Fairfax 2021

[Viking]

49 minutes ago, glider3834 said:

sorry should clarify its being carried at around 303 mil (at 31 Dec) & mkt value around 94 mil - I think high probability of impairment on this holding in Q4.

 

 

Yes, Farmers Edge certainly appears to be having its challenges. Fairfax has been incubating this company for years. It may be a good test of my theory of ‘new Fairfax’. Does Fairfax ‘double down’ on a clearly struggling business (an example of old Fairfax)? Or do they let it be - whatever that may be (an example of new Fairfax where companies have been told to run their business profitably and to not come to mamma in search of a cash bailout). 
 

Fairfax is, obviously, NOT going to hit on all of their investments. Boat Rocker just delivered a solid Q3 ( i think they are hitting many of their IPO targets). Dexterra is looking like it will be a great investment (although their Q3 was not great). I wonder how AGT is doing… i would group it with these companies. 

[glider3834]

1 hour ago, Viking said:

Yes, Farmers Edge certainly appears to be having its challenges. Fairfax has been incubating this company for years. It may be a good test of my theory of ‘new Fairfax’. Does Fairfax ‘double down’ on a clearly struggling business (an example of old Fairfax)? Or do they let it be - whatever that may be (an example of new Fairfax where companies have been told to run their business profitably and to not come to mamma in search of a cash bailout). 
 

Fairfax is, obviously, NOT going to hit on all of their investments. Boat Rocker just delivered a solid Q3 ( i think they are hitting many of their IPO targets). Dexterra is looking like it will be a great investment (although their Q3 was not great). I wonder how AGT is doing… i would group it with these companies. 

yes agree @Viking not every investment is going to work & its the overall bottom line result at the end of the day - on that point Fairfax's equity portfolio is continuing to do well & still looks to be up by over $500 mil since 30 Sep (including common stocks & consolidated/equity accounted positions) -  Boat Rocker & Dexterra on track & some of Fairfax's largest holdings have also seen solid Q3 results Atlas Corp, Stelco, Recipe, Kennedy Wilson - Eurobanks results still to come...

 

 

[petec]

I see FFH now owns 39.3% of RFP. If I was them I think I’d encourage RFP to buy back shares until I had control, and then put 100% of free cash to dividends.

[Viking]

The future path of inflation and its impact on bond yields will be important for Fairfax. If inflation remains higher for longer and bond yields move higher Fairfax is positioned to benefit in a big way (via higher interest income). A current headwind to earnings will become a tailwind. This will be something to watch in 2022. 

 

Interest and dividend income has come down quite a bit at Fairfax over the past 4 years. This is likely one of the reasons in explaining the weakness in the share price. What is driving the drop in interest & dividend income? Much lower interest rates. Most insurers are seeing a decline in the interest and dividend income bucket. And this is one of the key factors driving the current hard market. So there is a silver lining to the current low interest rate environment.

 

So what are the actual pre-tax numbers for Fairfax?

             Investments.     I&D Amount.      Yield

2018.         $39.0b             $784.             2.01%

2019.         $40.1.               $880.             2.19%
2020.        $41.1.                $769.             1.87%

2021E.       $45E               $661E ($496 Sept 30) 1.47%E

 

So interest and dividend income has come down significantly even as the size of the total investment portfolio has increased. The drop is about $100 million versus 2020 and $200 million versus 2019. Pretty significant.
 

The drop in bond yields is impacting Fairfax more than most insurers. For years Fairfax has been selling its longer dated bonds and increasing the % of its portfolio in cash and short term investments (so its total fixed income portfolio has very low duration). They have been very opportunistic in this regard. This strategy has allowed Fairfax to book gains on sales of longer dated bonds. But the rate Fairfax is able to reinvest the proceeds is also much lower… so the cost has been lower future interest income.

 

Why shorten the duration on your fixed income portfolio? If you believe interest rates are going to rise in the future. Higher interest rates will cause insurance companies to book losses on their bonds (especially longer dated bonds) and this will reduce BV. If interest rates increase Fairfax will have significant cash to invest in higher yielding bonds. This will spike future interest income. 
 

My guess is in 2021 we could see interest and dividend income bottoming out. Fairfax is increasing its total investments nicely. Dividends have also been increasing nicely in 2021. And inflation should result in higher bond yields which should provide Fairfax the opportunity to re-deploy some of its cash into higher yieldings investments. So 2022 might be the year we see ‘interest & dividend income’ bucket at Fairfax start to grow again.
—————

On the dividend front Stelco’s increase to C$0.40/share/Q x 13 million shares = C$20.8 million. Companies have reinstated and are now increasing dividends.

Edited November 12, 2021 by Viking

[StubbleJumper]

Rates have already shown a modicum of improvement.  I'm not sure what the bond team is thinking these days, but I wonder whether they are biting on 2-yr treasuries, which still provide inadequate interest rates, but are better than zero and don't lock you in for the long-term. I'd be surprised if they were planning to allocate much of the bond portfolio to the 5-yr, 10-yr or longer because there just isn't enough yield there at this point.  But, as one other poster noted this week, FFH seem to be fans of Van Hoisington, and their outlooks is still lower for longer, so who knows...

 

But that's just the interest rate aspect.  Inflation also impacts on indemnities, particularly those which take 2, 3, or 10 years to resolve.  One of my observations about the Q3 report was that there wasn't as much favourable development as I had expected to see.  I had anticipated that the 2019 and 2020 accident year CRs would have had a fair bit of cushion built into them because the pricing environment was favourable.  If that were true, in 2021, that should have resulted in healthy reserve releases -- maybe we'll see them when the reserves are assessed in Q4?  We didn't see that favourable development in the first three-quarters.  Is it possible that inflation is eating into our favourable development (eg, some guy's house gets obliterated in a hurricane in 2020, but the re-build cost 10% more than was expected when the claim was originally made)?  To what extent does this occur and is it material (I'm talking general inflation, not social inflation)?

 

 

SJ

[nwoodman]

19 hours ago, glider3834 said:

I think high probability of impairment on this holding in Q4.

 

Yep, was surprised they didn’t last quarter. But hey -20% yesterday, any write downs for last quarter wouldn’t have properly captured this $hitshow

Edited November 12, 2021 by nwoodman

[Viking]

31 minutes ago, StubbleJumper said:

Rates have already shown a modicum of improvement.  I'm not sure what the bond team is thinking these days, but I wonder whether they are biting on 2-yr treasuries, which still provide inadequate interest rates, but are better than zero and don't lock you in for the long-term. I'd be surprised if they were planning to allocate much of the bond portfolio to the 5-yr, 10-yr or longer because there just isn't enough yield there at this point.  But, as one other poster noted this week, FFH seem to be fans of Van Hoisington, and their outlooks is still lower for longer, so who knows...

 

But that's just the interest rate aspect.  Inflation also impacts on indemnities, particularly those which take 2, 3, or 10 years to resolve.  One of my observations about the Q3 report was that there wasn't as much favourable development as I had expected to see.  I had anticipated that the 2019 and 2020 accident year CRs would have had a fair bit of cushion built into them because the pricing environment was favourable.  If that were true, in 2021, that should have resulted in healthy reserve releases -- maybe we'll see them when the reserves are assessed in Q4?  We didn't see that favourable development in the first three-quarters.  Is it possible that inflation is eating into our favourable development (eg, some guy's house gets obliterated in a hurricane in 2020, but the re-build cost 10% more than was expected when the claim was originally made)?  To what extent does this occur and is it material (I'm talking general inflation, not social inflation)?

 

 

SJ

@StubbleJumper crazy low interest rates have been a key driver of the hard market. I wonder if high inflation is one of the key drivers of the hard market moving forward - and a big reason why pretty much all insurance companies expect the hard market to continue well into 2022. 

[Maxwave28]

am thinking about hidden / undervalued assets at Fairfax as we head into the end of 2021. 

 

Exco Resources comes to mind given the current natural gas price environment that everyone is aware of and the dearth of information out there

 

Prem had this to stay about Exco in the 2020 AR. 

 

"Fairfax owns 44% of Exco, a U.S. oil and gas producer. Despite weak energy prices in 2020, Exco generated
$128 million in EBITDA and $36 million in free cash flow. Net debt fell to $145 million (1.1 times EBITDA). Led by Chairman John Wilder and CEO Hal Hickey, Exco achieved these results through high field level productivity and
company-wide cost control. In December, Exco recorded its 73rd month without a lost time incident. Exco’s
Chairman, John Wilder, is a great partner. We are well served by his leadership."

 

Natural gas prices are up ~90% (3.8/2.0) from their 2020 avg, per https://www.eia.gov/dnav/ng/hist/rngwhhdm.htm

 

Henry Hub Natural Gas Spot Price (Dollars per Million Btu)
Year	Jan	Feb	Mar	Apr	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Avg.
2020	2.02	1.91	1.79	1.74	1.75	1.63	1.77	2.3	1.92	2.39	2.61	2.59	2.035
2021	2.71	5.35	2.62	2.66	2.91	3.26	3.84	4.07	5.16	5.51			3.809

 

Would imagine more than a doubling of ebitda of $128mm and free cash flow of $36mm from 2020 at 2021 avg. gas prices but have no idea how to ball park this. 

 

Does anyone have a feel for what kind of free cash flow Exco has been doing this year or a good framework to think about this?  Exco financials require a login for access and their website does not provide other useful info

 

thank you

 

 

[Viking]

3 hours ago, Maxwave28 said:

am thinking about hidden / undervalued assets at Fairfax as we head into the end of 2021. 

 

Exco Resources comes to mind given the current natural gas price environment that everyone is aware of and the dearth of information out there

 

Prem had this to stay about Exco in the 2020 AR. 

 

"Fairfax owns 44% of Exco, a U.S. oil and gas producer. Despite weak energy prices in 2020, Exco generated
$128 million in EBITDA and $36 million in free cash flow. Net debt fell to $145 million (1.1 times EBITDA). Led by Chairman John Wilder and CEO Hal Hickey, Exco achieved these results through high field level productivity and
company-wide cost control. In December, Exco recorded its 73rd month without a lost time incident. Exco’s
Chairman, John Wilder, is a great partner. We are well served by his leadership."

 

Natural gas prices are up ~90% (3.8/2.0) from their 2020 avg, per https://www.eia.gov/dnav/ng/hist/rngwhhdm.htm

 

Henry Hub Natural Gas Spot Price (Dollars per Million Btu)
Year	Jan	Feb	Mar	Apr	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Avg.
2020	2.02	1.91	1.79	1.74	1.75	1.63	1.77	2.3	1.92	2.39	2.61	2.59	2.035
2021	2.71	5.35	2.62	2.66	2.91	3.26	3.84	4.07	5.16	5.51			3.809

 

Would imagine more than a doubling of ebitda of $128mm and free cash flow of $36mm from 2020 at 2021 avg. gas prices but have no idea how to ball park this. 

 

Does anyone have a feel for what kind of free cash flow Exco has been doing this year or a good framework to think about this?  Exco financials require a login for access and their website does not provide other useful info

 

thank you

 

 

@Maxwave28 unfortunately i do not have any insight into EXCO. Looking at the old financial releases they certainly were skewed to gas. So as long as they were not hedged or locked in to contracts going into 2021 they should be making serious money at current prices. We may need to wait until the 2021AR for another update. 
 

i wonder if much M&A activity is happening in the oil and gas sector; perhaps it is still too early in the cycle. 

Fairfax has a pretty decent sized and diversified collection of resource investment: EXCO, Stelco, RFP, Altius Minerals, Foran Mining (new position). It will be interesting to see if Fairfax monetizes any of these positions in the next 12 months.
 

Stelco is up 125% from their purchase price; but it could have close to C$1 billion in cash at year end and Kestenbaum has been a master capital allocator so Fairfax may want to hang on and see what he can do with all the money that is raining down right now.

 

Other than EXCO, AGT is one of the few large privately held investments Fairfax still has; my guess is they likely could surface a fair bit of value with an IPO. However, i am not sure how the current supply chain issues are impacting AGT. There has been very little news on the company in 2021 (at least i have not been able to find much). 
 

We may be at a stage in Fairfax’s development where they largely like what investments they have and want to see what the different management teams are capable of in the coming years. Fairfax has been working hard to fix some companies and get the rest better positioned to succeed so it makes sense they will be patient.

 

ATCO is the largest investment and it is cheap with 20% growth pretty much locked in for the next few years. Eurobank also is cheap and also with solid growth prospects. Of the large equity investments perhaps Blackberry is the top candidate to be monetized; but i say this out of ignorance as i do not follow Blackberry closely enough to understand its current valuation / future prospects. 

 

What i like with Fairfax right now is they do not HAVE to do anything (in terms of monetizations). They are not short cash. They do not have a big part of their business chronically losing a bunch of money (like their short positioning did for years). Leverage is ok and improving (another $85 million in debt was redeemed in Oct). Subs are growing net premiums written +20%. 

Now Fairfax shares are dirt cheap so of course i would like to see a big buyback. And given how the shares have been trading since March, other than a big buyback, i do not see a near term catalyst. I was surprised Prem was not a little more upbeat on share buybacks during the call. Underpromise and overdeliver (the new Prem?)? Bottom line, Fairfax is hitting the ball out of the park right now in terms of delivering very good results. At some point the stock will respond and when it does the move will likely be fast (if history is any guide). 

 

Edited November 13, 2021 by Viking

[Viking]

I updated my post below (posted about a month ago) with the information we received in Q3 (much stronger than expected growth in net premiums). Given Q3 results (and I am pretty sure Prem said Fairfax expects net premiums to post 20% growth for the year) I increased net premiums earned forecast from 16% growth to 20% for 2021. Given all the positive commentary from pretty much all insurers I also increased expected growth in net premiums earned in 2022 to 12% (from 10%). My guess is the 2021 CR should come in a little below 97 (was 97.3 YTD in Q3). So Fairfax may earn around $500 million in underwriting profit in 2021 ($19/share pre-tax). If the CR comes in at 96 in 2022 Fairfax may earn around $750 million in underwriting profit ($29/share pre-tax). Both of these numbers would be a big improvement from underwriting profit booked the past three years (2018 to 2020) which averaged CR of 97.3 = $340 million = $13/share.    

-------------------

Is the current insurance hard market a big deal for Fairfax and Fairfax shareholders? Yes. Why? Because it results in significant growth in premiums (top line) and a lower combined ratio (bottom line). You get a double benefit. So underwriting profitability spikes. But there is a lag (depending on the type of business written). It takes time for net written premiums to become earned premiums. (For the insurance experts on the board, please correct any errors in my comments). 

 

In the example below 56% growth in net premiums earned (over 4 years) results in an increase in underwriting profit of 135%. Easy to understand why Fairfax is prioritizing supporting growth in its insurance subs during the current hard market (over stock buybacks).

 

It is not unreasonable to estimate that Fairfax will earn $750 million in underwriting profit in 2022 = $29/ share (pre-tax). And the longer the hard market continues to run the higher future earnings from underwriting will be for Fairfax. 
 

     Net premiums.     YOY

               earned      growth.   CR.        Underwriting profits

2018        $11.91           -          97.3         $318      $12/share

2019       $12.54          5%.      96.9         $395      $15

2020.      $13.86         11%.      97.8         $308      $12

2021 est $16.63         20%      Est 97      $500      $19

2022 est $18.63         12%.     Est 96      $750      $29

 

Why does a hard market result in a lower combined ratio? Price increases on the same unit of exposure are the big driver. A second benefit is a lower expense ratio (as top line grows faster than expenses).

 

There is also a lag. It takes time for net written premiums to become net earned premiums. And in hard markets loss picks tend to be conservative resulting in reserve releases in future years which is good for future profits.

 

And a hard market also provides significant benefits to the investment side of the business… by significantly increasing this magical thing called float…

————-

Please note, my numbers above do not include what is left of the runoff business after the Riverstone sale. 

[Xerxes]

Viking,

 

How should Berkshire (the industrial conglomerate that it is today) be valuated in your opinion ?  based on sum of parts ... or a multiple off its operating earning. At which point in its history did it make sense to shift from SOTP to multiple or vice versa for Berkshire. I know folks use both ways now.

 

Now, what about FFH ?

 

I am asking because the FFH-portion of the earnings from Atlas and Resolute looks about the same range, which was surprising to me given the disparity between the two in terms of management quality and size of the business. FFH owns about the same % of each of them. Perhaps RPF has its earning at its cyclical high while Atlas has it a cyclical low so seem to coincide at this moment in time. Which would mean there has to be a serious growth in Atlas's earning (as envisioned by Prem) and that would lift the base-line of that multiple valuation.

 

I say that because market clearly does not care about SOTP when it comes FFH. So value added by FFH's heavy-hitter Associates come in play only (1) if the management at some point monetize a sliver of the holding or (2) accounting rules are changed such that Associates get that mark-to-market. Since the latter is impossible and the former would only come into play when FFH is ready to monetize, than clearly it is that uptick in earning that needs to be there to lift the valuation by multiples.   

 

To be clear, i am talking about accounting earnings and not the "dividend & interest" line item, which is real cash. 

 

[glider3834]

3 hours ago, Viking said:

My guess is the 2021 CR should come in a little below 97 (was 97.3 YTD in Q3).

yes viking I think 96-97 sounds reasonable - I have done some calcs below as well

 

Worth noting too that while Q4 is usually cat heavy, it looks like this US hurricane season will likely a bit lighter in Q4 https://www.local10.com/weather/2021/11/12/hurricane-season-is-likely-over-yet-again/ 

 

Underlying CR (excluding covid, cats, favourable develop) looks to be on a downward trend on back of this higher net earned premium - so I think could potentially hit 88s region in Q4.

Q420        90.5

Q121         90.3

Q221        89.9

Q321        89.0

Q421        (88s??)

 

I would expect covid to have minimal impact based on Q3.

 

So remaining impact on CR will come from fav development and catastrophes.

 

Fav development has averaged 1.2% over last 3 quarters & was 5% in Q420. So for favourable development I would estimate around 1-2% in Q4. Lets say 1.5% slightly more than quarterly as would expect them to be conservative around releases pending the Q4 audit. On the flipside, I think economic inflation is something which will probably encourage them to be more restrained on any Q4 release.

 

For catastrophe losses, 6.6% in Q420 & 8.9% in Q419. Lets estimate catastrophes at the mid-point at 7.7% although noting that a lighter hurricane season could reduce this further.

 

Underlying CR 88.5 (lets estimate) + Fav devopment -1.5CR points + Catastrophes 7.7CR points = 94.7 CR estimate for Q4.

 

That would give an annualised CR of around 96.4

 

Of course, this is all guesswork as we are at the mercy of the weather

 

 

 

 

 

 

 

 

 

 

Edited November 14, 2021 by glider3834

[Viking]

1 hour ago, Xerxes said:

Viking,

 

How should Berkshire (the industrial conglomerate that it is today) be valuated in your opinion ?  based on sum of parts ... or a multiple off its operating earning. At which point in its history did it make sense to shift from SOTP to multiple or vice versa for Berkshire. I know folks use both ways now.

 

Now, what about FFH ?

 

I am asking because the FFH-portion of the earnings from Atlas and Resolute looks about the same range, which was surprising to me given the disparity between the two in terms of management quality and size of the business. FFH owns about the same % of each of them. Perhaps RPF has its earning at its cyclical high while Atlas has it a cyclical low so seem to coincide at this moment in time. Which would mean there has to be a serious growth in Atlas's earning (as envisioned by Prem) and that would lift the base-line of that multiple valuation.

 

I say that because market clearly does not care about SOTP when it comes FFH. So value added by FFH's heavy-hitter Associates come in play only (1) if the management at some point monetize a sliver of the holding or (2) accounting rules are changed such that Associates get that mark-to-market. Since the latter is impossible and the former would only come into play when FFH is ready to monetize, than clearly it is that uptick in earning that needs to be there to lift the valuation by multiples.   

 

To be clear, i am talking about accounting earnings and not the "dividend & interest" line item, which is real cash. 

 

Xerxes, you ask some thought provoking questions.

 

i have viewed BRK for the last few years like a bond substitute (rock solid; will deliver a much better return than a bond but with more volatility). I have owned BRK on and off the past few years (selling after it is up 6 or 8%). Rinse and repeat (i have been able to do this trade multiple times some years). My view was reinforced when i heard Buffett talk at the AGM… he sounded more like a custodian than a manager. The clear priority was to protect the capital of the many families who were early investors (where BRK now represents the vast majority of their net worth). The big new news (last 12 months) is the relentless stock buybacks we have seen. (Interesting question: where do you think BRK share price would be today without the big buybacks? My guess is the share price would be lower. That tells you how conglomerates are valued by the market today.) Finally putting large amounts of cash to work is a big deal and should drive the stock price  and multiple higher if it continues. This also telegraphs that Buffett believes the shares are cheap which perhaps provides a partial answer to your current valuation question. I do not own today so do not have a current view on valuation; if i do not own a company it usually falls off my radar. There are enough smart people valuing the company when i get interested i read their latest analysis and try and do an average to develop an opinion on valuation at that time. I like to look at all the different models; they all tell you something a little different about BRK.

 

i will answer the Fairfax part of your question a little later… got to go for dinner  

Edited November 14, 2021 by Viking

[drzola]

Farmers Edge really is a dud investment as of my opinion for whatever that may be worth here folks.

Several good posts on topic with FEdge below fyi.

 

https://mail.google.com/mail/u/0/#inbox/FMfcgzGlksCVNhfHTkQMsZHsrvhZNnnB

 

https://mail.google.com/mail/u/0/#inbox/FMfcgzGlksDcrDZDrxXWMSkRdtZNQSWL

[Viking]

18 hours ago, Xerxes said:

Viking,

 

How should Berkshire (the industrial conglomerate that it is today) be valuated in your opinion ?  based on sum of parts ... or a multiple off its operating earning. At which point in its history did it make sense to shift from SOTP to multiple or vice versa for Berkshire. I know folks use both ways now.

 

Now, what about FFH ?

 

I am asking because the FFH-portion of the earnings from Atlas and Resolute looks about the same range, which was surprising to me given the disparity between the two in terms of management quality and size of the business. FFH owns about the same % of each of them. Perhaps RPF has its earning at its cyclical high while Atlas has it a cyclical low so seem to coincide at this moment in time. Which would mean there has to be a serious growth in Atlas's earning (as envisioned by Prem) and that would lift the base-line of that multiple valuation.

 

I say that because market clearly does not care about SOTP when it comes FFH. So value added by FFH's heavy-hitter Associates come in play only (1) if the management at some point monetize a sliver of the holding or (2) accounting rules are changed such that Associates get that mark-to-market. Since the latter is impossible and the former would only come into play when FFH is ready to monetize, than clearly it is that uptick in earning that needs to be there to lift the valuation by multiples.   

 

To be clear, i am talking about accounting earnings and not the "dividend & interest" line item, which is real cash. 

 

@Xerxes  ‘How should Fairfax be valued?’

 

Context is important. Before i dig into the question above (i’ll post something in the next couple of days) here are some big picture thoughts. 

 

Fairfax stock today is trading today at a historically low price to BV. At the same time the company is poised to deliver record earnings in 2021. And its future prospects, with both insurance and investments, is looking very good - the best in a decade (perhaps longer). So what is the problem? Clearly, investors are struggling to value the company, and its future earnings, as it exists today. Why?

 

1.) the business is difficult to value: due to its vast number of equity investment holdings and how they are accounted (3 different ways: mark to market, equity and consolidated) IT IS difficult to value Fairfax. 

2.) historical earnings numbers are a mess: the historical earnings numbers for Fairfax are FULL OF NOISE. There were persistent large losses driven by issues that are mostly no longer relevant (i.e. shorting losses are the largest, but there are others). So past results do not provide investors today with a useful baseline. Past results tell investors little about what Fairfax will likely earn in the future.

3.) Covid: Covid’s impact, especially on investments, further muddied the water. It made it more difficult for investors to understand what was going on ‘under the hood’ at Fairfax: the changes that were happening and what the company’s earnings power is moving forward.

4.) investor sentiment in Fairfax is at an all time low: earnings the past 8 years have been volatile and terrible (not including 2021) when compared to market averages. Fairfax also has a long history of being a poor communicator. This has created trust issues with investors. Many investors have given up on the company. 

 

Much has changed at Fairfax that will materially impact earnings and BV growth in the coming years:

5.) we are in the third year of a hard market on the insurance side of the business: the benefit of the hard market is just starting to show up in earnings results in 2021 and should improve further from here.

6.) much has changed over the past 5 years with the investment side of business: the changes are numerous and material. No more shorting. Better buys (Digit, Atlas, Stelco, FFH TRS are 4 recent examples). Many problem investments have been fixed (i.e. Eurobank), sold (i.e. APR) or merged (i.e. Fairfax Africa). The changes have been gradual and many are not well understood or appreciated by investors.

 

My view is much has changed at Fairfax over the past 4 or 5 years with both insurance and investments. And it is not understood by investors. So investors are underestimating the future earnings power of the company. Fairfax is delivering record earnings in 2021 and investors remain sceptical. And that scepticism is what is creating the current opportunity in its share price

Edited November 14, 2021 by Viking

[modiva]

2 hours ago, Viking said:

@Xerxes  ‘How should Fairfax be valued?’

 

Context is important. Before i dig into the question above (i’ll post something in the next couple of days) here are some big picture thoughts. 

 

Good question @Xerxes. I look forward to hearing from @Viking 

 

Here are my perspectives. 

 

1) Using BV is a conservative way of looking at the value. 

 

Berkshire is trading at 1.3x book value (and traded at 1.4x book value at several times during the quarter). 

Fairfax is trading at 0.7x book value.  Viking mentioned reasons for the discount and hopefully it corrects soon.  

 

Interesting to note that Berkshire is buying back at a record pace, retiring  at ~5% shares/year.  They intend to buy back as long as the price is below intrinsic value, conservatively determined.  Clearly, they believe that the prices are below conservative intrinsic value, despite trading at 1.3x book value.  Even Fairfax also believes the intrinsic value is much higher than the book value. 

 

2) Using Intrinsic value is fair reflection of the value.  How to look at the intrinsic values?

 

Whitney Tilson has a simple approach to calculate intrinsic value that Warren Buffett himself has referred to in the past.  Let's look at it.  

 

First, he values the investments.  For example, below is the value of Berkshire's investments as of Q3 21.  

 

Second, he values the operating earnings from wholly owned businesses.  For example, below is the value of operating earnings as of Q3 21. 

 

Third, he applies multiple of 11 to value the operating earnings.  It translates to 11*17.557 = $193,000 per share. 

 

Finally, combine the investment value and operating earnings value to arrive at total intrinsic value.  This translates to intrinsic value of A shares $522,279.  Currently, it is trading at $431,575. 

 

Berkshire is trading at ~0.82x of intrinsic value, although it is trading at 1.3x book value. 

==> This means that the intrinsic value is almost 60% higher than the book value. 

 

I haven't applied this methodology to Fairfax.  But I would think that Fairfax's book value is fairly conservative, and the intrinsic value is similarly 50%+ higher than its book value.  I hope someone with better handle on Fairfax's businesses could provide perspective.  

 

==> If so, Fairfax is trading at <50% of its intrinsic value.  

 

 

 

Edited November 14, 2021 by modiva

[StubbleJumper]

Guys, let's not overthink this.  It's not necessary to do a Tilson-style or a Bloomstran-style analysis to obtain a valuation estimate down to the penny.  As WEB once said, "You don't need to know a man's weight to know that he's fat."  And so it is with FFH, you don't need an elaborate valuation model to know it's cheap.  If the stock price increases by, say, another 40% or so, that's the time to start the navel gazing about precisely how much it's truly worth.

 

That being said, the easiest valuation method for an outfit like Fairfax is a simple multiple of BV.  The issue is what level the multiplier ought to be (ie, 1x, 1.2x, 1.4x, something else).  So let us start with two broad scenarios: the first is that Prem's stretch-goal of a 15% ROE is actually the future reality, and the second being that historical ROE is representative of future reality.  So, just for giggles and farts, I've ripped off a chart of Return on Common Equity from tikr.com which I've attached below: 

 

As Viking noted, it's a chaotic, hell of a mess but in complete fairness to Prem, there were never any promises of stable returns.  Ignoring the volatility, if I've done the arithmetic correctly, the geometric mean of that chaotic mess is about 6.7%.  So, I'd say that Viking has nailed the issue quite nicely, which is that the 17-year mean ROE has been underwhelming, while Prem's stretch-goal of 15% ROE has only been attained on 5-of-17 years.  It is what it is.

 

Returning to the two-scenario approach, what would be an appropriate book-value multiple for an outfit that kicks out a 6.7% ROE and what would be appropriate for an outfit that kicks out a 15% ROE?  I would say that the former is worth approximately 1x book, and the latter would easily be worth 2x book.  Given that the shares trade at a considerable discount to book, current valuation is bat-shit crazy in either circumstance.

 

I don't blame the market for being skeptical of FFH because there has been chronic over-promising and under-delivering.  I would say that FFH is in a "show me" period when it comes to valuation.  The market will pay for true value generation, but it will take a few years to repair the damage done by that chaotic, hell of a mess of a ROE chart.  But, when it trades at like 0.7x BV, who gives a shit?  If it takes two years to get back to book and two more to reach an "appropriate" multiple based on the next few years of results from re-aligned strategy, it will provide a handsome return.  At this point, there's no need at all to over-think this.

 

 

SJ

 

[modiva]

2 hours ago, StubbleJumper said:

Returning to the two-scenario approach, what would be an appropriate book-value multiple for an outfit that kicks out a 6.7% ROE and what would be appropriate for an outfit that kicks out a 15% ROE?  I would say that the former is worth approximately 1x book, and the latter would easily be worth 2x book.  Given that the shares trade at a considerable discount to book, current valuation is bat-shit crazy in either circumstance.

 

I don't blame the market for being skeptical of FFH because there has been chronic over-promising and under-delivering.  I would say that FFH is in a "show me" period when it comes to valuation.  The market will pay for true value generation, but it will take a few years to repair the damage done by that chaotic, hell of a mess of a ROE chart.  But, when it trades at like 0.7x BV, who gives a shit?  If it takes two years to get back to book and two more to reach an "appropriate" multiple based on the next few years of results from re-aligned strategy, it will provide a handsome return.  At this point, there's no need at all to over-think this.

 

+1

[nwoodman]

3 hours ago, StubbleJumper said:

But, when it trades at like 0.7x BV, who gives a shit?

The challenge with this company is getting comfortable with the actual BV number and then trusting manage to "do no damage" to that book value.  Unfortunately it boils down to a test of faith.  I think it is a viable risk reward opportunity for a chunk of my capital but I choose to split the difference between the market and management's BV for a valuation.  There's still plenty that need's fixing or axing but agree much has improved.

[Xerxes]

My question wasn't so much to determine weather it is cheap or not. 

But the trigger for re-rating.

 

BAM is valued via its asset management business (multiple on FRE) + its carry + maybe also its invested capital.

While, BAM and FFH are completely different businesses, I would think that Fairfax also has an operating earning portion (we can argue what the can be) + potential monetization + etc. The market does not care about the second bucket "i.e. potential monetization", because much like BAM's carry, these are lumpy. If and when it comes, the market (and the accounting, i might add) will both recognize it then ... but wont bother with till. 

 

So it is the earning of the big associate (in absence of a re-rate on the bond portfolio, which is perhaps further in the future) that really need to get a lift.  

 

From Q3 earning: "Consolidated share of profit of associates of $227.3 million principally reflects share of profit of $82.0 million from Resolute, $43.3 million from Eurobank and $20.3 million from Atlas Corp."

 

Compare the scale of the dollar value of the earning coming from Resolute vs. what is coming combined from Eurobank and Atlas. I think, it is pretty well understood that the latter two' earnings are on an inflection point (I get that), but TODAY, they are collectively lower than the earnings from Resolute ! 

 

So why should the market  care TODAY about Atlas and Eurobank, and give it credit in Fairfax market value ? if the stock market is severely undervaluing Atlas itself, does it really surprise anyone that it is also discounting through FFH's own share price, Atlas's picture just gets muddier when seen through Fairfax. 

 

Bottom line, we need to see a good uptick of earning from Eurobank and Atlas (not their stock price going up, ... earnings) before seeing anything in term of "credit" given by the market on Fairfax valuation.  

 

 

Edited November 15, 2021 by Xerxes

[glider3834]

Here is a chart I put together to show Fairfax's investments per share multiple versus peers. 

 

What you do notice straight away is that insurers with lower combined ratios (higher levels of underwriting profitability) tend to trade on lower investments per share multiples. And this makes intuitive sense - the less profitable the underwriting, the higher the investment returns need to be for investors (ie you would require more investments for each $1 invested to earn an attractive return).

 

I estimate Fairfax had an average combined ratio (excl covid loss) over 2018-2020 of 96. By my calcs,  Fairfax's peers that have average combined ratios between 95 & 97, over same period, are trading on investments per share multiples of 1.5 to 2.3x . However, Fairfax's investments per share multiple looks to be 3.5x - much higher!

 

 

 

 

 

 

 

 

 

Edited November 15, 2021 by glider3834

[StubbleJumper]

39 minutes ago, Xerxes said:

My question wasn't so much to determine weather it is cheap or not. 

But the trigger for re-rating.

 

...

 

Bottom line, we need to see a good uptick of earning from Eurobank and Atlas (not their stock price going up, ... earnings) before seeing anything in term of "credit" given by the market on Fairfax valuation.  

 

 

 

The trigger for re-rating will be 3 or 4 years of *good* ROEs.  None of this chaotic +23% followed by -12% followed by + 7%.  Nope, 3 or 4 years of double-digit, positive ROE will likely garner some serious attention.  This year, 2021, is a fabulous start.  Another couple years of modestly good returns will change the narrative.

 

Eurobank and Altas share prices are not marked to market, so only the people doing a deeper-dive will ever realise the value from those positions.  The income from those outfits won't hurt, but we need to see reliable operating and investment returns from FFH for a few more years.  

 

But, whatever.  Even if FFH "only" re-rates to 1x BV in the next couple of years, that will be a fully acceptable return (ie, a reversion to 1x BV is 40% plus the gain in book, which would be ~60% over a couple of years).  If it reverts to 1.1x or 1.2x in four years, that will be fully acceptable too.

 

It's cheap.

 

 

SJ

[glider3834]

On 11/12/2021 at 4:08 PM, Viking said:

Yes, Farmers Edge certainly appears to be having its challenges.

I just had a listen to the Farmer's Edge Q3 conference call

- they expecting to be cash flow positive on annualised basis in 2024

- expect their cash burn to reduce going forward - they believe they have enough cash on hand until they become cash flow positive (so hopefully no further funding needed from Fairfax )

- expect Digital Agronomy revenues to be 33% higher in Q421 (over Q420) which should reduce their cash burn to b/w 5-10 mil in Q4.

- they have largely a fixed cost structure so path to break even & beyond comes down to acquiring new acres & selling related services.

- they are continuing to develop financial services products & insurance products in conjunction with Fairfax such as yield prediction feature (used by lender & insurers to manage underwriting risk)  

- expect revenue growth from carbon offsets

 

 

 

 

[glider3834]

AGT foods 

 

https://globalnews.ca/news/8035707/saskatchewan-commodity-trader-rail-network/

[Viking]

On 11/14/2021 at 6:10 PM, Xerxes said:

My question wasn't so much to determine weather it is cheap or not. 

But the trigger for re-rating.

 

BAM is valued via its asset management business (multiple on FRE) + its carry + maybe also its invested capital.

While, BAM and FFH are completely different businesses, I would think that Fairfax also has an operating earning portion (we can argue what the can be) + potential monetization + etc. The market does not care about the second bucket "i.e. potential monetization", because much like BAM's carry, these are lumpy. If and when it comes, the market (and the accounting, i might add) will both recognize it then ... but wont bother with till. 

 

So it is the earning of the big associate (in absence of a re-rate on the bond portfolio, which is perhaps further in the future) that really need to get a lift.  

 

From Q3 earning: "Consolidated share of profit of associates of $227.3 million principally reflects share of profit of $82.0 million from Resolute, $43.3 million from Eurobank and $20.3 million from Atlas Corp."

 

Compare the scale of the dollar value of the earning coming from Resolute vs. what is coming combined from Eurobank and Atlas. I think, it is pretty well understood that the latter two' earnings are on an inflection point (I get that), but TODAY, they are collectively lower than the earnings from Resolute ! 

 

So why should the market  care TODAY about Atlas and Eurobank, and give it credit in Fairfax market value ? if the stock market is severely undervaluing Atlas itself, does it really surprise anyone that it is also discounting through FFH's own share price, Atlas's picture just gets muddier when seen through Fairfax. 

 

Bottom line, we need to see a good uptick of earning from Eurobank and Atlas (not their stock price going up, ... earnings) before seeing anything in term of "credit" given by the market on Fairfax valuation.  

 

 

@Xerxes we have been discussing for quite some time what trigger would result in a re-rating of Fairfax’s stock price (back to historic norm of 1 or 1.1xBV). And i think the results of the discussion are inconclusive. I don’t know that there is one silver bullet (other than a big stock buyback - see bottom of post). 
 

Part of the challenge is it is unclear what exactly is causing the stock to trade at the significant discount it is today. Lots of good ideas have been presented: lack of growth in earnings, lack of growth in BV, lack of trust in reported BV, covid effects, low interest rates, increase in debt levels, complexity of valuing business, conglomerate discount, poor past management, lack of trust in management, family control, capitulation from long standing shareholders, no NYSE listing etc…

 

Bottom line, given the size of the hole Fairfax has dug for itself over the past 10 years, the trigger for a re-rating likely is TIME. I largely agree with what @StubbleJumper wrote in his post above. 
 

Earnings growth. BV growth. Lower debt levels. Improved underwriting. Better management. Better communication by management. These will all take time to come into better focus for investors.
 

Fairfax should exceed $95/share in earnings in 2021 (20% growth in BV from $478/share at Dec 30, 2020). They should be able to do another $90 in 2022, assuming $37 Digit revaluation is pushed into 2022 (15% growth in BV). They could earn $200/share 2021+2022. Not a crazy number. 
 

With the stock trading at $430, earning $100/year for a couple of years in a row (on average) will eventually matter (drive a higher stock price). 
 

That is why i am so focussed on earnings (and the various drivers of earnings) in lots of my posts. If Fairfax delivers what i think they are poised to deliver on the earnings front i am confident the stock will do very well from here. Fairfax will have the money to be opportunistic: buy back a bunch of stock or re-invest in the business.

 

And as the earnings train gathers steam i expect the multiple to start to improve. And as we all know earnings growth + multiple expansion = stock price heaven for investors. 
———————

‘Consolidated share of profit of associates’ is one of the earnings buckets for Fairfax and has been underperforming for Fairfax for years. However, 2021 is much better than 2020. And i expect 2022 to be much better than 2021. Steady improvement in the coming years.
 

Quarterly reported earnings at Resolute, Atlas and Eurobank are going to be volatile. I think reported earnings at Atlas this quarter took at big hit because of the debt transaction with Fairfax. Do i care? Not really. Because it was the right long term decision for Atlas.
—————-

Stock buybacks, if large and done over an extended period, would likely kick-start the re-rating process for Fairfax’s stock. The near term result is it would likely drive the stock to a new 52 week high. This in turn would likely bring in the technical/momentum crowd.
 

One benefit of much higher earnings at Fairfax today is the cash it will generate that Fairfax can potentially funnel into buybacks. And the more the equity holdings go up the greater the chance that Fairfax will start to monetize them resulting in more large realized gains and cash that might get funnelled into buybacks (via dividends from the insurance subs).
 

After listening to the Q3 conference call, I am now not convinced that a big stock buyback is imminent. So i am not holding my breath. I hope we get one but i will not be disappointed in it doesn’t happen right away.

Edited November 16, 2021 by Viking