2017 q4 result out!

[Viking]

Results came out on the 15th.

 

On the 16th, Crip and I both pointed out that there often seems to be a time lag between the time the results come out and share price movement.

 

Share price has barely moved until today and now pops 4-5%. This happens quite frequently and is almost like having advance knowledge of the results.

 

+1

[gokou3]

Results came out on the 15th.

 

On the 16th, Crip and I both pointed out that there often seems to be a time lag between the time the results come out and share price movement.

 

Share price has barely moved until today and now pops 4-5%. This happens quite frequently and is almost like having advance knowledge of the results.

 

I wonder if it is due to the re-opening of the share buyback window after earning release?  Trading volume for FFH is low, so even at Q4's buyback pace that represented a few % of daily volume.

[StubbleJumper]

Results came out on the 15th.

 

On the 16th, Crip and I both pointed out that there often seems to be a time lag between the time the results come out and share price movement.

 

Share price has barely moved until today and now pops 4-5%. This happens quite frequently and is almost like having advance knowledge of the results.

 

I wonder if it is due to the re-opening of the share buyback window after earning release?  Trading volume for FFH is low, so even at Q4's buyback pace that represented a few % of daily volume.

 

 

My vague recollection is that there was a presser last year saying that FFH engaged an investing outfit somewhere to continue to do a systematic buyback even during the quiet period.  Has my memory failed me?

 

EDIT:  Yes, I found it:

 

TORONTO, Sept. 29, 2017 (GLOBE NEWSWIRE) -- Fairfax Financial Holdings Limited (“Fairfax”) (TSX:FFH) (TSX:FFH.U) announces that, in connection with its previously announced normal course issuer bid effective September 28, 2017 (the “NCIB”), it has entered into an automatic share purchase plan (the “ASPP”) with a designated broker to allow for the purchase of its Subordinate Voting Shares under the NCIB at times when Fairfax normally would not be active in the market due to applicable regulatory restrictions or internal trading black-out periods. Before the commencement of any particular internal trading black-out period, Fairfax may, but is not required to, instruct its designated broker to make purchases of Subordinate Voting Shares under the NCIB during the ensuing black-out period in accordance with the terms of the ASPP.  Such purchases will be determined by the broker in its sole discretion based on parameters established by Fairfax prior to commencement of the applicable black-out period in accordance with the terms of the ASPP and applicable Toronto Stock Exchange rules. Outside of these black-out periods, Subordinate Voting Shares will continue to be purchasable by Fairfax at its discretion under its NCIB.

 

The ASPP commenced on September 28, 2017 and will terminate on the earliest of the date on which: (a) the maximum annual purchase limit under the NCIB has been reached; (b) the NCIB expires; or © Fairfax terminates the ASPP in accordance with its terms. The ASPP constitutes an “automatic securities purchase plan” under applicable Canadian securities laws.

 

Fairfax is a holding company which, through its subsidiaries, is engaged in property and casualty insurance and reinsurance and investment management.

 

For further information contact: John Varnell, Vice President, Corporate Development,

at (416) 367-4941

 

 

 

SJ

[petec]

As I have mentioned countless times, there is no ROE generated if you exclude capital gains. So to trade well above book and generate the respect that you guys seek they have 2 choices:

 

1- Grow really fast like in the late 80's and 90's by acquiring company after company with an overvalued currency.

2- Generate a portion of the return via sound, repeatable earnings. That means low cost, less interest paid, profitable underwriting and more deployed into sound investments with the blessings of regulators.

 

 

I think this makes a lot of sense. But I also think #2 is starting to be built. Compare the $425m of interest and dividend income reported for 2017 with what we (think we) know about the underlying portfolio:

- $9bn in bonds gets you $270m even if they're all in the 10-year - the real number will be higher.

- with the 2-year at 2.25% the $20bn in cash has earnings power of $450m without taking any real risk.

- $750m prefs and debentures announced in 2017 at 5-6% so about $40m of income - assuming they all got drawn - I am not sure if they did.

- $500m of committed investment at Arena (assuming Westaim drew all three tranches of prefs) earns 12% for another $60m once it is all deployed - or more if Arena levers as Zwirn's old shop did.

 

Add some dividends on stocks and you've more than doubled the 2017 reported number over a fixed holdco+interest cost base. Add consistent underwriting at say 98%, some cash flows from non-insurance subsids, some fees from FIH and FAH, and refinance your debts at lower rates, and you're starting to generate a base of sound, repeatable earnings. Not enough to justify much over 1x book, but the trend is in the right direction.

 

Not that it bothers me much - I am very happy to hold at book value and have my returns come from the investing side.

 

[Cardboard]

Good post Petec.

 

If they continue heading in that direction, it will work out but, it will take time for the market to consider this the new state. Buffett has done it for decades now and it does not trade at a large multiple of book value.

 

And these bonds or cash holdings are not permanent positions like a Precision Castparts or a BNSF. These will be sold or invested elsewhere.

 

So yes, if they do well and earn money, the stock should follow that rate of progress. However, to call Fairfax a table pounding opportunity at this point because it should pop and simply trade at a much higher multiple of book is wrong IMO.

 

Actually the market is likely making a favour to these people if they are true investors and not just looking for a quick exit or instant gratification since it allows to repurchase shares at a reasonable price which combined with a potentially profitable future that we just alluded to leads to a higher investment return.

 

Cardboard

[Spekulatius]

Once sound underwriting is in place, they can easily generate 8-10% ROE just with solid income from bonds and investments - no home runs needed. That is the model thwt most insurance companies work towards like WRB or TRV (to name a few good ones) and they are doing quite well now and will do even better with higher interest rates.

 

If they are doing well on the investment side, they probably can do a mid teens ROE and then they would deserve a 1.5-2x book value.

[petec]

And these bonds or cash holdings are not permanent positions like a Precision Castparts or a BNSF. These will be sold or invested elsewhere.

 

Agreed. That said, in the hands of competent investors (and I realise we all have different views about whether that applies here) investments that can be changes ought to compound faster than those that can't. Now, you might not get a premium to BV (on the basis that the portfolio can be replicated at BV externally) but you still compound faster. I am quite happy not to have *too* much money caught up in big operating business.

 

Totally agree about a pop above BV. That's not the core of the opportunity here.

[StubbleJumper]

Good post Petec.

 

If they continue heading in that direction, it will work out but, it will take time for the market to consider this the new state. Buffett has done it for decades now and it does not trade at a large multiple of book value.

 

And these bonds or cash holdings are not permanent positions like a Precision Castparts or a BNSF. These will be sold or invested elsewhere.

 

So yes, if they do well and earn money, the stock should follow that rate of progress. However, to call Fairfax a table pounding opportunity at this point because it should pop and simply trade at a much higher multiple of book is wrong IMO.

 

Actually the market is likely making a favour to these people if they are true investors and not just looking for a quick exit or instant gratification since it allows to repurchase shares at a reasonable price which combined with a potentially profitable future that we just alluded to leads to a higher investment return.

 

Cardboard

 

 

 

Cardboard, two or three days ago, FFH was trading pretty much bang-on at book value.  My heuristic for BV (or at least a BV that is mostly tangible) is that this is the point where the business as a going concern offers zero value.  This is the point where, if one could liquidate the assets for a "fair price" and put the business in run-off, you'd be equally well off to do so.

 

So, I'd say that FFH deserves to trade above book.  There's plenty of room to debate about how much above book it ought to trade, but my take is that this thing is not worth more dead than alive.

 

 

SJ

[Txvestor]

Good post Petec.

 

If they continue heading in that direction, it will work out but, it will take time for the market to consider this the new state. Buffett has done it for decades now and it does not trade at a large multiple of book value.

 

And these bonds or cash holdings are not permanent positions like a Precision Castparts or a BNSF. These will be sold or invested elsewhere.

 

So yes, if they do well and earn money, the stock should follow that rate of progress. However, to call Fairfax a table pounding opportunity at this point because it should pop and simply trade at a much higher multiple of book is wrong IMO.

 

Actually the market is likely making a favour to these people if they are true investors and not just looking for a quick exit or instant gratification since it allows to repurchase shares at a reasonable price which combined with a potentially profitable future that we just alluded to leads to a higher investment return.

 

Cardboard

 

 

 

Cardboard, two or three days ago, FFH was trading pretty much bang-on at book value.  My heuristic for BV (or at least a BV that is mostly tangible) is that this is the point where the business as a going concern offers zero value.  This is the point where, if one could liquidate the assets for a "fair price" and put the business in run-off, you'd be equally well off to do so.

 

So, I'd say that FFH deserves to trade above book.  There's plenty of room to debate about how much above book it ought to trade, but my take is that this thing is not worth more dead than alive.

 

 

SJ

 

Agree with you on this stuble. In addition the recent subsidiary sales transactions demonstrated value above BV as well. I think the market here is discounting recent poor investment performance and extrapolating that into the future. I can't say that is unreasonable. MKL deserves their stock price being above BV. They have invested well, acquired non-dilutively, and outperformed the markets consistently. If Fairfax does that for 5 yr, they will rerate as well. Will that happen? I am not so sure. But the investment thesis here is thet even without hitting it out of the park, they should be able to consistently grow BV 10-12% a year, a feat that has eluded them over recent times. Even that would get them to a higer multiple than 1BV. Prem just has to make sure he doesn't trip over his shoelaces yet again.

[petec]

Cardboard, two or three days ago, FFH was trading pretty much bang-on at book value.  My heuristic for BV (or at least a BV that is mostly tangible) is that this is the point where the business as a going concern offers zero value.  This is the point where, if one could liquidate the assets for a "fair price" and put the business in run-off, you'd be equally well off to do so.

 

 

Surely it should trade at 1xBV if the ROE=your cost of capital? If, for example, it generates a ROE of 10% but you've got a stack of ideas that offer a 20% return, you'd pay 0.5x book. If it generates 7% and your threshold is 7%, then you'd pay 1x.

 

Putting it another way, it is true to say that at BV the business is worth an equal amount as a going concern or liquidated, but only if the proceeds of liquidation are put into something else that generates your required rate of return. But it is not true to say that a business generating a 0% ROE, or a 2% ROE, is worth 1x BV whether it is kept going or liquidated. If the ROE is below your cost of capital then the business is only worth 1xBV if it is liquidated. If not, it is worth less.

 

Fairfax, assuming a fair long run return on a broad basket of stocks is 7%, should trade on 1xBV if the ROE is 7%. If the ROE is higher based on operating earnings then you could argue for a higher multiple, but that's not so easy if the higher ROE is based on investing results because you can, to an extent, replicate Fairfax's investments at 1xBV. The only reason you'd pay >1xBV for investment results is if the managers had an exceptional record and you couldn't successfully replicate the portfolio. So for example, if FFH puts their $20bn of cash to work in the 2y treasury you wouldn't pay >1xBV for that - but you might pay >1xBV for the investments where they have an advantaged position as a preferred provider of capital.

 

Oddly, therefore, 1xBV or not much higher might be the right price for FFH even if the equity compounds at 15%. It takes a bit to get my head round that but I think it's mathematically true. It's actually what I find very attractive about the stock - the likelihood that it will remain reasonably priced while compounding nicely.

 

 

[racemize]

Oddly, therefore, 1xBV or not much higher might be the right price for FFH even if the equity compounds at 15%. It takes a bit to get my head round that but I think it's mathematically true. It's actually what I find very attractive about the stock - the likelihood that it will remain reasonably priced while compounding nicely.

 

I see where you get to this, but the market does not value other businesses this way (e.g., see MKL or BRK)

[petec]

Oddly, therefore, 1xBV or not much higher might be the right price for FFH even if the equity compounds at 15%. It takes a bit to get my head round that but I think it's mathematically true. It's actually what I find very attractive about the stock - the likelihood that it will remain reasonably priced while compounding nicely.

 

I see where you get to this, but the market does not value other businesses this way (e.g., see MKL or BRK)

 

Arguably BRK is pretty cheap on BV compared to its historic returns. But I agree. It is quite possible the market will value FFH on a much higher multiple at some point. In fact it's highly likely, given how moody the market is. I'm simply saying that a potential multiple pop is not the reason I hold the stock. It's gravy.

[Cardboard]

"I see where you get to this, but the market does not value other businesses this way (e.g., see MKL or BRK)"

 

BRK ok and we know that it is much more than an insurer investing money. I would suggest that MKL is overvalued: any misstep will cause a rapid and painful derating.

 

Cardboard

[StubbleJumper]

Cardboard, two or three days ago, FFH was trading pretty much bang-on at book value.  My heuristic for BV (or at least a BV that is mostly tangible) is that this is the point where the business as a going concern offers zero value.  This is the point where, if one could liquidate the assets for a "fair price" and put the business in run-off, you'd be equally well off to do so.

 

 

Surely it should trade at 1xBV if the ROE=your cost of capital? If, for example, it generates a ROE of 10% but you've got a stack of ideas that offer a 20% return, you'd pay 0.5x book. If it generates 7% and your threshold is 7%, then you'd pay 1x.

 

Putting it another way, it is true to say that at BV the business is worth an equal amount as a going concern or liquidated, but only if the proceeds of liquidation are put into something else that generates your required rate of return. But it is not true to say that a business generating a 0% ROE, or a 2% ROE, is worth 1x BV whether it is kept going or liquidated. If the ROE is below your cost of capital then the business is only worth 1xBV if it is liquidated. If not, it is worth less.

 

Fairfax, assuming a fair long run return on a broad basket of stocks is 7%, should trade on 1xBV if the ROE is 7%. If the ROE is higher based on operating earnings then you could argue for a higher multiple, but that's not so easy if the higher ROE is based on investing results because you can, to an extent, replicate Fairfax's investments at 1xBV. The only reason you'd pay >1xBV for investment results is if the managers had an exceptional record and you couldn't successfully replicate the portfolio. So for example, if FFH puts their $20bn of cash to work in the 2y treasury you wouldn't pay >1xBV for that - but you might pay >1xBV for the investments where they have an advantaged position as a preferred provider of capital.

 

Oddly, therefore, 1xBV or not much higher might be the right price for FFH even if the equity compounds at 15%. It takes a bit to get my head round that but I think it's mathematically true. It's actually what I find very attractive about the stock - the likelihood that it will remain reasonably priced while compounding nicely.

 

 

1) They'll do better than ~7% ROE, which is why this thing is worth more alive than dead.  But, yes, if you think that their results will be sufficiently low, then it's worth less than BV.  The market is priced for FFH to perform with mediocrity.

 

2) You might very well pay FFH more than BV to invest in 2 year bonds because they have cost-free leverage from their float -- in fact, it's more than cost free leverage because they have every expectation of writing a CR < 100.  I do not know of any way that an individual investor can replicate cost-free leverage.

 

3) Haven't you slightly contradicted yourself?  You first (correctly) posited that if FFH's expected long-term ROE is ~7% it might actually just be worth roughly book.  We can quibble about whether 7% is the exact number, but I'd say your logic reasonable.  And then you close out your post by saying that if ROE is compounded by ~15% that 1x BV might be roughly right.  So which is it?  It strikes me that FFH is worth a great deal more than book if one truly believes all of that talk of a long-term expected ROE of 15%.

 

 

 

SJ

 

 

 

[petec]

 

1) They'll do better than ~7% ROE, which is why this thing is worth more alive than dead.  But, yes, if you think that their results will be sufficiently low, then it's worth less than BV.  The market is priced for FFH to perform with mediocrity.

 

2) You might very well pay FFH more than BV to invest in 2 year bonds because they have cost-free leverage from their float -- in fact, it's more than cost free leverage because they have every expectation of writing a CR < 100.  I do not know of any way that an individual investor can replicate cost-free leverage.

 

3) Haven't you slightly contradicted yourself?  You first (correctly) posited that if FFH's expected long-term ROE is ~7% it might actually just be worth roughly book.  We can quibble about whether 7% is the exact number, but I'd say your logic reasonable.  And then you close out your post by saying that if ROE is compounded by ~15% that 1x BV might be roughly right.  So which is it?  It strikes me that FFH is worth a great deal more than book if one truly believes all of that talk of a long-term expected ROE of 15%.

 

 

1. Agreed.

 

2. That's a fair point. I just have a sense that, insurance being the highly competitive, impenetrable, and volatile business that it is, people don't attach big book value premiums to 97% or 98% combined ratios. 80%, sure, but in the high 90's (which is where I guess Fairfax will come out in the long run) I think it's too hard to understand why the advantage exists, and too volatile (losses in bad years can be huge if the average is 98%) and I don't think that gets you a big premium. I'll be delighted if I am wrong.

 

3. My point is that it is quite possible for a business to be worth 1x BV but to compound at 15%. I realise that's a very unorthodox statement but if the majority of the return comes from investments that can be easily replicated in the market at 1x BV, then it is true. It is not true if the majority of the return comes from operating earnings or irreplicable investments.

 

Overall, then, I see Fairfax somewhere in the 1-1.5x book range. Over 1x because of the cheap leverage, profitable underwriting, and investment record. But not over 1.5x because of the black box nature of insurance and the replicability of much of the portfolio.

 

I realise a 50% gain to 1.5x would be wildly exciting to plenty of people on here. I can easily see that happening if they have another couple of good years. But personally I couldn't care less and would probably rather the multiple didn't rise, because I intend to hold this one for a VERY long time and would be happy to keep buying at 1x (and for years of buybacks to steadily reduce the share count a la Teledyne).

 

Still, its refreshing to be on the bearish end of a Fairfax discussion for once ;)

[FFHWatcher]

Can you imagine a stock that is $5.50 and then 20 years it is up to $6.50 ?

 

That's Fairfax if you move the decimal point.  Perhaps the next 20 years will be different than the previous years and a lot of great things have happened at FFH during that time yet here we are, 20 years later with a similar stock price.  The company is a lot different today, there have been dividends, cat losses, hedging gains, hedging losses, etc. but a lot of people in 1997 and 1998 said the exact same thing you just said (I will hold FFH for a VERY long time). 

I also heard the same scenario about 15 years ago that I am hearing today... 'If FFH only invests their cash in bonds at x%, what will be the earnings?'  Huge!! 

20 years is a long time.

 

[StubbleJumper]

Can you imagine a stock that is $5.50 and then 20 years it is up to $6.50 ?

 

That's Fairfax if you move the decimal point.  Perhaps the next 20 years will be different than the previous years and a lot of great things have happened at FFH during that time yet here we are, 20 years later with a similar stock price.  The company is a lot different today, there have been dividends, cat losses, hedging gains, hedging losses, etc. but a lot of people in 1997 and 1998 said the exact same thing you just said (I will hold FFH for a VERY long time). 

I also heard the same scenario about 15 years ago that I am hearing today... 'If FFH only invests their cash in bonds at x%, what will be the earnings?'  Huge!! 

20 years is a long time.

 

 

Sure, you might have heard that 15 years ago.  But as I recall, I bought a few shares right around Martin Luther King day almost exactly 15 years ago and I paid less than cdn$100. 

 

Purchase price matters greatly.

 

 

SJ

[Santayana]

And on a 25 year timeframe it's a 10 bagger.

[Cigarbutt]

20 years is a long time.

I've done very well with Fairfax and related holdings during the time period but the result has occurred in the context of a variable level of ownership.

Often hoped for a stable long term position but the ingredients have never been assembled (so far).

 

Thank you for the post FFHWatcher.

Perspective helps.

 

In 1997:

NPW=1392,6 (million CDN)

Total investments=4054,1 (million USD)

SO=11,1 (million shares)

 

In 2017:

NPW=9983,5 (million USD)

Total investments=39381,6 (million USD)

SO=27,8 (million shares)

 

Then, FFH was getting ready to acquire CFI and TIG.

Now, FFH is getting ready to play offense.

 

Humble tentative conclusion: the earning power has been multiplied and the P/B premium that needs to be applied is in large part a function of float deployment. 

 

 

[petec]

A lot of people in 1997 and 1998 said the exact same thing you just said (I will hold FFH for a VERY long time). 

 

Well, those people were dumb (apologies to anyone I've just called dumb!). If Fairfax gets back to the P/BV that it was at then, I won't hold it for a very long time. I know I didn't explicitly state that, but it's what I was getting at when I said I hoped the multiple would not rise. Price is (almost) everything and every statement about holding period should be viewed through a price lens.

[FairFacts]

my two cents...

 

BRK is currently valued at 1.6x BV

MKL is currently valued at 1.7x BV

FFH is currently valued at 1.1x BV (and even less if you add the unbooked adjustments to FMV of TC/Quess and FIH).

 

WB has always said that at 1.2x his company is undervalued and at 2x it is overvalued. I imply that the mid point 1.6x is his idea of FMV.

 

In my view FFH is so thinly covered by analysts and trades such low volumes its entirely possible (probable) that it is mispriced.

 

As they digest AWH, getting the under writing under control (AWH and BRIT), leverage the float AND grow revenues into a better market the insurance businesses look well placed to do really well over the next few years. Looking at some of the larger investments, BB, TC/Quess, FIH and Gravalia there is the possibility of some serious upside. Having dropped the hedging and winding down the CPI options we'll get a chance to see FFH for what it can really do. The market could wake up at any time and award this the multiple it deserves.

 

For me, the most compelling source of information is the conference calls and listening directly to PW. He has changed his emphasis notably this year:

1. Dropping the bond holdings, removing equity hedges, going on the offensive.

2. Still maintaining a conservative posture eg not reaching for yield.

3. Added AWH to the stable and stated that this is the last big acquisition.

4. Repeatedly stated that they will firstly strengthen FFH financial position and then buy back stock. (first part is underway and stock purchases starting slowly).

5. Most importantly on the year-end call he said "$15bil revenue now in place, we expect to generate 15% return to shareholders of about net $70/share"....later in the Q&A he said..."we expect $2bil after tax in 2018". I have never heard him get this close to giving guidance even though he emphatically said he was not and never would issue guidance.

 

All thats needed now is a liitle proof, if the next few quarters go according to plan I fully expect to see FFH priced at +1.5x BV by the end of the year.

 

 

 

 

[netnet]

Close FFH watchers correct me if I'm wrong, (not a close watcher myself) but it seems to me the trade for FFH has been buy at 1.1 or less and sell at 1.4.  This has been a regular trade over the last 6 years or so.

[StubbleJumper]

Close FFH watchers correct me if I'm wrong, (not a close watcher myself) but it seems to me the trade for FFH has been buy at 1.1 or less and sell at 1.4.  This has been a regular trade over the last 6 years or so.

 

 

Yep.  That's about right.  And it's currently about 1x when you make a couple of adjustments to BV.  So, the idea of it moving to 1.2 within a year or 18 months isn't crazy.  And then if BV rises ~10% after the divvy, you could see a healthy return.

 

 

SJ

[FFHWatcher]

Close FFH watchers correct me if I'm wrong, (not a close watcher myself) but it seems to me the trade for FFH has been buy at 1.1 or less and sell at 1.4.  This has been a regular trade over the last 6 years or so.

 

I am much less sophisticated than that. The point I was trying to make was that historically, FFH has not been one of those 'buy it now and ignore it for 20 years' type of stocks.  While the company has grown significantly in the past 20 years and is a much different company today, historically, it hasn't been a terribly nice stock to buy and hold (except if you have Prem's cost basis and number of shares). 

Going forward hopefully FFH has made the necessary changes to get the company on a steadier more consistent upward trajectory in earnings and in share price than in the past (much more of an earnings machine as opposed to a gamble hedge and hope to hit it big every 6-10 years).

[Txvestor]

It hasn't been a buy and forget, because of all the missteps HW has made. Were it not for the equity hedges and deflation swaps, BV would easily have been 50% higer. And the multiple to BV would likely have persisted. If you buy here, you are betting that Prem will not do anything value destructive in the next few years. The market has not ruled put that possibility and I think the market is probably right.

They jury remains out on the AWH purchase alone.

To the poster stating he mentioned 2B and $70 per share, I was on the call as well. When an analyst asked, he was clear that this was not guidance. On that I would just say he has also touted 15% annual gains in BV for many years, and keeps saying over the long term, that hasn't happened in post crisis era either.