Q1 2020 Results

[Bryggen]

Great input guys. Thanks.

 

I believe it is time for Fairfax to innovate and evolve. The old way of doing business may no longer work and there is a need to adjust to the current reality. What worked yesterday (read: 30 years ago) may no longer work and one need to change his stance and improve his business model to provide value once again. You usually experience that when a company get a new CEO who brings new ideas and perspective on the business to make it better. Bringing new blood they say. Now, Prem is there to stay and we all want that, but I truly believe he needs to open his mind to do things differently.

 

Now, speculating here: could it be that Rivett wanted such change and faced resistance? We will never find out, but something ought to change. No need to be drastic, but status quo isn't an option. My newbie opinion.... :)

[petec]

I think we all agree that "cigar butt" investing hasn't quite worked out for them. Having said that, based on only the two names they announced on the call as having purchased in Q1 (Google and Exxon), it seems those were good purchases and entry points to have made at that time. I'm encouraged by those moves.

 

The problem with the cigar butt framework is it isn’t really what they do. To me, cigar butt investing means investing in a declining company at a price that makes up for the declines. Maybe a few holdings fit that description but there are plenty that don’t (Eurobank, Seaspan, Quess, Kennedy Wilson, BIAL, BDT, ICICI Lombard, TCIL, CIB, CSB, UBN, etc etc).

 

My critiques of Fairfax’s long equity investing are that:

1) they are happier with leverage than I am.

2) they are wrong too often.

 

The combination is dangerous.

 

Edit: I’ll add

3) I don’t understand why they held Quess at 30x, and even wrote about how fast growth justified Indian valuations at those levels, but then dedicated a page of the annual letter to why businesses like Microsoft (a FAR better business than Quess) don’t deserve that sort of valuation.

[petec]

When you get this much pessimism around Fairfax, then you are approaching the bottom.  Unlike most, I expect more of a V-shaped recovery from the pandemic.  Yes, the lingering effects will go on for a couple of years, but the amount of capital injected, the strength of the financial system heading into this crisis, and the pent-up frustration and demand from consumers will bode well towards the end of the year and into next year. 

 

Most of Fairfax's losses were unrealized investment losses, part of which would have already recovered in April.  They did not incur significant impairment, and I can't see how their retail and restaurant businesses would have been hit any harder than Berkshire's or comparable companies.  Their insurance businesses are going to enjoy a hard market across the board, and they were already writing at a 96% combined ratio.  Brian bought a ton of corporate bonds paying over 4% while U.S. short-term rates are at zero. 

 

They did not have to tap into the revolver...as Buffett said, there was a moment in March when liquidity was about to completely dry up...Fairfax like everyone else saw that happening and tapped the revolver to make sure it couldn't be pulled on them.  Then they went and raised $650M to make sure they had enough liquidity to get them through another 2008!  But the Fed acted quickly this time...they had a game plan they could already use and liquidity returned to the markets immediately.

 

You think Fairfax just stood still after doing all that?  I guarantee you that they are doing everything to make sure that if you get an LA earthquake or a massive Gulf storm, they will still be walking around to take advantage of that market.  I would imagine they are doing whatever they can to make sure that Fairfax's financials are improving in case the pandemic gets worse. 

 

I've been through 1999/2000 with Fairfax, been though 2003-2005 when the hedge funds cratered the stock to $56 US, through 2008-2009 when liquidity ACTUALLY dried up around the world and now this global pandemic.  I have not held Fairfax consistently through that entire period, but took advantage of the irrationality of investors each time...swing batter batter...swing!  Cheers!

 

+1

[Parsad]

Great input guys. Thanks.

 

I believe it is time for Fairfax to innovate and evolve. The old way of doing business may no longer work and there is a need to adjust to the current reality. What worked yesterday (read: 30 years ago) may no longer work and one need to change his stance and improve his business model to provide value once again. You usually experience that when a company get a new CEO who brings new ideas and perspective on the business to make it better. Bringing new blood they say. Now, Prem is there to stay and we all want that, but I truly believe he needs to open his mind to do things differently.

 

Now, speculating here: could it be that Rivett wanted such change and faced resistance? We will never find out, but something ought to change. No need to be drastic, but status quo isn't an option. My newbie opinion.... :)

 

Paul's departure had nothing to do with anything like that.  He was 100% a team guy...worked his way from chief legal counsel to head of Hamblin-Watsa, VP of operations and then finally President.  I don't know of anyone who worked harder and bought into the system and culture at Fairfax.  He always thought it had the potential to be a mini-Berkshire and thought they were on that trajectory.

 

I don't know exactly what the reasons were, but I would imagine it had something to do with family.  If I emailed Paul at 1:30-2am (I'm a nightowl), I would get a response...remember I'm in Vancouver and he's in Toronto...so it would have been like 4:30-5am Toronto time.  That type of dedication to a company, to staff, to colleagues, to shareholders...it can take a toll over time.  While externally he still looks the handsome, dashing guy he's always been...mentally and physically it can be a grueling workload.  I think he just needed to slow things down a bit for himself and his family after like almost 18 years of 24 hour a day dedication.  Cheers!

[racemize]

Sanjeev, I'm curious as to what you think of the fact that insiders all all buying preferred shares rather than common shares?

 

They seem to have quite a bit of upside themselves these days...

[Gregmal]

The problem with this "the bottom is right around the corner" thinking, is that it keeps you glued with false hope in an otherwise bad investment. Fairfax has been pretty much exactly what it is today for as long time now. And since I joined this place, theres been a massive opportunity cost for many because they keep finding new ways to convince themselves that "its only a matter of time" before this outperforms...as if its a given. I do agree though, the GOOG and XOM purchases are encouraging. Stop trying to be a genius and just keep it simple.

[Spekulatius]

If people don't seem convinced of 2.5% net on those various forms of funding, then who the hell was buying this at $500-$600/share when the various forms so funding were the same, but the bar for acceptable performance far higher?

 

Normal human psychology.  The guys buying at $600 were the ones selling at $350-400!

 

 

This exchange made me smile. If there was value then there is extreme value now, even if covid-19 has permanently reduced the value of Eurobank, Recipe, Atlas, Bangalore Airport, etc. to a point below their current share prices.

 

Context is important. All insurance stocks have been crushed in the last 10 weeks. Chubb was trading over $160 in Feb and now it is trading below $100. WRB has fallen from $79 to $51. The declines have been 35-38%.

 

Fairfax has fallen from $625 to $350 a 44% decline. It also had a much larger Q1 loss and hit to BV.

 

So compared to other insurance stocks the decline in FFH looks reasonable.

 

The question moving forward is if you want to put new money into the insurance sector where do you do it? My vote, given the broad based sell off, is to put it into the highest quality names. My current picks are WRB and CB (two that i have followed for years and like).

 

I agree -  better risk rewards than FFH with other insurance stocks. I just bought some TRV yesterday and bought back some BRKB today.

 

I don’t like the extended financial leverage that FFH shows at this point. We are looking at the biggest I Insurance even in  history and you do t want to go into this with a leveraged balance sheet . We Heard- WEB very clear about this. FFH might not have liquidity issues  (insurance companies rarely have those anyways), but regulators closely look at solvency of subs.

 

Not to divert the thread, but I like CB as well. What I don’t like about them is they they have  1/3 of their equity (roughly ) in BB rated junk bonds (Vietnam ?) . I am not sure what their rationale for owning these is and I really don’t like insurance cos stretching for yield.

[Bryggen]

Great input guys. Thanks.

 

I believe it is time for Fairfax to innovate and evolve. The old way of doing business may no longer work and there is a need to adjust to the current reality. What worked yesterday (read: 30 years ago) may no longer work and one need to change his stance and improve his business model to provide value once again. You usually experience that when a company get a new CEO who brings new ideas and perspective on the business to make it better. Bringing new blood they say. Now, Prem is there to stay and we all want that, but I truly believe he needs to open his mind to do things differently.

 

Now, speculating here: could it be that Rivett wanted such change and faced resistance? We will never find out, but something ought to change. No need to be drastic, but status quo isn't an option. My newbie opinion.... :)

 

Paul's departure had nothing to do with anything like that.  He was 100% a team guy...worked his way from chief legal counsel to head of Hamblin-Watsa, VP of operations and then finally President.  I don't know of anyone who worked harder and bought into the system and culture at Fairfax.  He always thought it had the potential to be a mini-Berkshire and thought they were on that trajectory.

 

I don't know exactly what the reasons were, but I would imagine it had something to do with family.  If I emailed Paul at 1:30-2am (I'm a nightowl), I would get a response...remember I'm in Vancouver and he's in Toronto...so it would have been like 4:30-5am Toronto time.  That type of dedication to a company, to staff, to colleagues, to shareholders...it can take a toll over time.  While externally he still looks the handsome, dashing guy he's always been...mentally and physically it can be a grueling workload.  I think he just needed to slow things down a bit for himself and his family after like almost 18 years of 24 hour a day dedication.  Cheers!

 

Thanks for your always valuable input Parsad!

[jfan]

 

Fairfax’s investments (in aggregate) - including equities, hedges, warrants and private business purchases - have been value destroying for 8 years or so. Something looks broken in how they are managing investments (how they are picking individual securities and how structuring the overall portfolio). Confidence in management is at an all time low (in how it is managing the total investment portfolio). Many current investments are low quality and will struggle in the near term. If we get a severe recession that lasts into 2021 we can expect more large losses from the investment portfolio which will drive BV lower. Not surprising the discount to BV is where it is today. 

 

 

I wonder if part of what is broken is their investment decision "process" at Hamblin Watsa. Francis Chou and Mohnish Pabrai's harvard interview elucidates that at FFH they use a devil's advocate who is usually a senior member of the investment committee who is not going to have psychological imperatives towards deference to the portfolio managers.

 

However, this seems to lack the ability to incorporate a diversity of opinion. Some of which may actually come from junior members or the introverted individuals on the committee who may have a different perspective or special insight that would help the decision process or at least improve their accuracy.

 

Gary Klein and Paul Sonkin had a podcast on Capital Allocator's that was quite interesting about how to structure team discussions to make them more effective towards truth finding. Perhaps Sanjeev, you could pass this idea to them as it may have asymmetric outcomes (hopefully to the upside) and it costs them nothing.

 

On a secondary note, who makes the ultimate decision to increase FFH's financial leverage? Is it just Prem or do the executives play a role in the decision-making process? If Paul Rivett was to remain CEO, would he make the call?

[Parsad]

Sanjeev, I'm curious as to what you think of the fact that insiders all all buying preferred shares rather than common shares?

 

They seem to have quite a bit of upside themselves these days...

 

Hi Racemize,

 

I don't pay attention at all to whether or not insiders are buying or selling...or other managers for that matter. 

 

I bought BAC and AAPL before Buffett on both occasions and I've never owned BB even though Prem does.  Remember when David Einhorn was buying up New Century Financial as a director and head of the audit committee!  Ha, ha!  100-1 leverage and he was instilling confidence by buying stock as a director.

 

I learned my lesson early over 18 years ago, when I bought a specific stock because Baupost was buying it.  I got burned and I've never paid attention to what any manager buys...not Buffett, not Prem, not Mohnish, Francis, or even insiders. 

 

But if you are asking me whether I think the preferred are cheap...yes, they look cheap to me as well.  Especially if you want to earn secure dividend income with some upside on the preferred price.  Cheers!

[petec]

The opportunity cost - in capital but more importantly in time - has been immense.

 

What's interesting is how few decisions they were away from doing really well over the last decade. If they had (1) not hedged, and (2) invested in (say) Microsoft and JNJ, both of which were cheap, instead of (say) Blackberry and Resolute, then we'd be having a very different conversation. It really does not take a lot to turn this ship.

 

In light of this I find the extensive discussion about the broader investment team encouraging. I very much like some of their investments here, especially Atlas and Eurobank, so I don't want them to sell everything and start again. And I don't want them to give up their value style - I can easily invest in the momentum* stocks of the day myself, if I want to. But I do want them to protect downside better. They did this brilliantly with Atlas (consider that despite coronavirus, which was more or less completely unforeseen, Atlas still trades above their going-in price) but extraordinarily poorly with Resolute, the initial investment in Eurobank, Stelco, and others.

 

In the letter and the AGM call Prem was quite clear that the team has an increasingly significant influence, both via direct management of part of the portfolio and via input on Prem, Brian, and Roger's decisions. I think this shift will accelerate, if only for psychological reasons - giving up control is not easy, but once you've accepted the need to start it's easy to take the incremental steps. I expect the old guard slowly fade into the background here. Actually, I speculate whether the purchase of preferred shares by insiders isn't a sign of this. Some of these guys are of an age where income might be more important than capital growth. At some point the position will be reversed: Wade & team will run the portfolio and Prem, Brian, and Roger will consult. 

 

*This is not an implied criticism of these stocks - it's just that I consider value and momentum to be at opposite ends of the spectrum, not value and growth. You can be a value investor in growing stocks, but not in momentum stocks.

[Viking]

 

Fairfax’s investments (in aggregate) - including equities, hedges, warrants and private business purchases - have been value destroying for 8 years or so. Something looks broken in how they are managing investments (how they are picking individual securities and how structuring the overall portfolio). Confidence in management is at an all time low (in how it is managing the total investment portfolio). Many current investments are low quality and will struggle in the near term. If we get a severe recession that lasts into 2021 we can expect more large losses from the investment portfolio which will drive BV lower. Not surprising the discount to BV is where it is today. 

 

 

I wonder if part of what is broken is their investment decision "process" at Hamblin Watsa. Francis Chou and Mohnish Pabrai's harvard interview elucidates that at FFH they use a devil's advocate who is usually a senior member of the investment committee who is not going to have psychological imperatives towards deference to the portfolio managers.

 

However, this seems to lack the ability to incorporate a diversity of opinion. Some of which may actually come from junior members or the introverted individuals on the committee who may have a different perspective or special insight that would help the decision process or at least improve their accuracy.

 

Gary Klein and Paul Sonkin had a podcast on Capital Allocator's that was quite interesting about how to structure team discussions to make them more effective towards truth finding. Perhaps Sanjeev, you could pass this idea to them as it may have asymmetric outcomes (hopefully to the upside) and it costs them nothing.

 

On a secondary note, who makes the ultimate decision to increase FFH's financial leverage? Is it just Prem or do the executives play a role in the decision-making process? If Paul Rivett was to remain CEO, would he make the call?

 

If i had to pick one thing that Fairfax has gotten wrong with investing is it might be hubris. They appeared to get stuck in their old orthodoxy. It is/was almost like a religion cloaked in value investing clothes. They had success in the beginning and for many years. They then tried to replicate this same formula over and over and over. Even when it did not work and the world was changing. They were not able to make beneficial small incremental changes to their philosophy over time. Results suffered.

 

Value investing works. Bad investing (even if wearing the cloak of value investing) does not.

 

Buffett was, for many years, able to keep learning (inquisitive and open minded) and updating his model of ‘value investing’. The shift to buying quality was one shift of many. He got progressively better his first 30 years as Berkshire got larger.

 

The evolution of Fairfax’s investment philosophy the past 8 years has been pretty messed up and results reflect the challenges. The good news is with some new blood the investment part of Fairfax may be in transition. They are decent underwriters; if they can get average results on their investment portfolio the stock is dirt cheap. We will see what they do.

[petec]

 

Value investing works. Bad investing (even if wearing the cloak of value investing) does not.

 

 

This is a very good way of putting it. They made some excellent investments, but they made too many duds, and they hedged.

 

My guess is hubris and/or complacency (which are highly linked at a subconscious level) plus distraction (time spent on assembling and managing Fairfax's sprawling insurance business, rather than on investing) led to them applying simplistic heuristics (e.g. low p/bv, or supposedly great management) to investments rather than doing really hard investigative work.

 

[vinod1]

I read the Q1 Transcript to hear what Trump of the North has to say.

 

- Bleach could be effective antidote to Covid. We expect to generate a 15% return for our shareholders over time.

- One day it would go poof and we would have a big celebration. The best is yet to come.

- We are doing a fantastic job at the federal level to respond to Covid. Our investment team operating in a stock pickers market.

 

 

[bearprowler6]

I read the Q1 Transcript to hear what Trump of the North has to say.

 

- Bleach could be effective antidote to Covid. We expect to generate a 15% return for our shareholders over time.

- One day it would go poof and we would have a big celebration. The best is yet to come.

- We are doing a fantastic job at the federal level to respond to Covid. Our investment team operating in a stock pickers market.

 

Vinod1....brilliant....simply brilliant!

[Bryggen]

Also interesting noting RBC's report published May 2nd:

 

''While results are likely to be pressured over the near term, Fairfax continues to see good underwriting and operating results, particularly at OdysseyRe. The transformative Allied World acquisition, along with a number of smaller acquisitions, will meaningfully expand Fairfax's global footprint and we expect it to bring notable top-line and bottom-line growth. Our thesis is that Fairfax’s long-term track record of double-digit book value growth will continue and the current valuation provides an attractive risk-reward entry point for those willing to back the company’s long-term investment track record. Fairfax has a deep cash position and ample access to capital, which gives it the flexibility to be opportunistic as well as patient.''

 

Trying to put this with you guys' analysis together. This report seems positive while some opinion of yours are more bleak.

 

Newbie trying to figure out where to stand. Read: Buy more and sit on my ass. ;)

 

 

Maybe RBC was the outfit that extended the $2B revolver to FFH?  ::)

 

 

SJ

 

Interestingly, the author of this report was also pro-Fairfax back in 2006, but working out of a Washington DC firm: Mark Dwelle. Normal to have the same guy following/ promoting FFH over the years....? I have some investigator DNA. Maybe overthinking ;)

 

January 2006

 

https://www.theglobeandmail.com/report-on-business/rob-magazine/short-shrift/article702684/

 

"The third quarter served as a real-world 'field test' of the financial strength of Fairfax, a test the company comfortably passed," says Mark Dwelle, an equity analyst with Ferris, Baker Watts, Inc., a Washington, D.C.-based investment bank that has long rated Fairfax a "buy."

[petec]

Yes, it’s pretty normal for an analyst to cover the same stock for a long time. Dwelle knows Fairfax well.

[Bryggen]

Yes, it’s pretty normal for an analyst to cover the same stock for a long time. Dwelle knows Fairfax well.

 

Thanks Petec.

[Parsad]

Also interesting noting RBC's report published May 2nd:

 

''While results are likely to be pressured over the near term, Fairfax continues to see good underwriting and operating results, particularly at OdysseyRe. The transformative Allied World acquisition, along with a number of smaller acquisitions, will meaningfully expand Fairfax's global footprint and we expect it to bring notable top-line and bottom-line growth. Our thesis is that Fairfax’s long-term track record of double-digit book value growth will continue and the current valuation provides an attractive risk-reward entry point for those willing to back the company’s long-term investment track record. Fairfax has a deep cash position and ample access to capital, which gives it the flexibility to be opportunistic as well as patient.''

 

Trying to put this with you guys' analysis together. This report seems positive while some opinion of yours are more bleak.

 

Newbie trying to figure out where to stand. Read: Buy more and sit on my ass. ;)

 

 

Maybe RBC was the outfit that extended the $2B revolver to FFH?  ::)

 

 

SJ

 

Interestingly, the author of this report was also pro-Fairfax back in 2006, but working out of a Washington DC firm: Mark Dwelle. Normal to have the same guy following/ promoting FFH over the years....? I have some investigator DNA. Maybe overthinking ;)

 

January 2006

 

https://www.theglobeandmail.com/report-on-business/rob-magazine/short-shrift/article702684/

 

"The third quarter served as a real-world 'field test' of the financial strength of Fairfax, a test the company comfortably passed," says Mark Dwelle, an equity analyst with Ferris, Baker Watts, Inc., a Washington, D.C.-based investment bank that has long rated Fairfax a "buy."

 

Fairfax was at $175 when Dwelle wrote that report...Fairfax hit over $700 pre-pandemic...300% gain from 2006, through 2008-2009, all the way to the end of 2019...not 15%, but 11.3% annualized over those 13 years from 2006 to 2019.  S&P500 did around 7.7% annualized during that 13 years. 

 

And that is with alot of bungling by Fairfax...insurance wasn't running smoothly until 2012-2013...the purchase of BB...lack of investment in equities during the bull market...taking the hit on swaps...purchase of mediocre businesses/cigar butts, rather than the best in class businesses you all complain about.  With those mistakes, Fairfax with it's bond portfolio, insurance business and the picks they did get right, combined with their float and leverage, managed to still do reasonably well. 

 

I hope Brian teaches Wade and Lawrence everything he knows, because I think the day we lose Brian, it will be nearly as painful as losing Prem.  That being said, I think Wade and Lawrence will do better on the equity side long-term.  Cheers!