Fairfax stock positions

[Viking]

Fairfax's equity holdings (that I track) are up about $597 million so far in Q3 (9 of 13 weeks = 69%). Shaping up to be another quarter of solid performance. Split by accounting treatment can be seen below. I have attached my Excel file if you want a closer look.

 

Top Movers? All up this quarter:

• Thomas Cook India = $156 million
• FFH TRS = $154 million
• Eurobank = $110
• Broad based gains: 6 different equities are up more than $20 million
• Stelco = ($43) million: the largest decliner

 

Fairfax Sept 1 2023.xlsx

Edited September 2, 2023 by Viking

[glider3834]

Just looking at this Hellenic Bank deal (I have re-edited this post)

 

Eurobank now owns around 55% of Hellenic Bank https://www.ekathimerini.com/economy/1219382/hfsf-divestment-from-eurobank-is-put-off/

 

Eurobank reported €111M of negative goodwill gain in 2Q23 on the initial 29.2% stake acquired.

 

 

Assuming remaining 70.8% of Hellenic (estimate around 293M more shares - float is 413M approx) can be acquired at €2.35 per share & TBV was €3.02 at 30 Jun-23, I estimate Eurobank will have additional negative goodwill/bargain purchase gain of around €196M still to come.

 

Fitch has viewed the acquisition positively 

“If completed, the acquisition will enhance Eurobank’s business model, increase geographical diversification, and result in a better balance between retail and corporate banking activities,” Fitch noted.  https://cyprus-mail.com/2023/08/28/hellenic-bank-acquisition-by-eurobank-viewed-positively-by-fitch/ 

 

Hellenic had a 1H23 profit from continuing ops of €141M & has revised its FY23 forecast to €300M pre-tax (Assuming 13% (rounded) cyprus corp tax rate , thats around €260M profit after tax)

 

 

Eurobank had adjusted net profit of €599M in 1H23, so assuming around €1.2-1.3B annualised - this Hellenic transaction could potentially add around 20% increase to Eurobank's EPS & Fairfax's share of Eurobank profit. Plus Eurobank's expected repurchase of 1.4% of its shares held by HFSF will add to EPS.

 

Both Eurobank and Hellenic are benefiting from higher interest rate environment - a lot of their interest income floating so a key risk is that a drop in rates brings down their profitability. The path & duration of rates is a question mark  https://www.reuters.com/breakingviews/europe-faces-dirtier-inflation-fight-than-us-2023-09-06/

 

Other risks - deal integration risks, persistent inflation/cost of living pressures, financial impact from recent wildfires & flooding in Greece, ongoing war in Ukraine, uncertainty around upgrade of Greece's credit rating to investment grade.

 

 

Edited September 8, 2023 by glider3834

[SafetyinNumbers]

1 hour ago, glider3834 said:

Just looking at this Hellenic Bank deal (I have re-edited this post)

 

Eurobank now owns around 55% of Hellenic Bank https://www.ekathimerini.com/economy/1219382/hfsf-divestment-from-eurobank-is-put-off/

 

Eurobank reported €111M of negative goodwill gain in 2Q23 on the initial 29.2% stake acquired.

 

 

Assuming remaining 70.8% of Hellenic (estimate around 293M more shares - float is 413M approx) can be acquired at €2.35 per share & TBV was €3.02 at 30 Jun-23, I estimate Eurobank will have additional negative goodwill/bargain purchase gain of around €196M still to come.

 

Fitch has viewed the acquisition positively 

“If completed, the acquisition will enhance Eurobank’s business model, increase geographical diversification, and result in a better balance between retail and corporate banking activities,” Fitch noted.  https://cyprus-mail.com/2023/08/28/hellenic-bank-acquisition-by-eurobank-viewed-positively-by-fitch/ 

 

Hellenic had a 1H23 profit from continuing ops of €141M & has revised its FY23 forecast to €300M pre-tax (Assuming 13% (rounded) cyprus corp tax rate , thats around €260M profit after tax)

 

 

Eurobank had adjusted net profit of €599M in 1H23, so assuming around €1.2-1.3B annualised - this Hellenic transaction could potentially add around 20% increase to Eurobank's EPS & Fairfax's share of Eurobank profit. Plus Eurobank's expected repurchase of 1.4% of its shares held by HFSF will add to EPS.

 

Both Eurobank and Hellenic are benefiting from higher interest rate environment - a lot of their interest income floating so a key risk is that a drop in rates brings down their profitability. The path & duration of rates is a question mark  https://www.reuters.com/breakingviews/europe-faces-dirtier-inflation-fight-than-us-2023-09-06/

 

Other risks - deal integration risks, persistent inflation/cost of living pressures, financial impact from recent wildfires & flooding in Greece, ongoing war in Ukraine, uncertainty around upgrade of Greece's credit rating to investment grade.

 

 

That’s great analysis! Thanks for highlighting. 
 

Given Fairfax’s 32.2% is marked at US$1.77b, that contributes to ROE at 20%+. It really helps pull ROE higher. The street is for the most part ignoring earnings from the investment portfolio and they will likely keep getting surprised since it’s already too cheap based on the insurance operations alone, there is no need for reasonable expectations on the investment portfolio.

[glider3834]

1 minute ago, SafetyinNumbers said:

That’s great analysis! Thanks for highlighting. 
 

Given Fairfax’s 32.2% is marked at US$1.77b, that contributes to ROE at 20%+. It really helps pull ROE higher. The street is for the most part ignoring earnings from the investment portfolio and they will likely keep getting surprised since it’s already too cheap based on the insurance operations alone, there is no need for reasonable expectations on the investment portfolio.

[Viking]

3 hours ago, glider3834 said:

Just looking at this Hellenic Bank deal (I have re-edited this post)

 

Eurobank now owns around 55% of Hellenic Bank https://www.ekathimerini.com/economy/1219382/hfsf-divestment-from-eurobank-is-put-off/

 

Eurobank reported €111M of negative goodwill gain in 2Q23 on the initial 29.2% stake acquired.

 

 

Assuming remaining 70.8% of Hellenic (estimate around 293M more shares - float is 413M approx) can be acquired at €2.35 per share & TBV was €3.02 at 30 Jun-23, I estimate Eurobank will have additional negative goodwill/bargain purchase gain of around €196M still to come.

 

Fitch has viewed the acquisition positively 

“If completed, the acquisition will enhance Eurobank’s business model, increase geographical diversification, and result in a better balance between retail and corporate banking activities,” Fitch noted.  https://cyprus-mail.com/2023/08/28/hellenic-bank-acquisition-by-eurobank-viewed-positively-by-fitch/ 

 

Hellenic had a 1H23 profit from continuing ops of €141M & has revised its FY23 forecast to €300M pre-tax (Assuming 13% (rounded) cyprus corp tax rate , thats around €260M profit after tax)

 

 

Eurobank had adjusted net profit of €599M in 1H23, so assuming around €1.2-1.3B annualised - this Hellenic transaction could potentially add around 20% increase to Eurobank's EPS & Fairfax's share of Eurobank profit. Plus Eurobank's expected repurchase of 1.4% of its shares held by HFSF will add to EPS.

 

Both Eurobank and Hellenic are benefiting from higher interest rate environment - a lot of their interest income floating so a key risk is that a drop in rates brings down their profitability. The path & duration of rates is a question mark  https://www.reuters.com/breakingviews/europe-faces-dirtier-inflation-fight-than-us-2023-09-06/

 

Other risks - deal integration risks, persistent inflation/cost of living pressures, financial impact from recent wildfires & flooding in Greece, ongoing war in Ukraine, uncertainty around upgrade of Greece's credit rating to investment grade.

@glider3834 great summary. So at Eurobank’s price of €2.35/share Hellenic Bank is valued at €1 billion and it is on track to earn €260 million after tax in 2023. That looks pretty good. 
 

There are so many interesting layers to this transaction…
- I think the acquisition will take up to 12 months to be approved. So Hellenic Bank will likely be a much more valuable bank when they actually fork over the money next year. Especially if interest rates stay higher for longer.

- Eurobank still will not have more than 50% control. I wonder if they already have the next purchase lined up to get over 50%. 
- Eurobank sold the bank they owned in Serbia recently (at a pretty decent price if i remember correctly). Essentially flipped from being a smaller player in Serbia (8% market share) to being the largest player in Cypress (depending on metric being used). Proceeds from Serbian sale (70% of €280 million) will pay for a chunk of the Hellenic purchase. Looks like good strategy and good capital allocation.

 

The management team at Eurobank has been executing well for years. 

[glider3834]

44 minutes ago, Viking said:

I wonder if they already have the next purchase lined up to get over 50%. 

Yep they have secured 55.3%, subject to customary approvals, and you are right it will take time to get regulatory approvals 

https://cyprus-mail.com/2023/08/24/cysec-chairman-eurobank-mandated-to-bid-for-100-per-cent-of-hellenic-hank/

[nwoodman]

8 hours ago, glider3834 said:

Just looking at this Hellenic Bank deal (I have re-edited this post)

 

Eurobank now owns around 55% of Hellenic Bank https://www.ekathimerini.com/economy/1219382/hfsf-divestment-from-eurobank-is-put-off/

 

Eurobank reported €111M of negative goodwill gain in 2Q23 on the initial 29.2% stake acquired.

 

 

Assuming remaining 70.8% of Hellenic (estimate around 293M more shares - float is 413M approx) can be acquired at €2.35 per share & TBV was €3.02 at 30 Jun-23, I estimate Eurobank will have additional negative goodwill/bargain purchase gain of around €196M still to come.

 

Fitch has viewed the acquisition positively 

“If completed, the acquisition will enhance Eurobank’s business model, increase geographical diversification, and result in a better balance between retail and corporate banking activities,” Fitch noted.  https://cyprus-mail.com/2023/08/28/hellenic-bank-acquisition-by-eurobank-viewed-positively-by-fitch/ 

 

Hellenic had a 1H23 profit from continuing ops of €141M & has revised its FY23 forecast to €300M pre-tax (Assuming 13% (rounded) cyprus corp tax rate , thats around €260M profit after tax)

 

 

Eurobank had adjusted net profit of €599M in 1H23, so assuming around €1.2-1.3B annualised - this Hellenic transaction could potentially add around 20% increase to Eurobank's EPS & Fairfax's share of Eurobank profit. Plus Eurobank's expected repurchase of 1.4% of its shares held by HFSF will add to EPS.

 

Both Eurobank and Hellenic are benefiting from higher interest rate environment - a lot of their interest income floating so a key risk is that a drop in rates brings down their profitability. The path & duration of rates is a question mark  https://www.reuters.com/breakingviews/europe-faces-dirtier-inflation-fight-than-us-2023-09-06/

 

Other risks - deal integration risks, persistent inflation/cost of living pressures, financial impact from recent wildfires & flooding in Greece, ongoing war in Ukraine, uncertainty around upgrade of Greece's credit rating to investment grade.

 

 

Thanks for this.  Seems like a good deal.  I was surprised there wasn’t a mild increase in MS PT but as you point out it is more a 2025 story.  Love that deferred gratification.  
 

Foran Mining hitting ATH too. Have a great weekend all

[Viking]

10 hours ago, glider3834 said:

Yep they have secured 55.3%, subject to customary approvals, and you are right it will take time to get regulatory approvals 

https://cyprus-mail.com/2023/08/24/cysec-chairman-eurobank-mandated-to-bid-for-100-per-cent-of-hellenic-hank/

@glider3834 thanks for posting. I missed this last transaction. Great news. I was wondering if Eurobank was going to have to pay an additional premium to get over 50% and the answer is no. When they went to €2.35/share they had their ducks in a row to get +50%. Smart.

Edited September 8, 2023 by Viking

[glider3834]

15 hours ago, nwoodman said:

Thanks for this.  Seems like a good deal.  I was surprised there wasn’t a mild increase in MS PT but as you point out it is more a 2025 story.  Love that deferred gratification.  
 

Foran Mining hitting ATH too. Have a great weekend all

I just saw this report AXIA who have increased their PT for Eurobank as a result of this deal - here are some comments - they are estimating a 13% increase in EPS from Hellenic deal which is lower than 20% I thought might be possible, but they are assuming 100bp reduction in interest rates by ECB in this estimate so they are calling their model estimate 'rather conservative' - here is the article link below which I have translated to English from Greek

 

https://www.insider.gr/epiheiriseis/289381/axia-ti-fernei-sti-eurobank-i-elliniki-trapeza-oi-kryfes-axies-poy-agnoei-i

 

In the further strengthening of Eurobank 's position in Hellenic Bank , through the acquisition of an additional percentage of 7.2% (29,710,012 shares), thus reaching 55.3% and pending the approval of the regulatory authorities that will make it as a subsidiary of the group, turns AXIA , revealing the hidden values for the domestic systemic bank .

To the surprise of the analysts, the stock did not react to these developments and despite the size of the acquisition which is expected to further strengthen profitability, as well as its strategic position. AXIA estimates that through these moves Eurobank will boost pro forma EPS by 13%, bringing its return on equity ratio, ROTE, to 15.5% by the end of 2024, 100 basis points higher than analysts' previous estimates. The transaction is expected to reduce the CET1 ratio by 120 basis points, which is negligible given the bank's enhanced profitability generation capacity and current CET1 base.

• The Eurobank - National "battle" on the board of the Stock Exchange and the Hellenic "game changer"

In fact, AXIA considers its estimation model to be rather conservative as it assumes a reduction in interest rates by the European Central Bank by 100 basis points, without synergies of reducing costs in Cyprus and without any additional enhancement of net income through the bank's investment portfolio ( NII), despite excess liquidity.

From a strategic point of view , through the acquisition Eurobank: a) further diversifies its profitability "mix" outside the domestic market (domestic banking base will cover only 56% of net profitability by the end of 2024, from 65% in previous estimates ), b) creates the second largest player in the Cypriot market with a complementary loan portfolio, c) increases excess liquidity at the right time and d) acts as a basis for a further opening to other international markets, which include Middle Eastern countries , but also India , which is the home country of Fairfax CEO (Prem Watsa), the largest shareholder of Eurobank. Clearly, even a small percentage of the market in them could be a "game changer" , as AXIA claims.

At the same time, Eurobank offers a high quality, with a stable and diversified profitability base, while the acquisition of Hellenic Bank - which at the moment has gone rather unsought by the market and has not passed through valuations - offers the short-term "catalyst" for a further re-rating of the stock. The group's expanded base is expected to lead to the highest ROTE ratio among the rest, reaching 15.5% 2024, which explains a P/TBV ratio of 1x or €2.4 that AXIA sets as a target price, up from €2 previously (51% upside), with a firm 'buy' recommendation.

For 2024, the more "open" and new Eurobank will have:

 

- Higher net profits of €1.268bn, up 13% for adjusted ROTE to 15.5%, which is 100 basis points higher than Eurobank's previous base.

- The CET1 ratio will decrease by 120 basis points due to the consolidation of Hellenic Bank's higher risk assets.

- EPS (earnings per share) will increase by 13% to €0.35 (2024 P/E ratio at 4.5x from 5.1x) and the dividend will also increase to €0.30 (+25%) ), as AXIA estimates that the group will be able to increase the distribution rate on earnings.

[nwoodman]

2 hours ago, glider3834 said:

I just saw this report AXIA who have increased their PT for Eurobank as a result of this deal - here are some comments - they are estimating a 13% increase in EPS from Hellenic deal which is lower than 20% I thought might be possible, but they are assuming 100bp reduction in interest rates by ECB in this estimate so they are calling their model estimate 'rather conservative' - here is the article link below which I have translated to English from Greek

 

https://www.insider.gr/epiheiriseis/289381/axia-ti-fernei-sti-eurobank-i-elliniki-trapeza-oi-kryfes-axies-poy-agnoei-i

 

In the further strengthening of Eurobank 's position in Hellenic Bank , through the acquisition of an additional percentage of 7.2% (29,710,012 shares), thus reaching 55.3% and pending the approval of the regulatory authorities that will make it as a subsidiary of the group, turns AXIA , revealing the hidden values for the domestic systemic bank .

To the surprise of the analysts, the stock did not react to these developments and despite the size of the acquisition which is expected to further strengthen profitability, as well as its strategic position. AXIA estimates that through these moves Eurobank will boost pro forma EPS by 13%, bringing its return on equity ratio, ROTE, to 15.5% by the end of 2024, 100 basis points higher than analysts' previous estimates. The transaction is expected to reduce the CET1 ratio by 120 basis points, which is negligible given the bank's enhanced profitability generation capacity and current CET1 base.

• The Eurobank - National "battle" on the board of the Stock Exchange and the Hellenic "game changer"

In fact, AXIA considers its estimation model to be rather conservative as it assumes a reduction in interest rates by the European Central Bank by 100 basis points, without synergies of reducing costs in Cyprus and without any additional enhancement of net income through the bank's investment portfolio ( NII), despite excess liquidity.

From a strategic point of view , through the acquisition Eurobank: a) further diversifies its profitability "mix" outside the domestic market (domestic banking base will cover only 56% of net profitability by the end of 2024, from 65% in previous estimates ), b) creates the second largest player in the Cypriot market with a complementary loan portfolio, c) increases excess liquidity at the right time and d) acts as a basis for a further opening to other international markets, which include Middle Eastern countries , but also India , which is the home country of Fairfax CEO (Prem Watsa), the largest shareholder of Eurobank. Clearly, even a small percentage of the market in them could be a "game changer" , as AXIA claims.

At the same time, Eurobank offers a high quality, with a stable and diversified profitability base, while the acquisition of Hellenic Bank - which at the moment has gone rather unsought by the market and has not passed through valuations - offers the short-term "catalyst" for a further re-rating of the stock. The group's expanded base is expected to lead to the highest ROTE ratio among the rest, reaching 15.5% 2024, which explains a P/TBV ratio of 1x or €2.4 that AXIA sets as a target price, up from €2 previously (51% upside), with a firm 'buy' recommendation.

For 2024, the more "open" and new Eurobank will have:

 

- Higher net profits of €1.268bn, up 13% for adjusted ROTE to 15.5%, which is 100 basis points higher than Eurobank's previous base.

- The CET1 ratio will decrease by 120 basis points due to the consolidation of Hellenic Bank's higher risk assets.

- EPS (earnings per share) will increase by 13% to €0.35 (2024 P/E ratio at 4.5x from 5.1x) and the dividend will also increase to €0.30 (+25%) ), as AXIA estimates that the group will be able to increase the distribution rate on earnings.

Thanks hadn’t seen that one.  Even 1x’s P/TBV doesn’t sound stretched. Very bullish indeed.  Short of some catastrophe, Eurobank alone should get written up by around USD1B in the next couple of years.  I was always a little suspicious of FFH’s stated book value but there is certainly no shortage of examples to the contrary.

[petec]

On 9/9/2023 at 2:01 AM, glider3834 said:

and the dividend will also increase to €0.30

 

At current fx this is about USD385m a year to FFH, or a 2% yield on Fairfax's market cap.

[glider3834]

3 hours ago, petec said:

 

At current fx this is about USD385m a year to FFH, or a 2% yield on Fairfax's market cap.

the payout ratio Eurobank have indicated is 25%, I just wonder if they meant to say increase in payout ratio to 30%

Edited September 12, 2023 by glider3834

[petec]

On 9/12/2023 at 1:30 PM, glider3834 said:

the payout ratio Eurobank have indicated is 25%, I just wonder if they meant to say increase in payout ratio to 30%

 

Yes, possibly, although the bank is fairly well capitalised and analysts have to choose what to do with newly generated capital in their model. This one may simply have "chosen" to pay it out rather than let it accumulate.

[nwoodman]

Interesting to see the sleeper that is Helios Fairfax getting some interest

 

Anyone seen any news?  @glider3834 you are normally ahead of the curve

[glider3834]

On 9/15/2023 at 11:24 AM, nwoodman said:

Interesting to see the sleeper that is Helios Fairfax getting some interest

 

Anyone seen any news?  @glider3834 you are normally ahead of the curve

 yeh not sure whats driving this one - I can see there was higher than usual vol on Wed & Thu  - stock dropped back 11% or so on Fri 

[glider3834]

On 8/23/2023 at 7:36 AM, netcash1 said:

LONDON, 22 August 2023 - Exponent today announces that it has reached an agreement to sell a portion of its stake in Meadow, a leader in sustainable dairy, confectionery and plant-based ingredients, to Fairfax Financial Holdings Limited (‘Fairfax Financial’), a holding company headquartered in Canada.

Meadow partners with the world’s leading food manufacturers to solve their most complex challenges and supplies the crucial ingredients in many of the UK’s favourite brands. The company employs over 500 people across five sites in the UK (Chester, Peterborough, Holme-on-Spalding Moor, Dolgellau and Headcorn).

Building on its strong track record in identifying category-leading businesses under family ownership, Exponent acquired a significant stake in Meadow alongside the Chantler family in 2018. The family and Exponent will retain a stake in the business following the sale.

Under Exponent’s ownership, Meadow has expanded its production footprint and product set via sustained organic growth and strategic acquisitions. Key milestones in recent years include entering the plant-based category through the construction of a segregated plant based dairy facility in Chester and entering the inclusions and sweet sauces categories through the acquisitions of Nimbus Foods and Naked Foods.

Sustainability has been at the heart of Exponent’s strategy in working with Meadow. The business has become a market leader for sustainability in the dairy industry, partnering with farmers to reduce the carbon footprint of its raw materials inputs, targeting net zero operational sites by 2030 and to be fully net zero by 2050. With Exponent’s support, Meadow has re-set the work it does with farmers to reduce carbon emissions and help them prioritise biodiversity. The efforts have resulted in a 21% reduction in CO2e emissions per kilo of milk since 2018. Meadow’s suppliers are now producing milk which is 63% less carbon-intensive than the global average and 15% less carbon-intensive than the UK average.

Mark Taylor, Partner at Exponent, said: “When we invested in Meadow, we recognised the opportunity to support the business in its transformation from a commodity dairy player to a diversified speciality food ingredients supplier, building on our experience in the sector with the likes of Quorn Foods and Loch Lomond. Over the course of our partnership, the business has generated significant organic and inorganic growth, including four bolt-on acquisitions, and accelerated its shift into more value-added ingredients. It is a trusted partner to the world’s largest food and beverage companies. We are delighted to have played a key role in Meadow’s successful journey to date, and we wish the team well as the business prepares for its next phase of growth.”

Raj Tugnait, CEO at Meadow, said: “We are proud of the strong growth achieved since partnering with Exponent, and I’m delighted that Meadow has seen interest from a solid financial institution like Fairfax. The alignment of Fairfax’s culture and values and our shared vision for growth and innovation resonated with me personally. It is business as usual for our customers and Fairfax is the ideal long-term partner for Meadow’s journey ahead.”

 

 

So looks like Fairfax have taken a majority stake in Meadow Foods - looking at turnover and profit - I suspect this is a decent sized equity investment - but no transaction price disclosure https://globallegalchronicle.com/fairfax-financial-holdings-acquisition-of-a-majority-stake-in-meadow-foods/

 

Edited September 20, 2023 by glider3834

[SafetyinNumbers]

Bloomberg is reporting Stelco is considering a bid for US Steel. I assume the partner is not Fairfax but perhaps an international steel company. Others might assume otherwise and sell their shares in fear of a drawdown. I assume if they go ahead, it’s because it’s very accretive.
 

https://financialpost.com/pmn/business-pmn/canadas-stelco-holdings-is-said-to-weigh-bid-for-us-steel

[nwoodman]

Blackberry splitting out IOT via an IPO

 

https://finance.yahoo.com/news/blackberry-separate-iot-cybersecurity-business-212416261.html

Edited October 4, 2023 by nwoodman

[SafetyinNumbers]

3 hours ago, nwoodman said:

Blackberry splitting out IOT via an IPO

 

https://finance.yahoo.com/news/blackberry-separate-iot-cybersecurity-business-212416261.html

Does it have the chance of being a hot IPO? I think stand alone IOT and Cybersecurity businesses both trade at high P/S multiples relative to where Blackberry trades. Maybe rebranding and making it a pure play will get the new ticker a big audience. M&A would also be easier for both segments once they have price discovery. It makes sense to do a marketed offering to get the multiple. It will presumably be a tight float so has meme potential given Blackberry’s iconic brand.
 

I don’t know how to value these businesses so won’t participate but it does seem like it has event driven potential for someone with the right skill set. Could get interesting for Fairfax too. 

[nwoodman]

20 minutes ago, SafetyinNumbers said:

Does it have the chance of being a hot IPO? I think stand alone IOT and Cybersecurity businesses both trade at high P/S multiples relative to where Blackberry trades. Maybe rebranding and making it a pure play will get the new ticker a big audience. M&A would also be easier for both segments once they have price discovery. It makes sense to do a marketed offering to get the multiple. It will presumably be a tight float so has meme potential given Blackberry’s iconic brand.
 

I don’t know how to value these businesses so won’t participate but it does seem like it has event driven potential for someone with the right skill set. Could get interesting for Fairfax too. 

I hope you are right.  I had to chuckle at Morgan Stanley participating in the option review, and surprise, surprise, the answer was an IPO .  FWIW MS are also involved with the much-delayed Digit IPO.

[Viking]

How Does Fairfax Look When Compared To Other P/C Insurers?

 

There are lots of methods an investor can use to value a company and its stock price. In this post, we are going to use a method called ‘relative valuation.’ We are going to try and see what we can learn about Fairfax’s current valuation by comparing the company to a group of other P/C insurers.

 

To state the obvious: all P/C insurance companies have unique business models. For fun, I have also included Berkshire Hathaway.

 

We are going to keep the analysis very top line. What are the key take aways? Does anything jump out?

 

Who are we going to look at?

 

Here is the list of the seven P/C insurers we will compare (in alphabetical order):

• AIG: the fallen star; turnaround
• Berkshire Hathaway: the gold standard
• Chubb: traditional insurer; international
• Fairfax Financial: invests in equities; international
• Intact Financial: largest P/C insurer in Canada
• Markel: Baby Berk; US focus
• WR Berkley: traditional insurer; US focus

Change in Book Value

 

The most important metric used by investors and analysts to evaluate a P/C insurance company is book value. Yes, it has its flaws. However, it is a good place to start.

 

We are going to look at the change in book value from Dec 31, 2018 to June, 30, 2023, or a period of 4.5 years. This is a good length of time to use to understand how each insurer has performed. It also will allow us to compare our 7 companies. We have sorted their results in a table below from the best to the worst performers.

 

So which company has produced the largest increase in BV over the past 4.5 years?

 

Fairfax Financial.

 

Fairfax has increased BV by 93% over the past 4.5 years, a compound rate of 15.7% per year.

 

Were you expecting that? I bet you weren’t expecting that.

 

Five of the seven companies paid a dividend (and WR Berkley also paid a special dividend). I did not include this in my Total or CAGR calculation as I don’t think it would have changed the order.

 

 

Change in Share Price

 

Next, we are going to look at the change in the share price from Dec 31, 2018 to Sept, 30, 2023, or a period of 4.75 years. Once again, we have sorted the results in a table from best to worst performers.

 

Which company has produced the largest increase in share price over the past 4.75 years?

 

Intact Financial is the winner here. This is not a surprise to anyone living in Canada. Intact is by far the largest P/C insurer in Canada and the company and stock have been outstanding performers for many years. WR Berkley and Fairfax also delivered strong increases.

 

Performance for most P/C companies has been good to very good.  This makes sense because there are lots of quality companies on this list. And the hard market in P/C insurance began in about Q4 2019 and that has been a big tailwind.    

 

 

Now let’s put book value and share price together.

 

Price to Book Value

 

Both Intact and WR Berkley trade at the highest P/BV multiple. This is not surprising given they also saw the biggest increases in share price over the past 4.75 years. These two companies have been compounding machines for investors the past 5 years.

 

Does anything in the chart below jump out?

 

The company that has been compounding book value at the fastest over the past 4.5 years is also trading at the lowest P/BV valuation - and it is below 1.

 

Yes, our friend Fairfax.

 

Based on P/BV, Fairfax certainly looks cheap but let’s keep digging.

 

 

What about future prospects. Stock prices are supposed to be forward looking.

 

What about earnings expectations for 2023?

 

This is where things get a little messy.

 

Why?

 

Average duration and ‘available for sale’ accounting.

 

Please note: I am not an accountant. There may be errors in my analysis – you are warned. With what follows, I am not trying to say that insurance companies are doing anything wrong. They are following the accounting rules as they are laid out. My point is investors need to be aware of the ‘grey zones’ when it comes to accounting and reported results. Eyes wide open.

 

Most insurance companies have most of their massive fixed income portfolio stuffed in the ‘available for sale’ bucket for accounting purposes. As a result, gains and losses do not flow through to net income. Gains and losses instead flow through to ‘accumulated other comprehensive income’ (AOCI) and book value.

 

For the past 18 months, spiking interest rates is resulting in big unrealized losses in the fixed income portfolios of many insurance companies. But reported EPS looks great. And reported ROE. Yet book value has gotten hit (for some companies).

 

Let’s look at an example

 

An investor reading Chubb’s earnings report from 2022 will see reported earnings per share of $12.55/share and a reported ROE of 9.6%. Solid year. Right?

 

Well no. In 2022, shareholders’ equity dropped $9.2 billion. Book value per share at Chubb dropped $18.09/share or 12.9%. Holy shit batman!

 

Which is it? Solid or terrible?

 

When there are big changes in book value, investors need to understand what caused the swing and make sure they are comfortable with the reasons. 

 

Evan Greenberg, the CEO of Chubb, is one of my favourite insurance CEOs to listen to during earnings season. This guy is also one heck of a salesman. Here is his explanation for the big drop in book value (the quote below is from Chubb's 2022AR):

 

"Rising rates and a strong dollar during the year produced sizable mark-to- market losses on our fixed income invested assets, which have temporarily impacted book value in a significant way. For the year, book and tangible book value per share decreased 12.9% and 23.5%, respectively, driven mostly by after-tax net realized and unrealized losses of $10.9 billion in the investment portfolio. Ironically, I view the mark as a good thing because it speaks to future income power. We are predominantly a buy-and-hold, fixed income investor with an average portfolio duration of 4.5 years, so the mark is transitory. In fact, about half of the mark will accrete back to book value over two years."

 

 

Is this the case with all P/C insurers?

 

No. Fairfax does not use ‘available for sale’ accounting. As a result, changes each quarter in the value of the fixed income portfolio flow through to net earnings and book value. From what I can see all other six P/C insurers use ‘available for sale’ accounting.

 

‘Higher for longer’ interest rate regime means that these unrealized losses are likely not going away soon. And with interest rates spiking further on the long end of the curve we are likely going to see more unrealized losses getting booked in Q2 when insurers report. P/C insurers with long duration fixed income portfolios will be impacted more than those with low duration portfolios.

 

Apples and oranges

 

But here is the interesting thing. When Fairfax reports, the changes in the fixed income portfolio will be reflected in both EPS and book value. When the other P/C insurers report, the changes in the fixed income portfolio marked ‘available for sale’ will not be captured in EPS. Yes, it will be captured in book value.

 

When Fairfax reported Q2 results guess what analysts didn’t like? The ‘miss’ on investment gains (losses) that lowered reported EPS a little. It was driven by… drum roll please… yes, unrealized losses in fixed income (as interest rates went up in Q2).

 

The benefit for Fairfax? Moving forward, should interest rates fall meaningfully then unrealized gains in fixed income will flow though to EPS and book value. 

 

But the big unrealized losses don’t matter… right?

 

What happens if we get a 1 in 50 year catastrophe in the next year or two while a few of these P/C insurers are sitting on big unrealized losses in their fixed income portfolio? Not likely. But it would create added stress.

 

Do you think insurance regulators and ratings agencies care about the big hit to shareholders’ equity/balance sheet of some insurance companies? My guess is they do. 

 

This is probably another reason (along with a few others) that explains why the hard market is continuing.

 

There is another more immediate reason investors should care

 

Opportunity cost. As important as underwriting profit is, the biggest driver of earnings for P/C insurance companies is interest and dividend income. Especially moving forward with interest rates at 15 year highs. 

 

The insurance companies with low duration fixed income portfolios are able to pivot faster into much higher yielding securities and the significantly higher investment income will earn through very quickly. This is a big earnings advantage that low duration P/C companies will have over long duration peers for the next couple of years.

 

What is the average duration of fixed income portfolios?

 

It should be noted, at Dec 31, 2021, Fairfax had an average duration of 1.2 years on its $37 billion (at the time) fixed income portfolio. In 2H 2021, they sold $5.2 billion in corporate bonds and at a yield of 1% (and booked a realized gain of $253 million). Fairfax has slowly been extending duration over the past year and it now sits at 2.4 years.

 

Who was the other company with a super low duration on its fixed income portfolio at Dec 31, 2021? Berkshire Hathaway. Fairfax was in good company.

 

WR Berkley should also get a shout out as they were sitting at around 2.4 years at Dec 31, 2021. Not as good as Fairfax or Berkshire, but much better than peers.

 

In the chart below is where most P/C insurers sit today with average duration. I guessed at Markel’s at 3.5 years - they only say it matches their liabilities. Please let me know if you know what the actual number is. Same if anyone knows the average duration of Berkshire’s fixed income portfolio. My guess is it is less than 1.5 years. For AIG, I used North America P/C. 

 

 

Ok, let’s get out of that rabbit hole and return to our next comparison.

 

What are expectations for earnings for 2023? How do PE’s compare?

 

To keep things simple, I pulled the 2023 earnings estimates from Yahoo finance for each of our seven companies. 

 

Looking at PE, Fairfax is trading at 6.1, the cheapest valuation and it’s not even close. Because of how it reports changes in its fixed income portfolio, reported EPS is also more representative of economic reality - higher quality.

 

Why is Fairfax such an outlier? As we discussed already, Fairfax’s $40 billion fixed income portfolio was positioned perfectly for a spiking interest rate environment. Fairfax avoided the losses (which protected its balance sheet). And has been able to quickly pivot and take advantage of much higher interest rates. Interest income is spiking and this is spiking earnings. Investors still do not appreciate (believe?) the speed, size and durability of the increase in interest income.

 

 

Conclusion: Using ‘relative valuation,’ how does Fairfax look relative to peers?

 

Which insurance company has delivered the strongest CAGR in book value over the past 4.5 years?

• Fairfax at 15.7% (not including the dividend)

Which insurance company is the cheapest based on P/BV?

• Fairfax at 0.98.

Which insurance company is the cheapest based on PE (2023E)?

• Fairfax at 6.1.

Which insurance company has navigated the spike in interest rates the best?

• Fairfax. And Berkshire would be a close second 

 

“Although expectations of the future are supposed to be the driving force in the capital markets, those expectations are almost totally dominated by memories of the past. Ideas, once accepted, die hard.” Peter Bernstein

 

The turnaround at Fairfax happened a couple of years ago. Blinded by old ideas about the company, most investors still don’t see it. Even though it has been showing up in much improved results for a couple of years now. That is called a ‘fat pitch’ by the smart guy who lives in Omaha.

 

 

————

‘Available-for-sale’: What was said in a few of the annual reports

 

Berkshire Hathaway - 2022AR page K-75

 

(d) Investments in fixed maturity securities

We classify investments in fixed maturity securities on the acquisition date and at each balance sheet date. Securities classified as held-to-maturity are carried at amortized cost, reflecting the ability and intent to hold the securities to maturity. Securities classified as trading are acquired with the intent to sell in the near term and are carried at fair value with changes in fair value reported in earnings. All other securities are classified as available-for-sale and are carried at fair value. Substantially all of our investments in fixed maturity securities are classified as available-for-sale. We amortize the difference between the original cost and maturity value of a fixed maturity security to earnings using the interest method.

 

WR Berkley - 2022AR page 68

 

(D) Investments

Fixed maturity securities classified as available for sale are carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as a component of comprehensive income and a separate component of stockholders' equity.

 

Chubb - 2022AR page F-14

 

e) Investments

Fixed maturities, equity securities, and short-term investments

Fixed maturities are classified as either available for sale or held to maturity. Available for sale (AFS) portfolio is reported at fair value, net of a valuation allowance for credit losses, with changes in fair value recorded as a separate component of AOCI in Shareholders' equity.

Held to maturity (HTM) portfolio includes securities for which we have the ability and intent to hold to maturity or redemption and is reported at amortized cost, net of a valuation allowance for credit losses.

 

 Markel - 2022AR page 10K - 77

 

c) Investments. Available-for-sale investments and equity securities are recorded at estimated fair value. Available-for-sale investments include fixed maturity securities and short-term investments. Fixed maturity securities include government and municipal bonds and mortgage-backed securities with original maturities of more than one year. Short-term investments include certificates of deposit, commercial paper, discount notes and treasury bills with original maturities of one year or less. Unrealized gains and losses on available-for-sale investments, net of income taxes, are included in other comprehensive income. Unrealized gains and losses on equity securities, net of income taxes, are included in net income as net investment gains or losses. The Company completes a detailed analysis each quarter to assess declines in the fair value of its available-for- sale investments. Any impairment losses on the Company's available-for-sale investments are recorded as an allowance, subject to reversal.

 

Edited October 6, 2023 by Viking

[gfp]

5 hours ago, Viking said:

Substantially all of our investments in fixed maturity securities are classified as available-for-sale.  (BH)

 

"A couple of insurers do not use ‘available for sale’ accounting. Fairfax Financial and Berkshire Hathaway. "  

 

Thanks for generously sharing your work on Fairfax again Viking.  I'm not sure I follow your reasoning on Berkshire completely.  You state that Berkshire doesn't use "available for sale" accounting but then quote Berkshire has saying "substantially all of our investments in fixed maturity securities are classified as available-for-sale."

 

Anyway, if the choice is between available for sale and held to maturity, it seems like AFS is the more honest accounting treatment of the two. 

 

Also for Berkshire's average duration, I believe large portions of the treasury bill position should be included with the 1 and 2 year paper that gets classified as investments in fixed maturities.  There is no question that from a bond investment point of view Berkshire has managed the current environment better than Fairfax.  What we don't know is if we will feel the same 2 or 3 years from now since Berkshire is unlikely to attempt to lock in current rates for 3 years and Fairfax seems eager to do so.  Fairfax is my second largest position and I am (mostly) happy with how they handled the recent rate environment.  But while Fairfax was locking up 3.75% reinvestment rates on this year's future maturities, Berkshire was buying 5.5% bills and taking no losses.

[nwoodman]

Roughly right as always

 

 

[UK]

Well, to be fair, for quite a while bonds are not very important for BRK, so maybe it was easy for them to not reach for yield and I am not sure they will lock anything in the future for longer duration, at least below 8 per cent level. While at the same time, bonds are bread and butter for FFH. Maybe their timing is not all perfect, but I think so far they did teriffic job and it was harder to do for them, than for BRK. I own both:)

[gfp]

I think Berkshire has a much bigger "bond" portfolio than people realize.  It's just that most of it is 6 month paper.  That choice was and is available to Fairfax and actually pays better.  It's just a choice.  Berkshire doesn't care about locking in a certain rate of income for an arbitrary period of time.  Fairfax has indicated that they do.