Fairfax today

[petec]

Just wondering how people think about the valuation today.

 

P/TBV (unadjusted for unbooked gains) has gone from a recent low of 1.4x to 2.2x.

P/BV (also unadjusted) has gone from a recent low of 1.1x to 1.4x.

Book value sensitivity to a 100bps rise in rates has gone from 8% to 14% as they have doubled down on their long treasuries bet.

 

I've long had a monster position because I have seen it as an excellent underwriter/investor led by people I trust, with macro downside optionality, at a reasonable price.

 

At this price and with the increased sensitivity I am leaning towards "they'd better be right".

 

Any thoughts?  And does anyone have a reason for the recent price run?

 

EDIT: the valuations above are straight off Bloomberg.  Doing it myself it's on 1.5x.  If you assume all the intangibles are owned by controlling shareholders, then the stock is on 2.3x tangible book.  The other way to do this would be to value intangibles at 1x, so that gets you $3.3bn of the $14.3bn market cap, leaving $11bn.  The remainder of book value is $9.4-3.3=6.1bn, giving a p/bv of 11/6.1 = 1.8x.  Interested to know how other people think about this, or whether you prefer other metrics?

 

[petec]

Helpful, thanks.

[ValueMaven]

Dear petec,

 

I thought you raise some very interesting points honestly.  Valuation is at the long-end of Fairfax's historical range, and as you noted, interest rate sensitivity has increased materially.  Also, gains from investment management have been just OK, and hedging has really cost the firm.  Mr. Watsa will be speaking at a value-oriented conference in a month at NYC...It will be very interesting to see what he has to say!!!

 

Sincerely,

ValueMaven

[petec]

Yes, I saw your post - I will watch out for that!

 

 

[TwoCitiesCapital]

Just wondering how people think about the valuation today.

Book value sensitivity to a 100bps rise in rates has gone from 8% to 14% as they have doubled down on their long treasuries bet.

 

I haven't checked these numbers to know if they're accurate, but I think claiming they "doubled down" is probably a mischaracterization of what happened. Treasury rates hit record lows post-"Brexit". The 10-year fell 80 basis points from 2.27% to 1.47%. That's a massive move!

 

What that means is that Fairfax's bond portfolio increased in % relative to the rest of the portfolio which means they became more exposed to interest rate risk. Further, as interest rates fall, duration risk increases which boosted their exposure further. Since these are passive market moves, I think it's a mischaracterization to say they've doubled down on long-bonds and I wouldn't be surprised to see that they recognized some gains from sales in the next quarter's release. This wouldn't be the first time they've taken gains on bonds in the last few years.

 

 

EDIT: the valuations above are straight off Bloomberg.  Doing it myself it's on 1.5x.  If you assume all the intangibles are owned by controlling shareholders, then the stock is on 2.3x tangible book.  The other way to do this would be to value intangibles at 1x, so that gets you $3.3bn of the $14.3bn market cap, leaving $11bn.  The remainder of book value is $9.4-3.3=6.1bn, giving a p/bv of 11/6.1 = 1.8x.  Interested to know how other people think about this, or whether you prefer other metrics?

 

 

 

I tend to estimate Fairfax's equity book value around $9.5-10B as a rough estimate. That leaves me at a ~1.35-1.4x multiple and I'm relatively alright with that given the improvements in underwriting and the upside earnings potential if/when they ever remove those equity hedges. This is the real catalyst - there would be massive improvements in earnings power when Fairfax does this.

 

The best case scenario would be for markets to collapse, the bond portfolio/deflation hedges to explode in value, and then the reinvest that money near the bottom while removing equity hedges. Fairfax would be an easy double to triple in 2-3 years in that kind of scenario as earnings power would explode.

 

The next best case scenario is that Fairfax removes hedges without a major correction (I don't see this happening).

 

If we got closer to 1.6-1.75x without a major correction in equity markets, I might lighten up and sell a portion of the portfolio. If it fell to 1.25x or so without a deterioration in insurance, I would probably buy more. I think we're in that happy medium now where I simply intend to hold and wait.

 

 

 

[cwericb]

Value^2 said:  “they are worst investors in this business. In-fact the reason they still are in business, is that, they keep raising new equity by selling shares regularly to keep the turd afloat.”

 

I have owned FFH for about 10 years and have no intention of selling.

 

FRFHF share price has increased 29% in the past 24 months. From $448 to $579 = $131/ share U$

FFH share price has increased by 55%. In the past 24 months. From $490 to $761= $271/share C$

Not bad for a “turd”.

 

Plus Fairfax offers me substantial downside protection in the event of the market going south while their insurance business improves and expands throughout the world.

 

PS. During the same period BRK.B has moved from $141 to $146 or 3.5%

 

Perhaps I am in error?

[benhacker]

My view is quite similar to TCC's summary (both the response on doubling down, and views on valuation).

 

Thanks TCC for sharing your thoughts.

[petec]

 

FRFHF share price has increased 29% in the past 24 months. From $448 to $579 = $131/ share U$

FFH share price has increased by 55%. In the past 24 months. From $490 to $761= $271/share C$

Not bad for a “turd”.

 

 

Couldn't agree more.  Consider me a very happy investor in turds.  All I am currently considering is resizing my position because it's significant.

[ourkid8]

What is significant?

 

 

FRFHF share price has increased 29% in the past 24 months. From $448 to $579 = $131/ share U$

FFH share price has increased by 55%. In the past 24 months. From $490 to $761= $271/share C$

Not bad for a “turd”.

 

 

Couldn't agree more.  Consider me a very happy investor in turds.  All I am currently considering is resizing my position because it's significant.

[petec]

TCC: thanks for yours.  I very largely agree.

 

Re: doubling down, that was careless phrasing and overstates how active they have been but a) I believe they have sold some of their muni portfolio and reinvested in long treasuries and b) regardless of the reason, the interest rate sensitivity is higher.  This is significant to me because instead of getting deflation upside without much inflation downside, my risks are now more balanced.

 

Re: valuation, I guess the question posed in my edit is, do you value goodwill at >1x, and if so, why? 

 

Otherwise I am very much on the same page and as I've said earlier, this debate (for me) is about whether I have a huge position or a big one.

[petec]

What is significant?

 

 

FRFHF share price has increased 29% in the past 24 months. From $448 to $579 = $131/ share U$

FFH share price has increased by 55%. In the past 24 months. From $490 to $761= $271/share C$

Not bad for a “turd”.

 

 

Couldn't agree more.  Consider me a very happy investor in turds.  All I am currently considering is resizing my position because it's significant.

 

"Different for everybody" is the answer, but my position is >30%.

[cwericb]

I just want to note that a few days ago our board troll, Value^2, jumped in here once again in his quest to make disparaging remarks about FFH and Watsa. As usual, when he is challenged with facts he simply crawls back into his hole and disappears.

 

I bring this up again because it concerns me that when someone like petec asks a legitimate question they may not be aware of Value^2's history of mudslinging towards FFH. Because of that, some may legitimately assume that Value^2 knows what he is talking about.

 

Now in the ten years I have owned FFH, this “turd” as Value^2 refers to it, has increased in share price from $145 to $762 - or $848 if you include dividends - a nearly 500% return. But Value^2 never responds to FFH’s proven performance.

 

In July 2015, Ben Hacker commented on an exchange between Richard Gibbons and Value^2 regarding FFH’s performance.  Ben commented regarding Value^2's logic -  “Had to write it down to make sure I could follow along with sophisticated trolling; use of ignore activated.” 

 

This was seconded by TwoCitiesCapital. Now personally, I just muddle along with this investing stuff, but when it comes to board members who actually do know what they are talking about and you have Value^2 on one side and Ben H, Richard G, and Two Cities on the other side, well.... I think that probably speaks for itself.

[ValueMaven]

Has anyone put together a current valuation of Fairfax, and where that might stand today? 

[petec]

 

I bring this up again because it concerns me that when someone like petec asks a legitimate question they may not be aware of Value^2's history of mudslinging towards FFH. Because of that, some may legitimately assume that Value^2 knows what he is talking about.

 

 

Don't worry about me - one sentence was all I needed.  I'm a big fan of constructive, fact-based criticism of my positions.  That comment was neither.

[KinAlberta]

 

I bring this up again because it concerns me that when someone like petec asks a legitimate question they may not be aware of Value^2's history of mudslinging towards FFH. Because of that, some may legitimately assume that Value^2 knows what he is talking about.

 

 

Don't worry about me - one sentence was all I needed.  I'm a big fan of constructive, fact-based criticism of my positions.  That comment was neither.

 

Though I seldom offer up facts of any kind, I too am "a big fan of constructive, fact-based criticism."  I find it much easier and quicker to talk in wistful, airy-fairy terms.  :-)  However I try to avoid sharp critiques because that usually just points out my own ignorance.  So, speaking of which, Value^2 mentioned FFH dilution. That's an interesting angle. Does anyone have the stats on that readily at hand?

 

As for my financial interest in FFH. I've owned it off and off since the early to mid 1990s and have held some of shares for near two decade long stretches of time, and periodically it's been a significant position.  Today I own zero FFH shares.

 

That said, I am very interested in rational fact-based valuation commentary.

[petec]

 

So, speaking of which, Value^2 mentioned FFH dilution. That's an interesting angle. Does anyone have the stats on that readily at hand?

 

 

Actually what he mentioned was "issuing shares to keep the turd afloat" which, to the best of my knowledge, only happened once (in the mid-2000's with the private issuance to Markel and others).  Aside from that there has been huge share issuance mainly to fund acquisitions but the bvps history shows very clearly that shareholders have not had their value diluted even if their stake has been.

[racemize]

Yes, but that's almost a self-fulfilling prophesy.  If you can issue shares above book value, it is always accretive, which makes your BVPS growth look good.  Said another way, I wonder how much of FFH's BVPS growth comes from issuing shares at high valuations vs organic growth/investments.  E.g., if I recall correctly, they issued shares in the late 90s at 3x book value.  Not hard to get BVPS growth doing that.  They also used that to make a terrible acquisition (I guess that was in vogue at the time, MKL had one, BRK had one...).

 

Anyway, just rambling a bit.

[Crip1]

Yes, but that's almost a self-fulfilling prophesy.  If you can issue shares above book value, it is always accretive, which makes your BVPS growth look good.  Said another way, I wonder how much of FFH's BVPS growth comes from issuing shares at high valuations vs organic growth/investments.  E.g., if I recall correctly, they issued shares in the late 90s at 3x book value.  Not hard to get BVPS growth doing that.  They also used that to make a terrible acquisition (I guess that was in vogue at the time, MKL had one, BRK had one...).

 

Anyway, just rambling a bit.

 

 

Racemize - Referring to MKL's Terra Nova acquisition?

 

 

-Crip

[racemize]

Yes, although that may have been more like 2003.  It's been a while since I read all the letters.

[petec]

Yes, but that's almost a self-fulfilling prophesy.  If you can issue shares above book value, it is always accretive, which makes your BVPS growth look good.  Said another way, I wonder how much of FFH's BVPS growth comes from issuing shares at high valuations vs organic growth/investments.  E.g., if I recall correctly, they issued shares in the late 90s at 3x book value.  Not hard to get BVPS growth doing that.  They also used that to make a terrible acquisition (I guess that was in vogue at the time, MKL had one, BRK had one...).

 

Anyway, just rambling a bit.

 

I agree.  However, given the context, I'd point out that turds don't trade at >1x book for long.  This has done so for most of its life.

 

 

[Uccmal]

Yes, but that's almost a self-fulfilling prophesy.  If you can issue shares above book value, it is always accretive, which makes your BVPS growth look good.  Said another way, I wonder how much of FFH's BVPS growth comes from issuing shares at high valuations vs organic growth/investments.  E.g., if I recall correctly, they issued shares in the late 90s at 3x book value.  Not hard to get BVPS growth doing that.  They also used that to make a terrible acquisition (I guess that was in vogue at the time, MKL had one, BRK had one...).

 

Anyway, just rambling a bit.

 

They did issue shares in the late 1990s at 500 cdn one time to help finance the purchase of the dogs  breakfast companies.  There were others instances of share issuance way above book prior to that - this is a vague recollection and I have no inclination to go back.  The values in book value growth quoted in each report also include the first year, and early years when they had some really good growth and revaluing of holdings.  Once FFH got bigger by the late 90s the growth rates tailed off.  There are many companies in Canada and elsewhere that have had higher BVPS growth, through the financial crisis. 

 

There was a time when Prem had set 20% average BVPS per year as a target, then he reduced it to 15%, around 05/06, which has never been met.  In my opinion FFH is an average company these days,  but no where near the top, and it never will be.  At the moment it is defintiely a fairly  'safe', and reasonably predictable investment,  but that comes at a price. 

[SharperDingaan]

We're great fans of how FFH generally goes about its business, but at this point we think the next few years are 'ho-hum' at best; primarily because the current price is so high. A double will require an enormous improvement, whereas even a fairly small error will hurt quite a bit. The same $ amount invested in any of Canada's big 5 banks would also earn quite a bit more, & for about the same (but different) total risk.

 

We would also remind you that FFH returns are very 'lumpy', & 'compound return' is a smoothing mechanism. Nothing wrong in that so long as your cost price is low, you have a long runway, & recognise the limitations; many folks miss it.

 

This board is prone to 'hero worship' over prized cows.

Hero's are not always the 'best' investment, all the time - no matter how much we would like them to be. 

 

SD

 

 

 

[Uccmal]

We're great fans of how FFH generally goes about its business, but at this point we think the next few years are 'ho-hum' at best; primarily because the current price is so high. A double will require an enormous improvement, whereas even a fairly small error will hurt quite a bit. The same $ amount invested in any of Canada's big 5 banks would also earn quite a bit more, & for about the same (but different) total risk.

 

We would also remind you that FFH returns are very 'lumpy', & 'compound return' is a smoothing mechanism. Nothing wrong in that so long as your cost price is low, you have a long runway, & recognise the limitations; many folks miss it.

 

This board is prone to 'hero worship' over prized cows.

Hero's are not always the 'best' investment, all the time - no matter how much we would like them to be. 

 

SD

 

 

 

 

That is sort of my thinking on FFH.  Prem has built a wonderful global insurance conglomerate.  But these days, even Buffett is leery of the insurance industry. 

[Guest JoelS]

I have a slightly different view of Fairfax. If the world muddles through, then I expect returns to be mid single digit, lumpy, not outstanding. However, if stock markets crater 40-60%, I expect fairfax to be a fine investment, looking through the crisis, and 3-5 years beyond.

 

I am prepared to accept middling returns on Fairfax in the muddle through scenario, if it gives me optionality in a crisis and an imperfect hedge (not to mention mental resolve). To look at their portfolio of 1. Bonds 2. Cash 3. Market hedges at 100% of equities 4. deflation hedges on CPI - I struggle to imagine a stock that would better preserve capital, in the crash scenario. Have you found a better equity alternative?

 

To the final point on insurance, can we agree it is really reinsurance that is lacklustre? The Fairfax team have reduced the insurance book and are well prepared for the inevitable hard market.

 

I am commenting here in the hope that I will be corrected on any imperfect understanding of Fairfax that I have.

[SharperDingaan]

I have a slightly different view of Fairfax. If the world muddles through, then I expect returns to be mid single digit, lumpy, not outstanding. However, if stock markets crater 40-60%, I expect fairfax to be a fine investment, looking through the crisis, and 3-5 years beyond.

 

I am prepared to accept middling returns on Fairfax in the muddle through scenario, if it gives me optionality in a crisis and an imperfect hedge (not to mention mental resolve). To look at their portfolio of 1. Bonds 2. Cash 3. Market hedges at 100% of equities 4. deflation hedges on CPI - I struggle to imagine a stock that would better preserve capital, in the crash scenario. Have you found a better equity alternative?

 

To the final point on insurance, can we agree it is really reinsurance that is lacklustre? The Fairfax team have reduced the insurance book and are well prepared for the inevitable hard market.

 

I am commenting here in the hope that I will be corrected on any imperfect understanding of Fairfax that I have.

 

There is nothing wrong with FFH. Depending on your risk tolerance it may indeed be a fine investment.

It is simply that there are alternatives.

 

SD