find explains well the mechanism.
http://www.getreallist.com/natty-dread.html
What do you guys think? Is there a solid opportunity here?
Cardboard
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Mohamed El-Erian mentioned on CNBC recently that you have to prepare for what is likely to happen instead of preparing for what you are hoping to happen.
IMO, we are very likely to see war with North Korea and/or with Iran in the next 5 years. It is definitely not something that I want, but these two piece of news cement my fear.
http://www.cnn.com/2009/WORLD/asiapcf/06/13/un.north.korea/index.html
http://www.cnn.com/2009/WORLD/meast/06/13/iran.election/index.html
What history has taught us is that men fight on a regular basis and that dialogue has a very poor record with countries lead by such leadership. IMO, North Korea will be the first event. The odds of the old man there changing his stance are extremely unlikely and if you compare with the Iraq situation, we should be already at war with them. These guys launch ballistic missiles on a regular basis, have nukes and continually threaten their neighboors! The key is understanding how China and Russia will react. I hope that they will stand with Western nations, Japan and South Korea as the U.N. vote indicates, but when things truly heat up it is a tough call.
I was also hoping that Iranians would elect a more moderate president. It seemed like the youth wanted change and a better relationship with the world, but the overall population didn't. So the rhetoric will continue and Israel is likely to remain ready for war. A very dangerous situation which could deteriorate at any time, especially if something occurs with North Korea.
To protect yourself, it seems to me that one needs to deliberately keep some cash on hand over the next 5 years despite the temptation to be fully invested at times. Some gold and silver may not hurt either. Another option is to be less agressive with your fair value forecast: you wait for insane prices to buy and sell for something like a P/E of 10 at best. It just seems to me that these events which are becoming more and more probable are adding to the current case of staying defensive or being cautious. Very unlikely that the secular bear market which began in 2000 is now over.
It may sound like I am trying to "profit" from such devasting events and it does not feel right. At the same time, I feel like being fully invested with hopes that valuations will return to bull market levels and that everything will be peaceful is totally naive. I also know that Buffett has mentioned that all the dramatic events post World War II did not make a dent in the principles taught by Benjamin Graham. However, unless prices already discount such events should you not wait until they do? Kind of like what he has done when he bought stocks in South Korea.
Cardboard
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Thanks Pof4520,
That makes sense now. I had merged the Fed and the Treasury Department. :-[
I have been thinking too much about that stuff lately: inflation, interest rates, currencies and consequences of something like a long term bear in treasuries. It would be nice to totally ignore, but even in a bottom up analysis, you have to somehow figure out the business direction and if there is debt inside the corporation what interest rates are likely to do.
I am also trying to figure out if we are heading into another crisis that few are thinking about now. Guys like John Paulson and Kyle Bass were betting heavily on credit default swaps since they saw the coming debacle due to securitization. Now, they are both heavy in gold. We can also add David Einhorn to that list since he did find many holes in the financial system and is now also heavy into gold.
Cardboard
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Why are they issuing $19 billion in 10 year notes today and $11 billion in 30 year notes tomorrow considering the discussion about quantitative easing?
If I get it right, issuing these long term treasuries creates an IOU which brings cash to the Fed and someone forks real dollars to pay for them. So it is neutral in terms of money supply. However, it creates additional supply which depresses the price of treasuries which in turn increases their yield creating a drag on the economy.
Again if I understand correctly, quantitative easing is the buy-back of treasuries by the Fed in order to shrink their supply. But, they are doing this without real cash on hand to buy them, so new "electronic" dollars are given to the seller. This increases money supply. The yield on treasuries should be reduced helping the economy, but the effect appears to be only temporary since there is inflation created at the same time eventually leading to higher yields.
Why are they not simply doing the quantitative easing thing if that is their intention? Why issuing and then buying back pretty much the same securities? Is it a game of issuing as much as possible now at "high" prices to buy it back later at lower ones?
Cardboard
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Hi Viking,
The weighting to risky assets is not that large. There was around $4 billion in stocks at the end of March out of a portfolio of $18 billion (I include holdco). They still have over $3 billion in cash and over $9 billion in bonds. However, I don't know exactly out of the $9 billion what is in treasury, corporate and municipals.
It may look very risky compared to some portfolios of other insurance/reinsurance companies that you investigated recently, but not vs Fairfax historically. The other thing that I think reduces the risk significantly is the shift out of long term treasuries to municipals and some corporates. There is no way that the yield differential will go back to the huge gap that we have seen. So that gain is in the bank, however if the yield on long term treasuries keep increasing then it will put pressure on these other bonds. The only way out is to be all in cash.
In terms of being confident in risky assets to buy into Fairfax, I think it is slightly the opposite. Basically, Fairfax is priced like nothing positive occured since March 31. So if the market keeps marching forward, you have these gains for free plus whatever comes next. If the market goes back to the March lows for all their stocks and they keep them all, then the current price discounts that already.
On a longer term basis, this is a great market for Prem & Co. There are bargains available and with a murky economic picture there is going to be shifts from one sector to another, from pessimism to optimism and back and forth which will allow them to continually trade value.
Cardboard
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Ericopoly,
They have grown that WFC position massively in the first quarter from 3.5 million to 20.0 million shares. The average cost would have fallen off a cliff and I suspect that the original stake of 3.5 million was likely bought in the low 20's considering that it was built in the 4th quarter looking at the various 13-F's. I figure that the overall cost was around $325 million. Their stake is now worth $500 million and was above $550 million at the most recent spike.
There is no way that they did not lighten up a bit. We shall see in the next 13-F. My view is that they see WFC as a core holding or a long term hold. When they saw the price plummet in the first quarter, they loaded up. It does not mean that they won't take some gains as the stake grows larger in size due to price appreciation vs everything else that they own. So it could still be a good deal at $30 a share, but likely not with 20.0 million shares, especially with Prem's warranted cautious view of the U.S. economy.
Another thing to consider for the U.S. banks fans out there. I am absolutely convinced that there are massive limit orders and short sell orders already setup at the following prices:
JPM: $33
WFC: $23
USB: $17
If these stocks touch these levels, there will be quite a correction. The reason is that people long these stocks will fear a return to March lows and for short sellers, these prices will confirm a technical breakdown telling them to step in. So for those who feel that they have missed the boat, I suspect that a juicy opportunity will present itself in July/August. I also suspect that by then that many will fear and few will want to step in.
Cardboard
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Ericopoly,
You make an excellent point around goodwill and it is true that my comparison with Berkshire on that standpoint is quite weak. If Dell or JNJ were proportionally consolidated on Fairfax's balance sheet, instead of being accounted as investments, we would see a goodwill amount appear or just like when Berkshire makes the acquisition of an entire business above book value.
However, it becomes tougher to value because you have to figure out the market value of these individual businesses via look through earnings. With Fairfax at the moment, it is easy because most of their assets are traded securities. We can establish a liquidation amount quite easily.
So if we consider Fairfax as some kind of levered closed end fund, this liquidation amount should be the minimum amount that one would be willing to pay for this business: You risk $1, but there are many more at work for you and if they close shop tomorrow, you get your dollar back. Then one should ask, why should I pay anymore than this amount?
I believe that the answer lies in the confidence for management to underwrite properly (leading to cost of float) and to invest the funds at a high rate of return. How stable or risky is the business structured (amount of leverage, type of insurance) is probably also another important factor. We get more into the value of the insurance business itself or its sustainable earning power. Of course, if they are doing poorly in the above, then the risk to see your dollar back diminishes because book value is being eroded. Again, I don’t think that is the case for Fairfax anymore.
Cardboard
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Alertmeipp,
You could look into buying deep in the money call options on both COP and FFH to avoid selling one or the other. If you go far enough, the premium will be very small and they will trade very closely to the stock. Using these however, you will not receive the dividend. Using margin is also attractive currently since it is so cheap with the dividend on these two stocks being enough to cover the interest charges. However, you have to keep monitoring for margin calls, change in interest and the currency.
Cardboard
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Berkshire Hathaway does trade today at 1.36 times book value, but to compare it with Fairfax we should make an adjustment for goodwill. Goodwill at Berkshire is $33.8 billion or 33% of common equity. At Fairfax, it's only $286 million or 6.4% of common equity. Removing the goodwill at Berkshire makes it trade at 2.03 times book value.
Book value is simply the liquidation value of a company based on the value of the various assets and liabilities on its balance sheet using GAAP. It has nothing to do with the private or public value of this company or its subsidiaries. However, it is kind of a minimum as to what the company is worth assuming that the books are clean. It also makes some sense for financial companies since so many assets and liabilities are worth what they are stated at.
Therefore, I don't think it makes sense anymore for Fairfax to trade below book value at any given time. The company has survived the "test" when some market participants claimed that the liabilities were much higher than recorded. So after so much time, we have to conclude that the books are clean and that book value is solid. On top of that, the company is active (not looking to close shop), making money and growing its book value at a decent rate, so it makes no sense for it to trade lower than this amount.
I firmly believe that this time of trading below book value for Fairfax is rapidly coming to an end. This is a remnant of a previous era when doubts, financial issues due to too much debt, legacy under-reserving and poorly timed catastrophes caused the market to question the viability of the firm.
Cardboard
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Hi Viking,
Thank you very much for the spreadsheet! I will take a deeper look at it tonight.
Hi Crip,
There are many cheaper stocks than FFH out there. For example, I think that something like Canfor Pulp really is, but you need quite a stomach to hold it since you never know what pulp will do in the short term. Still, that stock could double tomorrow and would still be cheap while if Fairfax doubles tomorrow, I will be out.
Cardboard
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Don't you guys remember that the MSN Board was often slow and even not responding at times?
This new site is working great, it does not cost you a dime and you are complaining about a few little adds that "distract" your sight? Shame on you!
Cardboard
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It is true that reinsurance appears tighter than insurance currently, but I believe it is only temporary. Both follow the same cycle and drivers/issues are generally common. Just have a look at this Globe and Mail article regarding P&C insurance in Canada.
Early last year, I was a big advocate of investing in ORH at $37 vs FFH north of $300 U.S. because of a tangible gap in valuation. This time around, I am more inclined to go with daddy. Although, there is always that possibility of FFH buying the rest of ORH for a decent premium.
So yes, I am now back into Fairfax in part because I believe that the Street is significantly mispricing the recent gains in book value. As of April 24, we were told that book value had grown by at least $30 putting it above $285. If you look at various markets, you will see that they have rallied more in percentage between April 24 and now, than they did between March 31 and April 24.
On top of that, take a look at some of their big 13F holdings: DELL, JNJ, KFT, PFE, WFC. Only USB has not done much since April 24. I have not done the math for all the holdings disclosed in the 13F, but the result must pretty interesting. Of course, the long term treasuries have hurt the overall result, but adding another $30 to book value since April 24 does not seem that agressive to me. That is over $315. :P
I am also quite confident that Prem has booked obscene profits from this market rally. This will mean more cash to re-invest in other undervalued securities or a fast growing snowball from here in book value and earning power. This will really change the psychology of investors currently seeing Fairfax as described by Viking: "and yes, markets could crater tomorrow. FFH BV will be MUCH MORE volatile moving forward given their shift to risk assets." Booking very large profits two years in a row in what has been a terrible market for most will start to look more like talent vs luck. People pay for recurring.
Fairfax is certainly not the cheapest stock that I hold currently, but the certainty of return is mouthwatering. FYI, since 2003 Fairfax stock in USD has never closed below book value on Dec 31. The average for these last 6 years on Dec 31 was 1.145 times book. For the last 3 years it was 1.243, which I would argue represented better years for the company!
Cardboard
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Keep in mind that the inventory figure includes wastepaper, parts for machinery and others. It is not all saleable pulp. From the annual report, around 50% is pulp or $55 million out of $109.
If we apply the same ratio to the March 31 figure we get $62 million in pulp. Although, I agree with you. It seems like a low hanging fruit that they should go after agressively.
I am not planning to buy more at this time. I think that I will wait to see what gets done. I would also be very hesitant to buy the convertibles when you can go out and buy CFX.UN. It came back down recently because Dundee Securities downgraded it to a sell because the stock was ahead of itself. This one is a double from here and I would not be surprised to see it go back to $10 if pulp goes back to $900. Definitely a low cost producer, low risk and very nice upside from here.
Cardboard
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I am not sure what you mean by hedging SD. Buying the convertible debentures and shorting the common at $0.27? Shares are simply not available to short.
Now regarding the convertible debentures, I am not sure that the financial engineering that you proposed will do much for SFK. This company is showing annualized negative cash flow of around $17 million. Even if the convertible debentures were not requiring any interest payment, this would only save $3.6 million a year. I understand that there was a massive amount of downtime taken in the first quarter to align their production with demand, but remember that cash flow removes depreciation which is a very large component of fixed charges.
The ones who will be calling the shots here are the owner of the credit facilities if interest or principal are not paid per schedule. They are the ones who will be telling the jokers at SFK how they will be getting paid back.
To avoid this fate, they need to find a way to slash costs on a grand scale. And even if the company is financially restructured with the common losing everything and the convertible owners retaining something, they are likely to lose it all down the road unless the root cause or costs is fixed. Tembec is a great case.
Disclosure: I own a small position in SFK.UN and debating if I should simply sit and gamble with it or take whatever is left to invest in more promising ideas.
Cardboard
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Based on my view of the economy I think it has as well, but I did not take any chance and hedged some of my exposure this week (late to react of course) since I was quite heavy in USD. Something tells me that this thing will overshoot a lot here with all these hedgies out there.
I have read somewhere that consensus currently among money managers is that emerging markets is the place to be. So they will pile into foreign names, commodities and producers until something breaks. Chasing returns is their game.
With overall mortgage debt in the U.S. not decreasing by a lot and this second large wave of resets coming in 2010 (subprime resets are history, but non-subprime is just starting), it is hard for me to imagine a thriving economy. Then we have Sokol who sees the sales and inventories very clearly warning us that it will take a while for housing to recover.
Europe is no better. I think that when most realize that growth in the developed world will be very weak for years to come, that commodities will trend more or less flat from here. This makes them expensive which will favour substitution and with little demand growth if any from the developed world, supply will be adequate to feed China, India and a few other growers.
I am also not willing to accept this notion that only the USD will come down. What is so great about the Euro or the Yen? What I see happening is standard of living declining in the developed world due to higher costs (gas, food) and higher taxes to support an aging population with little increase to overall salaries since the developing world is turning capable to do the same for less.
Cardboard
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I did not load up in the $0.20 range back in November and I don't think it was a mistake. I think it was a mistake to not buy some after they leased some planes early this year and when Joe Hete was buying the stock (still in the $0.20 range) and then to back up the truck after they announced the incredible deal with DHL regarding the note. I got some, but I think that is where the psychology of quotations really hit me. Paying 2, 3 or 4 times the recent price seems crazy, but it was the right thing to do. I had bought a lot in the $1 range previously, so what was the hesitation at $0.40, $0.60 or $0.80?
Back in November the story could have turned very wrong. The 4 points that I mentioned in my March 24 post presented major challenges. Then imagine the following:
1- DHL enters a deal with UPS (both companies were confident that it would get done) leaving no business at all for ABX Air, the DHL note remains repayable in full and timing still in question, no possibility to agree on the capital leases.
2- With management continuing its agressive expansion plan: converting many B767's to freighters with put proceeds from other DHL planes and the delivery of one more this year, cash becomes really tight, lenders are worried and potential customers smelling blood lease the planes at very poor rates.
This could have well happened. The odds of significant value erosion and a potential bankruptcy were not zero. I think that the market over-reacted, but was still trying to price these odds vs value vs other opportunities appearing with the crisis in the marketplace.
Cardboard
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Hi Myth465,
It has been quite a roller coaster! I am loving the current share move and glad that this is turning into a return on capital vs return of capital.
I believe the key is that we have had strong data points confirming the value of their B767's fleet:
1- New customers signing to lease them at what appears to be good rates from their latest financial results. This is being done at a terrible time for air cargo demand.
2- DHL reversing its stance from being a foe to a "friend".
Oil turning higher is certainly helping demand for these B767's.
The share price move has been really fast, but I am convinced that there is more to go over a longer period of time. Annualized earnings were $0.68 from the first quarter results. Free cash flow around $1.80. These will come down when they become taxable in 2012 and when you make out some adjustments for current DHL earnings, but still. A current target of $4-5 does not seem crazy at all.
I see them turning into a smaller company with a very stable cash flow model, paying back their debt and eventually distributing back to shareholders via share buy-back (they are now allowed) and/or dividends.
Cardboard
Market neutral strategy
in General Discussion
Posted
The S&P 500 is now around $920. Reported earnings are quite poor to support this index level and if you look at normalized earnings, we are probably trading around 13 times earnings. It is really hard to estimate normalized earnings going forward since there has been a major distortion in earnings from the financial sector which was until recently a huge contributor.
In Canada, the financial sector has been on fire. With banks now trading around 13 times 2010 earnings and around twice book, I think that the move up is largely done.
The multiples above are around normal vs the past 100 years. To me it means that you are very unlikely to see a 50 to 100% advance in the S&P 500 or Canadian financials in the next 12 to 18 months. Add to this the mountain of uncertainty related to massive issues of U.S. treasuries, a likely California default and very few signs of green shoots and it is hard to imagine large growth in index earnings or very much improved investor sentiment.
If you look at smaller companies, there are still opportunities despite the market advance since March 9. But 10 to 20 cents on the dollar opportunities have largely disappeared. You have to be very selective and aware of recessionary impacts on small companies especially if they carry debt.
So what I am investigating is to be short the market and long individual opportunities. I am typically close to fully invested, but I had to sell some positions since they got close to fair value or quite above my portfolio valuation. Cash is now building up and I am having difficulties finding new mouthwatering bargains. If the market retreats I will likely be able to easily reload.
In the meantime, cash is earning nothing. I could wait for opportunities to simply appear or for me to find them to redeploy this cash. It just seems to me that some bear ETF's could provide some "income" if the market pulls back, same as cash if the market stays flat and could hurt me if the market advance. The latter should simply mean fewer gains since some of my stocks should explode with a better economic climate.
Another strategy previously described by Mohnish Pabrai is to buy BRK when cash is building up. It would seem very smart at this time since BRK seems very attractive. Buying FFH or ORH currently also seem to fit the mold since they have a built-in discount vs the S&P: they should be valued higher due to their gains in S&P stocks, but the market has not reflected it.
Anyone in this situation or looking to employ such strategy?
Cardboard