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FFH upside


shalab
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What is the upside for FFH moving forward? If there is a catastrophe ( cyclone, earthquake etc. ), it seems it could hurt FFH. The law of large numbers will also start to affect FFH as its market cap is 8 billion now. Given that FFH will always be a pure insurance play, I think the upside is limited. I would be interested in contrary opinions.

 

 

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Never say "always" as Mr. Watsa can surprise us...

 

Our ownership in Ridley Inc is 70.16%.  Guess who is the Chairman - Bradley P. Martin... Fairfax controls the company and also added the chairman and it is only a matter of time that they possibly bring this company into the Fairfax family...

 

The initial purchase was 69%, then Mr. Watsa upped his stake to 70.16% and now with the share repurchase program it would be slightly more...

 

Does anyone have a position in Ridley?  It is selling for below book and being a partner with Mr. Watsa is almost a safe bet!

 

Thanks,

 

Shahed

 

 

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Does anyone have a position in Ridley?  It is selling for below book and being a partner with Mr. Watsa is almost a safe bet!

 

Try telling this to those who partnered with him in Canwest and Abitibi! I'm a great fan of Prem Watsa but this is no way to "invest." Ridley is a very small position for a company with $20b of investments.

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None of this is new.  Fairfax has had at least a couple of wholly owned businesses outside insurance in the past.  Midland Walwyn brokerage, Lindsay Morden come to mind - both disastrous.  They have also had people on boards such as Russel Metals (Hartog, Griffiths), ICO (Sam Mitchell).  They are no stranger to operating businesses.  It is just not something that has been a priority. 

 

Shalab, I dont expect the law of large numbers to catch up to them anytime soon.  That applies to Buffett, Microsoft, Walmart or GE, when making 5 B acquisitions more every year no longer moves the needle. 

Fairfax will only appear on the Fortune 400 companies list for the first time this year.  This may be a worry in 15 years but not right now.  They can always forestall the day by dividending out pieces of the business along the way as Leucadia has done. 

 

Upside from here is 15% per year average (at least) until Prem says otherwise.  That means book value a year from now could be 425.  I personally expect the growth will be much larger for two to three years as the investments made in the crash bear fruit.

 

With a couple of minor exceptions I now deliberately stay away from companies that FFH invests in.  They are using diversification to protect the downside.  I dont have the luxury of spreading things around that much.  I will break this rule for something they have held all the way to the coffin lid, that is surviving and they are still holding (sfk.un). 

 

OEC, I expect that the only place that FFH will place a company will be in the holding company(s) which are cash limited.  For wholly owned companies they wouldn't use insurance float due to liquidity concerns.  I believe this is the model that Buffett uses as well for wholly owned or majority owned businesses.  If I am wrong on the last assumption please let me know! 

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(1) Relatively stable BV growth of 15%+/year, but expect some bumpiness in the quarterly numbers. Primarily a portfolio consideration, as this allows you to take a reasonable risk elsewhere should you choose to do so.

 

(2) Acquisition. At some point the arc will get built out; when it does so we can expect multiple expansion on all the assets, & it is would be highly likely to happen very quickly. $100's of share price.

 

(3) Post recession 'New World'. Canadian Index & regulatory considerations would be better served if there were a healthy stand-alone counter-weight to the Sched-A banks. Manulife, Sunlife, GWL, FFH, ELF as the insurance weighting is probable; particulary if FFH & ELF also have share splits to enlarge their floats. Liquidity, along with OSFI/BoC as the quiet protector/enforcer.

 

The dissonance here is when the something like this occurrs.

That it will occurr, isn't really in dispute.

 

SD

 

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I think the quickest driver of FFH's share price would be multiple expansion (I do not think this likely in the near term). At some point in the next few years it would not surprise me to see it trading at 1.2 or 1.3 x BV. Currently the whole insurance sector is out of favour and multiples are low.

 

A key challenge today is the soft pricing environment. As a result CR's next year will be BAD to UGLY (industrywide) especially if a few large hurricanes hit.

 

Interest and dividend income will be good. Investment returns will be ??? Should stocks continue upward (very possible), FFH will easily hit 15% target. 

 

Best thing that could happen for FFH is a bad year next year for catastrophes. Yes their share price would get hit. However, they have more excess capital than most. We would then have an instant hard market and FFH would then start to see some serious growth on the insurance side.... underwriting profit, good interest and div income and investment results for a few years. You will want to be holding FFH when this happens. 

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Given that FFH will always be a pure insurance play, I think the upside is limited.

 

Has it been a "pure insurance play" the past two years?  What exactly is a "pure" insurance play anyhow?  

 

I would consider a pure insurance play to be a company that

1)  relies on underwriting profit to drive earnings

2)  and invests the float in short term govt bonds.

 

 

Fairfax is neither.  Fairfax is an investment vehicle.  The investments drive the growth in book value per share.  

 

JNJ is not an insurance company.

WFC is not an insurance company.

GE isn't either.

Munis neither.

 

Fairfax's results will be driven by the outcome of these non-insurance investments.

 

Same as ever.  Think ORH's 20% growth the past 8 years or so were driven by underwriting profits alone?  It was mostly the investment returns.

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Klarman talked about the opportunities in distressed fixed income products, particularly morgage backed securities that most people can't or won't own at this point. If only there was a company with a bunch of cash, investing expertise, and some cheap leverage to exploit this situation . . .

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OEC, I expect that the only place that FFH will place a company will be in the holding company(s) which are cash limited.  For wholly owned companies they wouldn't use insurance float due to liquidity concerns.  I believe this is the model that Buffett uses as well for wholly owned or majority owned businesses.  If I am wrong on the last assumption please let me know! 

 

I reread my post and realise that my comment "this is no way to invest" was not clear. I wasn't referencing FFH's investment in Ridley; rather, I was referring to Ourkid8's remark that it is an "almost safe bet" to partner with PW.

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Fairfax is a top performing hedge fund without the hedge fund fees. Investors will eventually realize it is better to buy FFH and pay a 20% premium than it is to invest in a hedge fund which charges a 20% performance fee. I don't know why FFH isn't already 1.2x book for that reason alone. When investors realize how superior are Prem's investing skills the multiple will overshoot.

 

I don't mind the insurance business attached to the Fairfax "hedge fund" for two main reasons. First, as a  value investors I anticipate that it will give me an opportunity to acquire more FFH at favourable prices from time to time when other investors are emotional. Second, a quality "hedge fund" attached to an insurance company will provide that insurance company with moat. It is not easy to find an insurance company with moat so I don't mind the attached insurance risks as the moat helps ensure that the insurance side will provide a reward over the long term.

 

Aberhound

Long FFH

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I find that Prem Watsa has been one of the best CEO's over the past 2 or 3 years (maybe the best), but I share the same concern as the author.  What will be the big driver of the stock price moving forward (by the way, I am not suggesting there won't be any...but,)

 

Big investments in Kraft, Wells Fargo and JNJ don't seem to have potential to move the needle much further.  I love the moves into stocks and muni's, but is there another big rabbit that Prem W. will pull out of the hat? 

 

I agree with another poster that this is like a hedge fund without the 20% fees.  However, I don't see a short term catalyst to drive this company much higher.  I do believe FFH will steadily grow BV per share, which is not such a bad thing. 

 

 

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I don't really agree with the hedge fund analogy. Fairfax in an insurance company first and foremost. With that comes the risk of needing to pay out large amounts of $ at the drop of a hat in the occurrence of a major catastrophe. This is of course the reason it (and so many other insurance companies) trade below book value, as cash they have on hand or in equities is not = to a company like Apple sitting on a boat-load of cash. While hedge funds can be faced with quickly changing market prices and redemptions, it is not comparable. 

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Big investments in Kraft, Wells Fargo and JNJ don't seem to have potential to move the needle much further.  I love the moves into stocks and muni's, but is there another big rabbit that Prem W. will pull out of the hat? 

 

 

Huge resurgence of Dell? lol.

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Based on the first 9 months of 2009, annualized interest and dividend income (less interest expenses) comes to 8% (pre-tax) of book value.  At a 30% tax rate it comes to 5.6%.

 

So, capital gains (relative to book value) need to be roughly 9.5% in order to drive BV by 15%.

 

Are you guys saying that they can't do 9.5% from capital gains?  Too big?  I strongly disagree.

 

Have you ever heard of a $7b fund that can't return 9.5% based on an argument that it is "TOO BIG"?  I can't quite grasp how you can really believe that.

 

 

 

 

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Some arguments against 15% growth/year

 

1. A catastrophe can hit any time causing the insurance company's to pay out

2. We are talking about 1.2 billion growth in business value per year and higher every year without any major catalyst to drive it up

3. If this persists, in five years we are looking at a company with business value of 16 billion

4. In Berkshire's case, the driver has been the acquired businesses - it was part of the model from the very beginning, even in the sixties

5. 15% growth is the sunniest estimate

 

cheers!

Shalab

 

1) Dividend and interest income is 700 m per year and growing continuously.  This same number a year ago was 560 m.  

2) The stocks they hold are nearly universally undervalued right now.

3) If this persists we are looking at a company with a value of 16 B - yes - and so, Bershire is worth 170 B or whatever - That gives alot of run time.

4) The bulk of Berkshires growth came from skillful use of the insurance flloat.  That is why Buffett has kept buying insurance companies

5) Insurance itself is in a soft market.  When there is a hard market FFH will write at least double the business.  Suppose they write 12 B per year of business at a profit margin of 4% after tax - That's 500m + 700 + 560 M per year (I used the old number as an assumption that interest rates may be lower) = 1700 M per year.  Of course the 700 + 560 will still be compounding.

 

All of the above excludes capital gains completely.  15% a year should be easily doable for 10 years forward.  

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Yes, we currently are not sitting on massive gains in book value that most everyone seems to be missing making the purchase pretty much a no brainer. Perhaps we have been spoiled in the past.

 

Looking at the current price of the stock which is trading at a small discount to BV my view is FFH is a decent buy. On a go forward basis, they will have OK underwriting, very good interest and dividend income and strong investment returns. One will likely generate satisfactory returns buying FFH at current levels.

 

If global stock markets plumb new lows and corporate yield spreads widen significantly then FFH BV will have some near term issues. However, what if stock markets continue to rally? FFY will outperform. What if the soft market gets worse? What if a mega cat hits?

 

Who knows what will happen tomorrow? Bottom line is there are many moving parts. Each person will need to weigh the individual pieces and make a decision. Currently I do not own FFH. However, should it fall below CAN$370 I will likely again be a buyer. The single biggest reason I will be is my respect for how FFH is navigating through the current turmoil. I KNOW they are much smarter than me and I will be happy to have them manage some of my money at a nice discount to current BV.

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As Eric pointed out, the insurance side (and associated fixed income investments) should contribute over 5% per year to book value. THIS, in no uncertain terms, is the value of the insurance business. Sure it will be lumpy, but no one here seems to be suggesting it won't happen.

 

If you invested in a good mutual fund like FAIRX, and I told you that I would gross up your after-tax returns by 5% each year - with the caveat that I might do it in arrears - every year for ten years, what would you pay me for this? If you had the choice between owning FAIRX at NAV or owning FAIRX + 5% per annum, what would you pay for the second option.

 

Adding 5% per annum to after-tax returns gives you a result in ten years that is roughly 50% higher than what it otherwise would have been. If you think we could have a hard market and a 95% combined ratio, then the insurance business could add 10% per year. When you consider that float could also grow in a harder market and the power of compounding, the numbers get large quickly.

 

Since few people here seem to think the insurance business (which is the business they are in) is worth anything, I suggest you look at it another way. If you think that FFH can compound book value at 15% per annum for the next ten years, then they are basically trading at a P/E of 6.5 and growing at 15% per year. Obviously all the different ways FFH makes money doesn't flow into reported earnings, but the after-tax gain in book value each year is what they have earned.

 

If anyone else knows of a big, safe, conservative company with great management and a bright future trading at 6.5 times earnings and growing at 15% per year please let me know. I would like to buy as much as possible of a company like that.

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I think Bargainman was kidding - although he is correct on the inspiration for my handle.  In any case, while I am sure no clarification is needed, I am no Warren Buffett and am certainly not THE Warren Buffett.

 

 

Yes I was kidding.  That's why I put a ;-).  Goodness, it's ok to joke around once in a while, even on such a serious topic as value investing!

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