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ELF Q3


returnonmycapital
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Book value per share at $672 (up 10.3% year to date). 

Float per share at $1,485 (up 11% year to date).

Investments per share at $2,276 (up 11% year to date).

 

Current stock price at $475.

 

Operating problems this year mean float has come at a high cost; 9% (including life insurance).  The average has been 3% per year.  The main culprit is P&C which is showing a CR of 117% year to date. Management says premium pricing has improved and 2010 is projected to continue to harden.  Management also suggests that something is being done about claims severity and frequency.  CR has not been this high in the last 11.75 years I have data for (going back to and including 1998).

 

On the investment side, the company now has 116% of book value in common and preferred equity (including equity method investments, which are mainly comprised of 2 closed-end funds trading at about 0.7X NAV each).  Continued writedowns in these closed-end funds mean little as they are reflecting a wider market price discount to NAV.  Therefore, ELF continues to invest $0.70 of cash into $1 of equities through these funds.  In an even stranger twist, the largest investment inside Economic Investment Trust (the second largest closed-end fund investment) is ELF itself.  So, effectively, the company is purchasing and retiring its own shares (7,031 shares year to date) at .7 X .7 = .49X book value per share.

 

 

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The real book value of ELF as at Sept. 30/09 is $722/share.  Price to book value is less than 2/3 for a growing, profitable company with conservative management.

 

I have recalculated the company's equity method investments to their net asset value.  The difference between carrying value and net asset value, less 14.5% income tax on the gain (as per management's advice), comes to $50 per ELF share.

 

I have asked management why they do not highlight or explain the following in their reporting:

 

1) net shares outstanding (3.3 million) versus total shares outstanding (4 million)

2) book value per share

3) the net asset value of equity method investments, which are predominantly closed end funds

 

The answer was that they think no one cares.  After some nudging, they are talking about improving their reporting.   

 

30% of the company is held by outsiders.  That's 1 million shares.  They have a story to tell.  The only insurance company I follow that has grown investments per share faster (+10%/yr) in the last 10 years was ORH (+15%). FFH (+3%), BRK (+6%) and Co-operators (+5%) are way behind.  Book value has grown 11%/yr since 1998.  ORH (+18%), FFH (+11%), BRK (+7%), Co-operators (+8%). 

 

Is no one looking at this?  What are others' thoughts on the merits of this sleeper?

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The real book value of ELF as at Sept. 30/09 is $722/share.  Price to book value is less than 2/3 for a growing, profitable company with conservative management.

 

I have recalculated the company's equity method investments to their net asset value.  The difference between carrying value and net asset value, less 14.5% income tax on the gain (as per management's advice), comes to $50 per ELF share.

 

I have asked management why they do not highlight or explain the following in their reporting:

 

1) net shares outstanding (3.3 million) versus total shares outstanding (4 million)

2) book value per share

3) the net asset value of equity method investments, which are predominantly closed end funds

 

The answer was that they think no one cares.  After some nudging, they are talking about improving their reporting.   

 

30% of the company is held by outsiders.  That's 1 million shares.  They have a story to tell.  The only insurance company I follow that has grown investments per share faster (+10%/yr) in the last 10 years was ORH (+15%). FFH (+3%), BRK (+6%) and Co-operators (+5%) are way behind.  Book value has grown 11%/yr since 1998.  ORH (+18%), FFH (+11%), BRK (+7%), Co-operators (+8%). 

 

Is no one looking at this?  What are others' thoughts on the merits of this sleeper?

The real answer is that they are quite happy that the stock is undervalued they are constantly buying back stock I own both ELF and EVT the trust.
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ubuy2wron,

 

Now that ELF is close to voting control over UNC, what do you think the odds are of disolving the fund and issuing its holdings to shareholders?  Munger used to do stuff like that back in the day.  It would mean a balance sheet revaluation from $46/sh to $66/sh or so.  On 6 million shares, that's a boost of $120 million to balance sheet assets, or $36 per ELF share.

 

I imagine it's low, but that won't stop me from talking to them about the idea soon.

 

There is so much that can be done at ELF to unlock accounting value and improve disclosure.  I can't help but get excited.  The only reason I can think of that would deter its revaluation is whether management (majority shareholders) are only thinking of themselves. 

 

I even explained to the CFO that I thought it was important for new and old shareholders alike to enjoy changes in intrinsic value over time, much like what Bufett/Watsa urge.  I sort of intimated that they were cheating shareholders by not expalining how it all comes together on an NAV/IV basis.

 

 

frog03,

 

My holdings are really concentrated in insurance and banking at the moment.  I still have all my prefs from March as well, 100% margined on their cost.

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The trusts were created before the crash of 29 by Hal Jackmans father. They were levered at the time and they almost went to zero. I suspect that nothing significant will happen until after Hal's passing so you better be patient. The Jackmans who are one of Canada's wealthiest families have a lock on this company and nothing is going to get done with the structure unless they want it to change. Hal has slowly divested himself over the years of many of his holdings he had control of National Trust it was sold to Scotia Bank hence the largish holding in Scotia Bank. I wish they would merge or sell to Prem as it would allow Prem to invest the float and excess capital which exists in ELF. They do operate the business with an owners mentality and extremely conservatively, however Hal has been operating the worlds longest creeping takeover and I think unless someone can strucure something that will be very tax friendly to them it probably is not going to change. This is an investment where you will likely get very decent long term returns and then one day in the fuure you will see a large increase in value because of a transaction either going private or merger or sale but it will be on the Jackmans terms. An interesting point on the NAV of UNC and EVT is that they are actualy understating their NAV as the report the NAV on an after tax basis given that their historical costs on some  large  investments is close to zero this understates their value.

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Hi sreenr ... when looking at documents for a company on Sedar, be sure to check out the annual information form, which TSX-listed companies are obligated to file annually.  Generally the AIF describes business strategies with a longer term horizon than the annual reports.  Not all AIF's are informative, but ELF's is ... filing date of latest AIF is 17-March-2009, document dated 09-March-2009.

 

Does anyone have any perspective on ELF's increased ownership position in Algoma Central?

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woodstove,

 

In the financials on Algoma Central, they target a ROE of at least 10%/yr on avg.  The stock is trading at about 2/3 book value.  And they are taking on more ships in the next 1-2 years.  A prospective increase business and a cheap stock add up.

 

The chairman did point out to me the fact that they were adding to their holdings in Algoma Central, much like BRK is doing with BNI.  But, at a prospective 15% earnings yield (on current business).  Take into account the ships coming on and that may look conservative.

 

bargainman,

 

The closed end funds (United Corporations and Economic Investment Trust) are decent proxies for their equities.  You can find their investments in their financials on SEDAR. In addition, ELF holds about $100 million in an emerging market fund.  Managed by?

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Woodstove,

 

I should also add that Burgundy Asset Management looks after some of ELF's equities. 

 

So, outside their managers are Jarislowsky Fraser (GARP) and ValueInvest (value?) at United Corporations, Sanford Bernstein (GARP?) at Economic Investment Trust, Burgundy Asset Management (value) at ELF, and an emerging market fund.

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Guest bernard

 

 

morning,

 

-the way i understand it,there are 4.019 shares and they "own" +/- 700 shares via their investments ;

at 30/09/09,equity is +/- 2.230m;you can use the +/- 3.319 number of shares but for me you have to deduct the value of the 700 shares(i suppose it's at market value) accounted on the asset side,+/-320m;your book value per share is then +/ 575 dollars

 

-on the equity method investmens,why is the value of evt,46m, so low?uic and algoma are +/- market value

 

 

 

 

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Bernard,

 

You make a good point with respect to the 700k shares effectively in treasury.  To properly net them out, we must deduct their cost.  I have put in a call to management to find out how much they cost.

 

Again, you make a good point on EVT.  The company told me that it accounts for its equity method investments as follows:  At cost +/- future changes in NAV.  ELF added EVT as an equity method investment at Jun 30 at a value of $78 million ($68/sh).  At Sep 30, they show a value at equity of $46 million ($40/sh) when the NAV went from $74/sh to almost $86/sh.  Only a small amount of shares were added during the 3rd quarter, so the cost argument (based on market price discount to NAV) is not valid.  How did they manage to take such a huge writedown if NAV went up by 16%?  Another question I will ask the CFO.

 

I'll be back shortly.

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return,

 

a strange explanation may be that,for valuing evt,they take out the value of elf shares in evt, then it will be +/- 63m;

and perhaps,they value other elf shares in the asset side are at +/- 0;in that way,they can apply +/- 3.3m shares for book value and earnigs per share,as you did

 

but it will be quite strange for me

 

nice day

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thanks,good idea

 

also,2 minor questions

 

1/details of the bond portfolio,duration and what change in value if interest go up or down by +/- 1%

 

2/what's the idea behind the serie A pref ? +/- 400.000 pref  still authorized,indefinetely convertible 1 to 1

always a risk for me

 

 

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Hi Returnonmycapital...  Thanks for that info about Algoma.  I've now had a read, and it looks pretty good.  Book value seems a good approximation to value, ie $105/sh, but with the new ships coming on, should see about 25 pct growth in revenues.  I'll guess $12/sh approx earning power is safe assumption.  Say 10x, because of debt:equity leverage high approx 1:1, gives post-expansion value of maybe $120/sh.  So buying at $75 as ELF did seems very advantageous.  I think ALC will work out well.  ELF seems to me the better choice for investing, ie indirectly in ALC and other ELF holdings.

 

I haven't any questions for ELF's CFO aside from what others have mentioned.  Thanks for gathering and sharing info.

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I spoke with the CFO and his responses were as follows:

 

1) Quasi-treasury shares: To deduct the cost of the 700k ELF shares indirectly-owned, use well less than $100 per share. He wouldn't tell me the exact number as it is not public information, yet.  He does think he will add the information in the next and future annual financial statements.  I am using $90/sh.

 

2) Economic Investment Trust (EVT): The charge is to reflect the deduction of the ELF shares indirectly owned by ELF due to its investment in EVT.  It comes to a total of 70,185 ELF shares, valued as at Sept 30 at $29 per EVT share (34% of EVT is invested in ELF).  Considering the writedown was worth $46 million, that suggests a value of $655 per ELF share written down.  I will be asking him to confirm this value and my sums.

 

3) United Corporations (UNC): ELF owns 47.2% of UNC (up from 41% at the end of 2007). If they go over 50%, they must consolidate UNC and ELF book value reflects UNC NAV, not market.  The effect is $20 per UNC or $120 million. They will still continue to be able to buy UNC shares on the market but they must reflect them at NAV in their statements.  Pretty material accounting gain, if it happens.

 

4) Convertible, series 2 prefs: Convertible at ELF's option as early as October 2011. No plans to convert these shares.

 

5) Bond portfolio: The annual report states maturity profile and interest rate sensitivity for their bond holdings for each of their sections (corporate investments, general insurance, and life insurance).

 

Given the above, I calculate effective ELF book value at $695 per share, up 13% ytd.  ELF trades at 0.68X book value.

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return,thank you

 

1/strange,no?you have to deduct 70m from the equity in order to use the 3.320 number;but it's not public info....!!!!they are using that number for the eps and normalized dividend

 

2/evt has,i think,341.000 elf shares

 

4/i was talking about the nominal amount of the special convertible series with a quite good authorized number,not the 2 classic series;

 

i still think that book value is max 650,you have to accept that the accounting is not so transparent

 

thank again

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bernard,

 

1) Yes, it is strange that GAAP requires them to deduct the indirectly owned shares for eps but not for balance sheet discussion, i.e. book value.  They seem to want to rectify this.

 

2) EVT has 343,706 shares of ELF but ELF owns 20% of EVT, so 70,185 shares of ELF indirectly owned.

 

4) If you are talking about the Series A convertible preference shares, the CFO told me those date back many years and are not at risk of increasing.  I have added them to the common share count, but that's only 258 additional common shares.

 

If book value is close to what I suggest, it means that - based on current market value - ELf offers a historical return on investor's capital of 16% per annum, and 19%+ for 2009 ytd.

 

I plan to continue to suggest that management improve on its transparancy and explanation of its logic to shareholders.

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Thanks Return, for that info.  I think you're entirely on the right path, encouraging management to improve on transparency and clarity of the cross holdings implications.  All shareholders will benefit from that - and from the reponse you got re cost basis of indirectly held shares, it sounds like the CFO is very much attuned to the need for fair disclosure of info to all shareholders.

 

The Q3/09 report, note 12 capital stock, discusses the reciprocal shareholdings and defines Adjusted Common Shares (3,319,470 shares net), and states that is used for calculating basic net income per share.  Good - that is what makes sense - and I suppose it must be in agreement with GAAP. In effect, the company has (indirectly) repurchased 7,031 of its shares in the past 12 months.

 

IFRS may throw a curve at this reporting.  I have no idea what though.

 

Basically, I'm happy to have the company run well operationally and for investments.  The accounting presentation will improve as time goes by, provided management is doing its best to provide good info to shareholders - as I believe they are.  There is no particular urgency or desire for any windfall related to GAAP presentation as some holding goes over 50 pct or whatever -- better would be to look for operational and investing performance and let the reporting follow as necessary.  I just hope that the reporting changes mandated by GAAP or IFRS get explained, as best can be for very complex matters.  I'm not an accounting specialist and appreciate having the experts do the hard work and explain it to shareholders in somewhat simpler terms.

 

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bernard & woodstove,

 

I checked with the CFO yet again and he mentioned my sums were incorrect w.r.t. the indirectly held shares. He said their cost is already reflected in book value because they have been netted out of each indirect investment on the balance sheet and the cost has been deducted from P&L with writedowns, as per Q3 writedown of EVT. So, there is no need to reduce the cost of the 700k shares, it has already been done.  Effective book value is around $715 per share.

 

I asked about IFRS and he suggested that nothing material will happen to the balance sheet. He said that Canadian GAAP accounting over the last couple of years has been tough.

 

 

 

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