Fairfax 2021

[petec]

26 minutes ago, Viking said:

In a recent report RBC also stated that Fairfax tends to write more long tailed business than its other insurance peers.

 

To what extent is inflation a risk for FFH? Presumably it impacts claims, and they can only offset that with higher interest income to the extent that bond yields rise with inflation?

[gary17]

On 9/28/2021 at 10:35 AM, ander said:

my understanding is the reason for the process behind these authorizations (versus Berkshire) has to do with it being a Canadian listing and the rules there.

yes i believe rules in canada require disclosure, which is different in the US.

   interesting for me as an observer they issued shares at much lower prices before and now buying them at higher prices.  not sure if overall those capitals raised in prior years resulted in good returns.

[Viking]

3 hours ago, petec said:

 

To what extent is inflation a risk for FFH? Presumably it impacts claims, and they can only offset that with higher interest income to the extent that bond yields rise with inflation?

My guess is inflation will be a hot topic on Q3 conference calls. Transitory or not? Just another reason for the current hard market to last longer. 
 

in terms of Fairfax i am not sure how inflation will impact them. The insurance side of their business has developed into a real strength. And given their investment positioning with their bond portfolio (very low duration) they see higher interest rates in the future (with rising inflation being the leading cause). The size and makeup of the equity portfolio may also serve as a partial hedge of sorts. 

Edited September 29, 2021 by Viking

[glider3834]

3 hours ago, petec said:

 

To what extent is inflation a risk for FFH? Presumably it impacts claims, and they can only offset that with higher interest income to the extent that bond yields rise with inflation?

Higher than expected & transitory (consensus view) - impacts short tail more - less of a problem 

 

Higher than expected but longer term - impacts long tail more - would be more of a problem but not consensus view

 

I believe Fairfax are expecting higher inflation than market is expecting - on fixed income side they are high quality & short duration. So if over longer term we get incremental inflation with incremental increases in interest rates, this would be beneficial for Fairfax is my read.

 

And if we follow through with that logic, they should also be factoring in their higher inflation expectation into their insurance pricing & liability reserves.

 

Having said all of this, if we get really high, unexpected & sustained inflation that would be a big negative for Fairfax & the whoel P&C industry. I think this is a lower probability because you can tie a lot of the price pressure to covid which is causing supply chain disruption.

 

Here is a good article on impacts 

 

 

 https://www.insurancejournal.com/news/national/2021/03/23/606467.htm

 

 

What Does This Mean for the Property/Casualty Industry?

As with most financial institutions, higher-than-expected inflation has adverse effects on the results of property/casualty insurers. The risk to insurers falls in three buckets:

Liabilities. Insurers carry liabilities in the form of loss reserves that are intended to pay claims in the future. If inflation is higher than the rate built into the loss reserves, then future payments will be greater than expected. The impact of inflation varies by line of business, but an increase of 1 percent in inflation can raise the P/C industry combined ratio by two to three points. For personal lines of business, where liabilities are short in duration, a 1 percent increase in inflation may increase the combined ratio by less than one point. For a long-tailed line of business such as medical professional liability, the same 1 percent hike in inflation may increase the combined ratio by more than five points.

Pricing. Insurers charge prices today that will pay for future claims. If inflation proves to be greater than the inflation rate anticipated in the prices, then insurers may not have sufficient funds to pay claims. The dynamics of underestimating the inflation rate built into prices is like that of liabilities—i.e., a 1 percent increase in inflation will result in overall prices inadequacies of 2-3 percent (which varies by line of business).

When setting liabilities and pricing business, insurers must be sure to look at the components of the losses and use inflation rates that reflect the payments that will be made. For example, workers compensation losses, on average, consist of 50 percent for medical payments and 50 percent for lost wages. If the overall annual CPI inflation rates for medical costs and wages are 3 percent and 2 percent, respectively, then an annual trend rate of 2.5 percent is reasonable. However, if the insurer writes more professional services classes of business in areas with high costs of living, then the inflation rate for wages may be closer to 4 percent and the average annual trend rate should be 3.5 percent.

Investments. Approximately 80 percent of the assets held by the P/C industry are in fixed income instruments such as Treasury, municipal and other bonds. These assets are structured to match the payments (cash flows) of the loss reserve liabilities they support. If companies sell current bonds so they can invest in newer, higher-yielding bonds, they will have to book losses upon the sale because higher interest rates drive down bond prices. However, if they hold onto current assets while the ultimate values of the underlying loss liabilities are increasing, then companies will have a mismatch between their assets and liabilities. This mismatch would have to be accounted for by a reduction in the company’s surplus. There is no efficient way for companies to hedge inflation risk, but they can try to dampen the risk through holding assets such as stocks and real estate (which bring their own inherent risks to a balance sheet).

 

 

 

 

 

 

[glider3834]

5 hours ago, Viking said:

Glider, yes, it will be interesting to see where the CR goes in the next few years for Fairfax. In the current quarter Fairfax is likely now in the third year of getting price increases (rate on rate on rate). However, it will take time for written premiums to become earned. And if loss picks are more conservative this will also delay the benefits of current pricing flowing through to reported results - some of the benefit will come via reserve releases in future years. Significant top line growth will also lower the expense ration (and result in lower CR). Every quarter from here that we continue to get strong top line growth is just gravy. 
 

When doing some back reading i was surprised to learn that Fairfax had a pretty spectacular 4 year run consistently posting a CR in the low ‘90’s:

- 2013: 92.7

- 2014: 90.8

- 2015: 89.9

- 2016: 92.5

The driver if these stellar numbers was Odyssey Re, who posted an average CR under 85 over these 4 years. I was not following Fairfax closely at the time so was not aware what they had accomplished.

 

In a recent report RBC also stated that Fairfax tends to write more long tailed business than its other insurance peers. Long tail business usually earns a higher CR. However, regulators allow the investment portfolio of long tail business to have a higher equity weighting. Not sure how accurate RBC’s comments are. 

Yes also think average favourable development 2013 to 2017 was around 7.7 & avg CR looks to be around 91.5 & for 2019-2020 average fav development was 3.6 & avg CR was 97.5 - so I think that might explain part of the difference. But also need to factor in the impact of covid in 2020 - if you take covid away, the CR for 2020 drops to 93.

 

 

 

 

 

 

[Viking]

1 hour ago, glider3834 said:

Higher than expected & transitory (consensus view) - impacts short tail more - less of a problem 

 

Higher than expected but longer term - impacts long tail more - would be more of a problem but not consensus view

 

I believe Fairfax are expecting higher inflation than market is expecting - on fixed income side they are high quality & short duration. So if over longer term we get incremental inflation with incremental increases in interest rates, this would be beneficial for Fairfax is my read.

 

And if we follow through with that logic, they should also be factoring in their higher inflation expectation into their insurance pricing & liability reserves.

 

Having said all of this, if we get really high, unexpected & sustained inflation that would be a big negative for Fairfax & the whoel P&C industry. I think this is a lower probability because you can tie a lot of the price pressure to covid which is causing supply chain disruption.

 

Here is a good article on impacts 

 

 

 https://www.insurancejournal.com/news/national/2021/03/23/606467.htm

 

 

What Does This Mean for the Property/Casualty Industry?

As with most financial institutions, higher-than-expected inflation has adverse effects on the results of property/casualty insurers. The risk to insurers falls in three buckets:

Liabilities. Insurers carry liabilities in the form of loss reserves that are intended to pay claims in the future. If inflation is higher than the rate built into the loss reserves, then future payments will be greater than expected. The impact of inflation varies by line of business, but an increase of 1 percent in inflation can raise the P/C industry combined ratio by two to three points. For personal lines of business, where liabilities are short in duration, a 1 percent increase in inflation may increase the combined ratio by less than one point. For a long-tailed line of business such as medical professional liability, the same 1 percent hike in inflation may increase the combined ratio by more than five points.

Pricing. Insurers charge prices today that will pay for future claims. If inflation proves to be greater than the inflation rate anticipated in the prices, then insurers may not have sufficient funds to pay claims. The dynamics of underestimating the inflation rate built into prices is like that of liabilities—i.e., a 1 percent increase in inflation will result in overall prices inadequacies of 2-3 percent (which varies by line of business).

When setting liabilities and pricing business, insurers must be sure to look at the components of the losses and use inflation rates that reflect the payments that will be made. For example, workers compensation losses, on average, consist of 50 percent for medical payments and 50 percent for lost wages. If the overall annual CPI inflation rates for medical costs and wages are 3 percent and 2 percent, respectively, then an annual trend rate of 2.5 percent is reasonable. However, if the insurer writes more professional services classes of business in areas with high costs of living, then the inflation rate for wages may be closer to 4 percent and the average annual trend rate should be 3.5 percent.

Investments. Approximately 80 percent of the assets held by the P/C industry are in fixed income instruments such as Treasury, municipal and other bonds. These assets are structured to match the payments (cash flows) of the loss reserve liabilities they support. If companies sell current bonds so they can invest in newer, higher-yielding bonds, they will have to book losses upon the sale because higher interest rates drive down bond prices. However, if they hold onto current assets while the ultimate values of the underlying loss liabilities are increasing, then companies will have a mismatch between their assets and liabilities. This mismatch would have to be accounted for by a reduction in the company’s surplus. There is no efficient way for companies to hedge inflation risk, but they can try to dampen the risk through holding assets such as stocks and real estate (which bring their own inherent risks to a balance sheet).

Great summary. Thanks for posting

[petec]

3 hours ago, Viking said:

Great summary. Thanks for posting

+1

[Viking]

Just came across this news story. Perhaps partially explains the weakness in Fairfax shares today. 
 

Brit certainly has had a tough couple of years. Hopefully the CEO is ok. 

 

https://www.insurancebusinessmag.com/uk/news/breaking-news/brit-ceo-takes-leave-of-absence-interim-ceo-appointed-311531.aspx

[glider3834]

3 hours ago, Viking said:

Just came across this news story. Perhaps partially explains the weakness in Fairfax shares today. 
 

Brit certainly has had a tough couple of years. Hopefully the CEO is ok. 

 

https://www.insurancebusinessmag.com/uk/news/breaking-news/brit-ceo-takes-leave-of-absence-interim-ceo-appointed-311531.aspx

yep saw that too, I hope he is ok 

 

no idea either - maybe some algo traders selling on technical weakness - of course this type of trading can cut both ways, to the upside as well.

 

Yes markets might be weak but provided we don't have some major stuff up in world economy, isn't the margin of safety looking pretty decent - I just keep scratching my head, you can buy the whole business now for 10.2 bil USD take out Digit ok lets round it down to 2bil from 2.3 = 8 bil - they paid 4.9 bil for Allied world in 2017 & it only generated 25% of their GWP premiums last year! Whichever way you start pulling the pieces apart & look at the market price - this doesn't make sense IMO. The private valuation looks totally divorced from public valuation to me.

 

I am sure Prem & Co will find a way to get creative & take advantage (even small buybacks will be advantageous). I can't fault them operationally this year - they have done everything they can do.

 

I am starting to think if Prem gets a great offer (& I might get in trouble for saying this) for one their key insurance businesses like Zenith for example- he should take it & maybe take out 20% of the share float at around 2/3 book value and it would also ignite the TRS position. 

 

Edited October 1, 2021 by glider3834

[modiva]

4 minutes ago, glider3834 said:

Whichever way you start pulling the pieces apart & look at the market price - this doesn't make sense IMO. The private valuation looks totally divorced from public valuation to me.

 

+1. Sum of parts >> Whole. If the situation persists, its not a bad idea to unlock the value by selling some parts. After all, the idea is to unlock the value, isnt it? 

[KPO]

10 minutes ago, glider3834 said:

yep saw that too, I hope he is ok 

 

no idea either - maybe some algo traders selling on technical weakness - of course this type of trading can cut both ways, to the upside as well.

 

Yes markets might be weak but provided we don't have some major stuff up in world economy, isn't the margin of safety looking pretty decent - I just keep scratching my head, you can buy the whole business now for 10.2 bil USD take out Digit ok lets round it down to 2bil from 2.3 = 8 bil - they paid 4.9 bil for Allied world in 2017 & it only generated 25% of their GWP premiums last year! Whichever way you start pulling the pieces apart & look at the market price - this doesn't make sense IMO. The private valuation looks totally divorced from public valuation to me.

 

I am sure Prem & Co will find a way to get creative & take advantage (even small buybacks will be advantageous). I can't fault them operationally this year - they have done everything they can do.

 

I am starting to think if Prem gets a great offer (& I might get in trouble for saying this) for one their key insurance businesses like Zenith for example- he should take it & maybe take out 20% of the share float at around 2/3 book value and it would also ignite the TRS position. 

 

This has happened three or four times with Berkshire over the 23 years since I’ve followed it. I remember it being grossly undervalued in March of 2000 and up 50%+ a year or so later. Same around the time they bought BNSF in 2009 and then again for 12+ weeks in the first half last year. Fairfax isn’t quite of the same caliber as Berkshire, but the pattern is similar and they’ve done a nice job with the insurance operations during this time. Enjoy it and buy more. That’s what I did with Berkshire and that’s what I’m doing here. 

[glider3834]

I was thinking about Fairfax India as well - FFH are carrying Fairfax India at around $10 per share but sitting on $20 in book value,  if you can buy FFH at 30% or greater discount to book ,then provided you can say rest of FFH's book value is at a minimum at fair value (ie all else being equal) you are effectively buying Fairfax India at at 30% discount to its carrying cost or around $7 per share (compared to its share price in $13 range & its book value at around $20)

Edited October 2, 2021 by glider3834

[maplevalue]

4 hours ago, Viking said:

Just came across this news story. Perhaps partially explains the weakness in Fairfax shares today. 
 

Brit certainly has had a tough couple of years. Hopefully the CEO is ok. 

 

https://www.insurancebusinessmag.com/uk/news/breaking-news/brit-ceo-takes-leave-of-absence-interim-ceo-appointed-311531.aspx

 

A headline like that + potential trading around the start of a new quarter -> makes sense we get a strangely outsized move today.

[KPO]

17 minutes ago, glider3834 said:

I was thinking about Fairfax India as well - FFH are carrying Fairfax India at around $10 per share but sitting on $20 in book value,  if you can buy FFH at 30% or greater discount to book ,then provided you can say rest of FFH's book value is at a minimum at fair value (ie all else being equal) you are effectively buying Fairfax India at at 30% discount to its carrying cost or around $7 per share (compared to its share price in $13 range & its book value at around $20)

I agree 100%. It’s like Russian dolls. I’m of the opinion that when you account for the recent behaviors of the CCP, such as the “common prosperity fund” (AKA unforeseen tax), India represents a more interesting and predictable investment option than China. And from a book value perspective at ~$400USD you mathematically get a free rider on India in that the discount to book effectively writes Digit and Fairfax India to zero. 

[Spekulatius]

^ Holding discounts persists due to complexity and FFH’s complexity has been going up over time. Then add to this sometimes questionable execution and volatile performance and you get to where we are.

I believe the best way to reduce holding company discounts is to reduce complexity. There is plenty of stuff that could need some trimming:

 

1) Stelco and RFP. they should dump RFP or at least get large cash dividends to invest elsewhere. Perhaps weed out some Private Investments that don’t work out (Toys are US etc).

 

2) WTH are they doing in Africa. If they think they have expertise and an edge in India, they should put the focus there. I think they should get rid of FF Africa and roll proceeds into FF India. also get rid of that Egyptian bank when they get a chance - this country has screwed over investors several times (nationalization) and will probably continue to do so.

 

3) some of the insurance subs probably could use some pruning, but they are not the main issue now.

 

Besides reducing complexity, higher interest rates will be the main driver of revaluation. I think higher interest rates are becoming more likely and they will benefit long tail insurers like FFH in particular. If interest rates really rip, you want to own life insurers, I think.

 

Edited October 2, 2021 by Spekulatius

[bearprowler6]

23 minutes ago, Spekulatius said:

^ Holding discounts persists due to complexity and FFH’s complexity has been going up over the year. Then add to this sometimes questionable execution and volatile performance and you get to where we are.

I believe the best way to reduce holding company discounts is to reduce complexity. There is plenty of stuff that could need some trimming:

 

1) Stelco and RFP. they should dump RFP or at least get large cash dividends to invest elsewhere. Perhaps weed out some Private Investments that don’t work out (Toys are US etc).

 

2) WTH are they doing in Africa. If they think they have expertise and an edge in India, they should put the focus there. I think they should get rid of FF Africa and roll proceeds into FF India. also get rid of that Egyptian bank when they get a chance - this country has screwed over investors several times (nationalization) and will probably continue to do so.

 

3) some of the insurance subs probably could use some pruning, but they are not the main issue now.

 

Besides reducing complexity, higher interest rates will be the main driver of revaluation. I think higher interest rates are becoming more likely and they will benefit long tail insurers like FFH in particular. If interest rates really rip, you want to own life insurers, I think.

 

As always Speculatius you make great points! Despite the attempts by all the Fairfax fanboys on here to talk up the stock price the stock remains on a downward trajectory and is trading well below where it was before the pandemic broke out. Apparently it is still well below intrinsic value---whatever that mythical number is for Fairfax? You need to focus on the long term the fanboys will say....I guess 10 years is not long enough? 

 

In addition to the points raised by Speculatius--- I would add the following in no particular order:

 

1) OMERS role to basically offer financing to Fairfax for an extended/permanent period of time (with only the form of collateral changing) at approx 9% shows that Fairfax cannot fund its own growth. The ongoing rate paid to OMERS for this service is ridiculous.

2) The eastern European and South American insurance operations along with those in the middle east and South Africa are too small to be meaningful. They are basically cast offs from AIG and we all know why AIG was selling!

3) Executive transition plan----Prem had basically stepped down from the CEO role when Paul Rivett was appointed President. Prem even stopped appearing on the quarterly conference calls. Well Rivett has been gone almost 2 years and no replacement has been named and the last time I checked Prem is not getting any younger. 

4) How will Fairfax unwind the TRS on its own stock. The minute it does it will signal a market top in the stock price which the market will not react well too. Not to mention the exposure that the company faces if Fairfax stock price has a large downward movement. It is ridiculous to place this kind of risk onto the company.

5) As for the stock portfolio---a few winners over the large 12-18 months for sure but who on this board hasn't seen a huge increase in the value of their portfolios over that same period of time? Being honest---nothing really remarkable from the Fairfax team here! 

6) I remain unconvinced we will experience higher interest rates anytime soon. Stagflation is more my bet which will not be good for Fairfax. 

7) It is ridiculous to suggest that "Mr Market" is unaware of all the great things (e.g., digit) that Fairfax has done recently. The market is aware of Digit, Atlas Corp  however when balanced with all the negatives (listed above and elsewhere on this board) the result is the current stock price---stubbornly below so called "intrinsic value" and most notably below the pre-pandemic price despite the huge move up in global stock prices in the last 18 months.

 

So there you have it. I await the onslaught of criticism from those who still believe. The opportunity cost of holding Fairfax over the last 1, 3, 5 and 10 years could make a growing man weep however keep in mind it is not to late to sell  out of Fairfax and redeploy the funds elsewhere!

 

[Viking]

2 hours ago, Spekulatius said:

^ Holding discounts persists due to complexity and FFH’s complexity has been going up over time. Then add to this sometimes questionable execution and volatile performance and you get to where we are.

I believe the best way to reduce holding company discounts is to reduce complexity. There is plenty of stuff that could need some trimming:

 

1) Stelco and RFP. they should dump RFP or at least get large cash dividends to invest elsewhere. Perhaps weed out some Private Investments that don’t work out (Toys are US etc).

 

2) WTH are they doing in Africa. If they think they have expertise and an edge in India, they should put the focus there. I think they should get rid of FF Africa and roll proceeds into FF India. also get rid of that Egyptian bank when they get a chance - this country has screwed over investors several times (nationalization) and will probably continue to do so.

 

3) some of the insurance subs probably could use some pruning, but they are not the main issue now.

 

Besides reducing complexity, higher interest rates will be the main driver of revaluation. I think higher interest rates are becoming more likely and they will benefit long tail insurers like FFH in particular. If interest rates really rip, you want to own life insurers, I think.

 

spek, it is possible that the Fairfax stock price may carry a permanent hold co discount moving forward given the reasons you state above. We will see. What i do know is Fairfax’s stock is very volatile. Wicked drops and wicked moves higher. I think you are going to earn an easy 10 or 15% over the next 4-6 months on your purchase of shares below US$400 on Friday.
 

I backed up the truck last fall and have sold and bought shares (around a core position) a couple of times since then. I have been adding to my position during this recent decline. And i will lighten up when we get the next spike higher. So i am happy to hold a core position given i like how the company is positioned today. And i am also happy to take advantage of the volatility in the stock by flexing my position up and then back down.

On complexity: Yes, Fairfax is a complex animal. I do think they have made some moves in recent years that have helped. One significant example is selling Riverstone/runoff. Was anyone able to value this part of Fairfax? Or build it into their valuation of the company? Other recent examples: selling APR to Atlas, IPO of Boat Rocker, IPO of Farmers Edge, reverse takeover of Horizon North by Dexterra. Publicly traded positions are much easier to follow and value for outside investors.
 

But, i completely agree, Fairfax is very complex and this does make it very difficult to do a ‘sum of the parts’ kind of valuation. 
 

‘Questionable execution’ will always be a watch-out for me. While i remain encouraged by what i have seen from Fairfax management over the past couple of years (in aggregate) i also have my eyes wide open. 
 

I think the core driver of the current very low valuation of the stock is very poor past performance. Fairfax’s performance (BV, stock price) has been terrible for 7 or 8 years. It will take more than 9 months of outperformance to win back support from the investment community. 
 

What is it going to take to get Fairfax shares more fully valued? Improved performance. Over a couple of years (not one or two quarters). If Fairfax is able to string together 2 or 3 years where they increase BV by 12-15% my guess is the stock price will pop. Earnings growth and multiple expansion is a beautiful thing for investors. So while the performance at Fairfax the past 3 quarters has been stellar we need to see this performance sustained.

 

The other factor that will help the share price are stock buybacks. Fairfax has been ‘cash poor’ the past few years. And during the pandemic rising debt levels jumped further. The Riverstone / Brit sales have helped Fairfax bring debt levels down. The insurance subs look pretty well capitalized given their earnings and the performance of their equity holdings. And as we come out of the pandemic (improving US and global economies) this should lead to improving cash earnings at Fairfax. Higher equity markets will also allow Fairfax to start to harvest some equity positions. And what will they use growing free cash flow for? Stock buybacks look like a pretty easy decision. 

 

Here are some other thoughts:

1.) RFP: what you do with Resolute really depends on what your view is of lumber. And this depends on where you think new home construction is going in the US over the next 5 years. Another factor is what the opportunity is for Resolute to sell some of their non-lumber operations. Bottom line, i understand why Fairfax may want to wait a little longer and see how things play out. (i.e. are we in the early days of a commodity super cycle?)
2.) Stelco: same as RFP

3.) Africa / CIB (Egypt) / International insurance operations

- I think John Templeton was a mentor to Prem and the Fairfax team in the earlier days. This influence may partly explain what we see at Fairfax with some of their international insurance and equity holdings. Lauren Templeton (great niece of John) is on Fairfax’s board. Sanjeev might be able to provide a little more insight here. 
- Fairfax Africa WAS an absolute train-wreck for shareholders. We will see how the partnership with Helios works out. I am neutral on Helios (not a concern nor do i expect big things…). I don’t view it today as an issue.
- CIB: although the bank has performed well over the years, it has been a poor investment for Fairfax (driven by currency devaluation driven by political situation). And it is a big position (US$280 million Sept 30). Continued ownership of this position is a head scratcher for me.
4.) in terms of the core insurance businesses Brit is the watch-out for me (even before the CEO going on leave). Fairfax has owned it long enough that i am not expecting and big negative surprises. I am just not sure how profitable the platform can ever become. The good news is Fairfax has done a good job over the years of winding down businesses that do not meet their underwriting standards. I think we also need a few more years of results to see what kind of a business Allied will become. No concerns; just not sure. 
5.) in terms of the international insurance businesses, Fairfax has had outstanding success in Asia (First Capital was sold for $1.6 billion). What i like is they appear to be implementing pretty good underwriting discipline into each of the various international operations. The operations in aggregate were writing at a CR under 100 in 2020. Hopefully this continues moving forward. Bottom line, this collection of assets has moved from ‘red flag’ to ‘monitor closely’ for me. These are clearly long term plays for Fairfax.

[glider3834]

Good discussion guys - appreciate different perspectives 

 

bearprowler you said

9 hours ago, bearprowler6 said:

it is not to late to sell  out of Fairfax and redeploy the funds elsewhere!

 Out of curiosity, what is your valuation & target price for Fairfax?  

 

I bought CAD shares in Fairfax so paid in USD equivalent around the US$350s range (buying mostly over late last year & early this year) versus a book value which could potentially hit US$600 by this year end provided we don't see any blow up in the market. I didn't expect that operating performance and happy to sit on my hands. 

 

I agree that The Market needs to see consistent operating performance from Fairfax - but as BUffett says you pay a high price for certainty & this significant discount to book wouldn't be available if they were crushing it.

 

More importantly, its not the discount to book that matters but knowing what percentage return they can compound that book at - its looking like 25% for this year Fy21. Is that repeatable in FY22? Probably not but I estimate over time a double digit avg compounded return of at least 12% is doable & anything on top is a bonus(also I would use an adjusted BVPS as Fairfax is carrying significant positions now well below market value eg Atlas Corp, Fairfax INdia)

 

The BV valuation perspective has been discussed here, but lets look from another angle at Fairfax - from an earnings perspective.

 

I estimate they can do around US1.2 bil in pre-tax profit in FY22 (excluding any investment gains)

 

Here I have broken it down - 

Revenue

$800 mil (UWP) based on 16 bil in net earned premium at a 95% combined ratio (see my other forum post on underlying combined ratio breakdown)

$650 mil interest & dividends ( approx 2 x 1H 2021 result)

$500 mil profit from associates (see my previous forum post for breakdown)

$50 mil profit from non-insurance segment 

 

$2 bil - revenue

 

less

Expenses

-$450 mil interest exp

-$330 mil corp overhead

 

$1.22 bil - pre tax profit

 

If we then subtract taxes & allow for non-controlling interests we get a net result of close to $1 bil or around $38.61 per share.

 

My estimate is forward PE of approx 10x factoring in no net investment gains plus

- included in associates result is a break even result from two of their most valuable associates (Bangalore Airport & Quess) in FY22 - but these two associates are trading on depressed multiples and FY23 & FY 24 will likely improve considerably

 

- Fairfax's fixed income positioning short duration & high quality is also depressing that PE if you believe that interest rates have the potential to move up from here. The 10 year treasury is already hinting at that possibility.

 

With the above , I am just looking at earnings potential contribution to BVPS growth, but more than 50% of Fairfax's BVPS growth  since inception has come from net investment gains (see below) - in FY21 Fairfax net investment gains of $3 bil looks a real possibility( consider up to 2bil to Q221 & Digit revaluation subject to approvals will add $1.3 bil approx more). Would you bet against Fairfax continuing to generate decent net investment gains in the next few years? 

 

 

 

 

 

 

 

 

 

 

Edited October 3, 2021 by glider3834

[nwoodman]

5 hours ago, Viking said:

4.) in terms of the core insurance businesses Brit is the watch-out for me (even before the CEO going on leave). Fairfax has owned it long enough that i am not expecting and big negative surprises. I am just not sure how profitable the platform can ever become. The good news is Fairfax has done a good job over the years of winding down businesses that do not meet their underwriting standards. I think we also need a few more years of results to see what kind of a business Allied will become. No concerns; just not sure. 

 

This article,  22nd September, implies that the issues around Covid BI reinsurance recoverables persists.  While Hiscox was highlighted as having the greatest leverage, Brit is up there.  Does anyone know how much of Brit’s book was/is BI?  An extract from the CC below also reinforces the view that it is still a work in progress.  The table below shows Brit’s recoverables to TE dropped quite significantly from H1/20 to H1/21 is a positive. 

 

https://www.theinsurer.com/analysis/hiscox-most-exposed-to-covid-bi-reinsurance-failure-as-impasse-continues/18350.article

 

 

 

“As the industry-wide impasse between reinsurers and their cedants over certain Covid-19 claims continues, research by The Insurer shows Hiscox is leveraged at 2x tangible equity to reinsurance collectibles.

The higher the number the greater an insurer’s sensitivity to reinsurance recoveries which have been booked as an asset on its balance sheet but are yet to be collected. 

Last month, Hiscox revealed its reinsurance recoveries had ballooned to a new record high of $4.4bn at H1 2021, a further leap on what was a new high of $3.6bn at year-end 2020.”

 

“In contrast, a 10 percent adverse movement in reinsurance collectibles for Hiscox peers, such as Beazley and Lancashire or even Fairfax Financial-owned Brit Insurance, would have significantly lesser impact because they have substantially lower leverage.”

 

 

 

From the recent CC

 

Jaeme Gloyn

Good. First question is on the on the reserve developments in the quarter and I guess for the first half of the year, kind of coming in the 1%-ish range. I'm seeing a little bit more favorable reserve development from other insurance companies. I'm just wondering if you can give us a little bit more detail as to what you're seeing on that front? If you can have any comments and maybe around Odyssey where we saw some unfavorable reserve development.

Prem Watsa

Jaeme, we've got Peter here who's our Chief Operating Officer, and he used to be the Chief Actuary. So, Peter, your comment.

Peter Clarke

Sure. I guess, Jaeme, I think what's distorting the numbers a little bit is we had approximately $60 million in development on COVID losses. So, that's sort of a one-off thing in our minds. And excluding the COVID losses, I think we had favorable development of around $90 million, which isn't that far off from the previous year. But generally speaking, it's the second half of the year where we do more thorough reserve reviews, specifically off the third quarter reserves and that's when we'll make more significant adjustments. Our reserves continue to be extremely strong and I think our companies are very conservative on the lost picks they're making on the current years. So, we would expect that we'll be building up some redundancy as we go through this strong pricing environment.

Prem Watsa

A basic view, Jaeme, that we've said for many, many years now is that the past reserves can develop favorably or unfavorably and we just want it to be developing favorably. And so it's a risk in the property casualty business and we've had favorable development, I think for more than a decade now and perhaps even longer than that. But that's a very important requisite in the property casualty business.

Jaeme Gloyn

Okay, understood. On those COVID loss development, can you describe what it was that was driving that? Is that anything related to BI [ph]? A little bit more color on those COVID reserve developments at all?

Prem Watsa

Sure thing. Peter?

Peter Clarke

Yes. Really, it relates on our reinsurance business primarily at Allied and Odyssey. And it's a non-U.S., so it's in Europe where there are still uncertainty around what's covered, what's not covered. Is it one event, many events? So it's really just IBNR that's still being put up on the reinsurance books, mostly in Europe.

Jaeme Gloyn

Okay. And related to BI, I guess?

Peter Clarke

Related to BI and some of the BI issues, you might remember the UK ruling came out late last year. That's still filtering through the system.

 

 

Edited October 3, 2021 by nwoodman

[modiva]

2 hours ago, glider3834 said:

My estimate is forward PE of approx 10x factoring in no net investment gains plus

Thanks @gilder3834 for the perspectives on PE from earnings (with out investment gains) and its historical contributions of less than 50% of overall gains. 

 

So Fairfax is ridiculosly cheap both from BV and PE perspectives. It is getting cheaper with time this year. But, as long as the strong performance continues, the price will correct to > book. Although it is impossible to predict the timing,  I think it will correct sometime in the next 3 years.

 

Here are my expectations:

 

BV by Dec 2024: $900 (15% cagr)

 

Net earnings in the next 3 years (2022, 2023 and 2024):  $4B (15% cagr) which I hope they deploy to retire debt and stock.

 

Target Price in Dec 2024: USD $1000-$1200 (1.11x-1.33x book)

 

This should be a 3x bagger in 3 years. 

 

I am going to be patient unless there is a big mistake or sustained poor performance. 

Edited October 3, 2021 by modiva

[Spekulatius]

I don’t think it is likely that FFH’s discount to NAV will close, the complexity and the fact that it is an controlled entity will make sure of that, even if performance improves (which is the bet that we are making). I can see this going to 1x book perhaps, but quite frankly, I don’t see this going to 1.3x book for a long time.

 

This is more of a reversal to the mean stock than a LTBH compounder for sure.

[StubbleJumper]

With respect to discount to BV that the Fairfax entities trade at (ie, FFH, FF India and FF Africa), I would note that this is not entirely unusual for family controlled companies.  One only needs to look at the Jackman family entities, namely E-L Financial, Economic Investment Trust and United Corp.  All of them have chronically traded at a discount to book, despite solid but unspectacular management by the Jackmans:  

 

[KFS]

2 hours ago, Spekulatius said:

I don’t think it is likely that FFH’s discount to NAV will close, the complexity and the fact that it is an controlled entity will make sure of that, even if performance improves (which is the bet that we are making). I can see this going to 1x book perhaps, but quite frankly, I don’t see this going to 1.3x book for a long time.

 

This is more of a reversal to the mean stock than a LTBH compounder for sure.

 

FFH was trading at about 1.2 - 1.3x book as recently as October 2018.  Looks like 1.3x was roughly average in 2016 and 2017 and during those years it was not any less complex or any less of a "controlled entity" so I don't see how this alone explains anything.  

 

[modiva]

1 hour ago, KFS said:

 

FFH was trading at about 1.2 - 1.3x book as recently as October 2018.  Looks like 1.3x was roughly average in 2016 and 2017 and during those years it was not any less complex or any less of a "controlled entity" so I don't see how this alone explains anything.  

 

+1. It is ironic that Fairfax business is in much better position now than at any time in pre-pandemic past...but the Fairfax stock is in much worse position now than at any time pre-pandemic past.

[Viking]

On 10/2/2021 at 8:22 AM, bearprowler6 said:

As always Speculatius you make great points! Despite the attempts by all the Fairfax fanboys on here to talk up the stock price the stock remains on a downward trajectory and is trading well below where it was before the pandemic broke out. Apparently it is still well below intrinsic value---whatever that mythical number is for Fairfax? You need to focus on the long term the fanboys will say....I guess 10 years is not long enough? 

 

In addition to the points raised by Speculatius--- I would add the following in no particular order:

 

1) OMERS role to basically offer financing to Fairfax for an extended/permanent period of time (with only the form of collateral changing) at approx 9% shows that Fairfax cannot fund its own growth. The ongoing rate paid to OMERS for this service is ridiculous.

2) The eastern European and South American insurance operations along with those in the middle east and South Africa are too small to be meaningful. They are basically cast offs from AIG and we all know why AIG was selling!

3) Executive transition plan----Prem had basically stepped down from the CEO role when Paul Rivett was appointed President. Prem even stopped appearing on the quarterly conference calls. Well Rivett has been gone almost 2 years and no replacement has been named and the last time I checked Prem is not getting any younger. 

4) How will Fairfax unwind the TRS on its own stock. The minute it does it will signal a market top in the stock price which the market will not react well too. Not to mention the exposure that the company faces if Fairfax stock price has a large downward movement. It is ridiculous to place this kind of risk onto the company.

5) As for the stock portfolio---a few winners over the large 12-18 months for sure but who on this board hasn't seen a huge increase in the value of their portfolios over that same period of time? Being honest---nothing really remarkable from the Fairfax team here! 

6) I remain unconvinced we will experience higher interest rates anytime soon. Stagflation is more my bet which will not be good for Fairfax. 

7) It is ridiculous to suggest that "Mr Market" is unaware of all the great things (e.g., digit) that Fairfax has done recently. The market is aware of Digit, Atlas Corp  however when balanced with all the negatives (listed above and elsewhere on this board) the result is the current stock price---stubbornly below so called "intrinsic value" and most notably below the pre-pandemic price despite the huge move up in global stock prices in the last 18 months.

 

So there you have it. I await the onslaught of criticism from those who still believe. The opportunity cost of holding Fairfax over the last 1, 3, 5 and 10 years could make a growing man weep however keep in mind it is not to late to sell  out of Fairfax and redeploy the funds elsewhere!

 

bearprowler6, i think most on this board would agree with your assessment that Fairfax shares have performed very poorly over the last 2 year and longer time frames. Over the past year, however, the stock is up 30% which is a solid return. And the question investors really want answered is where is the stock going to go from here (US$397)?

 

Do you really think people post on this board to to drive a short term pop in the stock price of Fairfax? Of any company? 
 

What i see are many people spending a great deal of time laying out their thinking (sometimes in great detail) and hoping to engage in debate of the facts. When i post i am hoping someone takes the other side. I want to engage in healthy debate. I want to know what i am missing or where there are flaws in my analysis. Why i am i wrong? 
 

I think we all understand that Fairfax has its flaws as all companies do. As investors we need to digest and synthesize the various inputs and come to a decision: what do do? There is no right and wrong. The ‘decision’ will be different for every investor. And that is what makes markets. And that difference of opinion is a very cool thing, not something to be despised or ridiculed. 
 

Yes, Fairfax’s stock price is trading well below where it was trading before the pandemic. In early 2020 the stock was trading in the US$450 range and today the stock is trading at US$397. The natural question to ask is ‘why?’ Personally, i think Mr Market mis prices lots of stocks. 
 

I agree, in general, the term ‘intrinsic value’ is a much overused phrase. Lot’s of the posts on Fairfax and the discussion that follows are pretty detailed. Fairfax is the most studied and debated company on the board. As a result people have lots of useful very information to draw whatever conclusions they like regarding Fairfax as an investment. 
 

Here some other thoughts:

1.) OMERS: yes, the various OMERS deals certainly warrant further study. Yes, the cost looks high. However, there is value for Fairfax with the relationship. For me, the relationship with OMERS is a ‘monitor’.

 

I agree the need to tap OMERS over the years suggests Fairfax has been cash poor. However, i do see Fairfax’s ability to generate cash internally is improving (lower CR, improved earnings from associates, potential to harvest equity gains). We will see.

 

2.) International insurance operations: yes, AIG and others have been selling their international insurance operations, some to Fairfax. As i outlined in more detail in my post to spek yesterday these operations posted an underwriting profit (in aggregate) in 2020. If they can do this moving forward then i am ok. Another in the ‘monitor’ bucket.

 

3.) executive transition plan: yes, it would be good to know if a replacement for Paul will be chosen or not. And given Prem’s age succession planning is important. We do have Andy running insurance. And we also know more of the equity portfolio is transitioning to younger managers. 
 

4.) TRS: given that i think Fairfax shares are very undervalued i like this holding. And, as i have said many times before, it is weird. How will they exit the position? No idea. Does it concern me? No. But i am not an options expert. 
 

5.) the stock portfolio last 12-18 months. You state ‘nothing really remarkable from the Fairfax team here!’ I could not disagree more. Over the past 18 months how much has the stock portfolio increased in value? $3 or $4 billion? Wow! And the holdings are positioned to continue performing well.

 

6.) interest rates: Higher interest rates would benefit Fairfax given the positioning of their bond portfolio. You see stagflation? We will see  

 

7.) Mr Market: what i love about investing, as i stated above, is we all have access to pretty much the same information. As investors we make decisions. And hopefully we make some money along the way. What is Fairfax really worth?   

Edited October 3, 2021 by Viking