Fairfax 2022

[nwoodman]

On 8/13/2022 at 4:31 PM, StubbleJumper said:

My disappointment is that the stock has been more buoyant than I would like.  Mr Market really didn't hate the headline EPS number that they released two weeks ago.  Here we are halfway through August and all is quiet in the Atlantic basin, so the typical angst about hurricanes hasn't affected the market at all.  How is a guy supposed to get a bargain around here?!!  Maybe if Jen Allen would resign quietly with little explanation the stock would sell off as they always seem to do when the CFO suddenly quits.

 

I was hoping for a buying opportunity in the low to mid $400s....

 

 

SJ

In terms of hurricanes the season is still forecast to be above average, just off to a slow start.  The next 2-3 weeks may be key

 

https://www.insurancejournal.com/news/national/2022/08/17/680843.htm

[Xerxes]

@Viking 

Wouldn't an earning multiple be more appropriate for a business that does not have "lumpy" returns. And Fairfax's lumpy returns at that, happen to have a wide variety of "quality".

 

Perhaps in a distant future it will be like that, but for now its valuation will remain anchored based on sum of the parts (i.e. BV). What do you think ?

 

[Viking]

10 hours ago, Xerxes said:

@Viking 

Wouldn't an earning multiple be more appropriate for a business that does not have "lumpy" returns. And Fairfax's lumpy returns at that, happen to have a wide variety of "quality".

 

Perhaps in a distant future it will be like that, but for now its valuation will remain anchored based on sum of the parts (i.e. BV). What do you think ?

 

@Xerxes My view is the current multiple on Fairfax stock is not because of lumpy results. It simply reflects terrible long term past performance. The multiple Fairfax has today was earned over many, many years. Fairfax will have to demonstrate to investors that past errors will not be repeated (the 'what has changed' thing). And it will need to deliver great results... over many years. And lumpy is OK.

----------

Fairfax’s past results have been a hot mess since 2010. For over a decade. As a result, my view is most investors have no idea what Fairfax’s earnings power is on a go forward basis. Based on the businesses they currently own. And the strategies the company has in place today. Looking at historical results does NOT inform an investor what Fairfax’s likely future results will be. Fairfax’s past results are grossly understated for a number of reasons i will get to shortly.

 

I also think Fairfax destroyed its former investor base. Terrible results for a decade will do that. As a result Fairfax shares receive a very low multiple from Mr Market - and rightly so. Looking only at past results - going back to 2010 - an investor would have to be an idiot to own Fairfax today, especially as a long term investment. 

 

Why are Fairfax’s past results understated? The primary reason was its failed shorting strategy. Back in 2010 Fairfax was convinced that deflation was coming (Great Depression 1929, Japan 1990 and Great Financial Crisis 2008) so they shorted/hedged 100% of their equity exposure (I think they were Lacy Hunt deciples at the time). They did not really start to remove the equity hedges until 2016 (Trump’s election being the reason given). And they did not remove their final short until 2020 (despite saying they were done shorting previously). Over 11 years ‘equity hedges cost Fairfax $5.4 billion in aggregate. This averages to $494 million each and every year from 2010 to 2020. The final loss in 2020 was $529 million.

 

The amazing thing is Fairfax was able to eat a $500 million loss every year for 11 years straight (on average) AND STILL GROW AS A COMPANY. Lots of very good things were happening at Fairfax from 2010-2020. Most importantly, it significantly expanded its insurance business and now has a global platform that has been completely digested within Fairfax (headed up by the very capable Andy Bernard). The size of its investment portfolio is now massive (+$50 billion) and looks well positioned to deliver record results moving forward. (I will have much more to say on the positive changes that have been happening in the investment portfolio in a future post.)

 

Fairfax is a turnaround today. Looking at past results (in aggregate) is next to useless to determine what it will earn in the future or what it should be valued at today. With turnarounds you have to do a detailed bottom up calculation of what the company will earn in the future. Ending the shorting campaign has completely changed Fairfax’s future earnings trajectory and in a big way.

 

What will remedy the situation (very low stock price)? Sustained improved performance (yes, it will be lumpy quarter to quarter). And that is what we have been seeing at Fairfax for the past 7 quarters. As Fairfax delivers investors will eventually come to understand what the true earnings power is of the company. My guess is that is when we will see the multiple expand. Perhaps the next stop on the Fairfax train is for the stock to be valued at 1 X book value. Hardly expensive for a quality insurance company (with lumpy earnings).

 

Equity Hedge Results 2010 to 2020

 

2020	-$529
2019	-$58
2018	-$38
2017	-$418
2016	-$1,192
2015	$502
2014	-$195
2013	-$1,982
2012	-$1,006
2011	$414
2010	-$937
Total	-$5,438
avg	-$494

Edited August 19, 2022 by Viking

[nwoodman]

@Viking agree mostly.  I would also add that the market may be also trying to figure out who the patsy is.  Certainly minority shareholders at the sub level can lay claim to that fate from time to time.   I think, given the discount, this feeling extends to FFH share holders as well.  I have a decent chunk of capital betting against patsification and for regression to the mean based on their longer term results.  Time will tell

[Xerxes]

Thanks Viking,

I must have misunderstood your earlier comment, few pages back.

 

I thought you were making an argument that over time FFH will start to be valued on an earning multiple (P/E) as the earning grows and not be based on book value (P/B).

 

So my last comment was really an answer to that 

[Viking]

2 hours ago, Xerxes said:

Thanks Viking,

I must have misunderstood your earlier comment, few pages back.

 

I thought you were making an argument that over time FFH will start to be valued on an earning multiple (P/E) as the earning grows and not be based on book value (P/B).

 

So my last comment was really an answer to that 

@Xerxes perhaps a simpler way to look at this is: What is the proper price to BV multiple an investor should pay for a P&C insurers who grows BV by:

A.) 2% per year + 2.5% div = 4.5% (Fairfax 2010 to 2020)

- BV was $376 at YE2010 and $478 at YE2020
B.) 17% per year + 2% div = 19% (Fairfax 2021 to 2025)

- BV was 478 YE 2020 and est $1,050 at YE 2025

 

I think B.) will command a higher price to book multiple.
 

I think Fairfax is transitioning from A.) to B.). Mr Market is expecting Fairfax to continue to deliver A.) = 4 to 5% total return on average from 2021-2025.
 

So we will see what happens. My guess is by year three (2023) investors will finally start to understand that the higher earnings growth IS sustainable. And that is when the higher price to BV multiple will likely come. 
—————

Below is one possible scenario of how things might play out for Fairfax. I view the numbers below as a reasonable base case. Fairfax could do worse… and i also think they could do better (a 1 x BV multiple in 2024 is very possible). Fairfax stock price is highly volatile so what actually happens will likely not be nice and clean like i model below (that volatility thing).

                       Aug 19.      2022YE.      2023YE.     2024YE
Stock Price      $517.          $570.           $710.         $875

                                             10%.             25%.          23%

BV.                    $588.         $670.           $790.         $920

                                             14%.             18%.           16%

Price to BV        0.88.          0.85             0.90           0.95

————-

Shares outstanding: Prem on the Q2 conference call highlighted buying back shares as a priority for use of excess capital. I don’t think the 2 million stock buyback in Dec 2021 was a one off. I think more large buybacks are coming. I am waiting to see how big the take out of minority shareholders in Allied World will be. If it is modest ($500 miilion), where Fairfax buys out only a portion this year, then i think another $1 billion stock buyback might be possible in Q4. Regardless, I do see share count coming down meaningfully over the next couple of years (4 to 5% per year on average). Especially if the stock price continues to trade so low. Constantly falling share count really starts to impact per share metrics a few years later.

 

Edited August 19, 2022 by Viking

[glider3834]

6 hours ago, Xerxes said:

Thanks Viking,

I must have misunderstood your earlier comment, few pages back.

 

I thought you were making an argument that over time FFH will start to be valued on an earning multiple (P/E) as the earning grows and not be based on book value (P/B).

 

So my last comment was really an answer to that 

My view earnings are tied to ROE, so tied to rate of BV growth & what BV multiple you would apply.

 

I think if you look at insurers that have higher P/B values, generally speaking they are focused in specialty insurance/E&S & as a result they tend to have lower combined ratios (than their peers).

 

Higher underwriting profit combined with decent investment returns has allowed these insurers to generate decent operating earnings along with higher ROE/growth in BV. 

 

Two examples of specialty focused insurers I can think of would be RLI  P/B 3.7x approx (adjusting for Maui Jim sale)  & WR Berkley P/B 2.8x.

 

During this hard market, Fairfax has been growing out its US E&S business  - in fact it has close to  doubled its market share in the last 5 years - from #11 in 2016 with 2.4% market share

 

Up to #4 in 2021 with 4.7% market share - its E&S DPW has quadrupled over that time.

 

 

If you look at how Fairfax's underlying combined ratio has trended in recent years, it has been trending down & Fairfax's insurance operating earnings trending up. Both favourable trends IMHO when we think about what BV multiple to use.

 

 

Edited August 19, 2022 by glider3834

[nwoodman]

@glider3834 thanks for posting those tables.  Great to see Berkshire and Markel jump up the list.  3 out of 4 ain’t bad.  Any chance you could post the source link?

[glider3834]

2 hours ago, nwoodman said:

@glider3834 thanks for posting those tables.  Great to see Berkshire and Markel jump up the list.  3 out of 4 ain’t bad.  Any chance you could post the source link?

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/most-top-e-s-insurers-see-market-shares-decline-in-2021-premiums-rise-yoy-70287307

[nwoodman]

4 hours ago, glider3834 said:

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/most-top-e-s-insurers-see-market-shares-decline-in-2021-premiums-rise-yoy-70287307

Many thanks, quite spectacular.

 

“Fairfax Financial Holdings Limited, the fourth-largest insurer in the rankings, was the only company among top 10 players to log a year-over-year increase in market share. The insurer's share of the E&S market rose to 4.77% from 4.50%. Fairfax Financial jumped two spots in the rankings, thanks to a 40% increase in premiums to $3.0 billion from $2.14 billion a year ago.”

Attached are a couple of MS notes on  on the Industry.  I noted that Morgan Stanley India are one of the parties named as book managers for the IPO so hopefully we might be able to get some further info in due course

INSURANCE_20220819_0000.pdf INDIA_20220818_0000.pdf

[Xerxes]

Thanks @Viking @glider3834

Cheers 

[gfp]

Noticed this bit of news, no idea if it’s a big deal or not:

 

”

On Friday we revealed a major data breach at Fairfax-owned specialty carrier Crum & Forster.

Hacking group RansomHouse is understood to have exposed sensitive financial and medical data including detailed information relating to customers, trading partners, and employees.”

 

-insurance insider weekend recap 

 

 

I wonder if an insurer who writes cyber coverage also buys cyber coverage for themselves 

Edited August 21, 2022 by gfp

[maxthetrade]

3 hours ago, gfp said:

I wonder if an insurer who writes cyber coverage also buys cyber coverage for themselves 

 

Cyber coverage is one area that really makes me nervous, especially at Allied World. I don't think this risk can be modeled. At least they have a 25mm cap. 

[nwoodman]

8 hours ago, gfp said:

Noticed this bit of news, no idea if it’s a big deal or not:

 

”

On Friday we revealed a major data breach at Fairfax-owned specialty carrier Crum & Forster.

Hacking group RansomHouse is understood to have exposed sensitive financial and medical data including detailed information relating to customers, trading partners, and employees.”

 

-insurance insider weekend recap 

 

 

I wonder if an insurer who writes cyber coverage also buys cyber coverage for themselves 

 

If they eat their own cooking, it’s hardly a ringing endorsement of Blackberry (Cylance)

[Viking]

The near term set up for Fairfax is looking very good:

1.) benign hurricane season (so far): positive for underwriting income

2.) interest rates are headed higher once again. 4% Fed funds rate later this year is possible; this would likely drive interest and div income to $1.3 billion (run rate).  Each quarter moving forward should see a nice increase in this bucket. 

3.) monetizations:

- pet insurance: $1.4 billion

- Resolute: $600 million + 

- Stelco: do they tender?

- Digit IPO: timing?

- other monetizations? I wonder how much Exco is worth right now? Especially if nat gas prices spike higher as we get into the fall?

4.) other:

- Atlas: how does take private conclude?

- Recipe: how does take private conclude?

- minority owners Allied ($750 million debt offering): details?

5.) stock buybacks: when and how much?

- NCIB or another dutch auction

6.) what else will Fairfax do? 
 

Bottom line, given all the tailwinds, i think US$505 is a great entry point. And i won’t be disappointed if it does lower (what do you do when one of your favourite cereals go on sale at the grocery store?).

—————

Near term risks:

1.) hurricanes

2.) Sept/Oct bear market in stocks

3.) Ukraine was escalation

4.) energy crisis in Europe worsening; spreading to rest of world 
5.) Fairfax specific: one or more announced deals do not close

Edited August 23, 2022 by Viking

[petec]

On 8/19/2022 at 7:27 PM, Viking said:

I think more large buybacks are coming. I am waiting to see how big the take out of minority shareholders in Allied World will be. If it is modest ($500 miilion), where Fairfax buys out only a portion this year, then i think another $1 billion stock buyback might be possible in Q4.

I know what you’re saying but it’s a slightly false distinction. Buying in the minorities at Allied, Brit, and Odyssey effectively *is* a huge buyback, even if it doesn’t bring the share count down. You still own more of those business per share, and they’re the beating heart of Fairfax. 

[Viking]

5 hours ago, petec said:

I know what you’re saying but it’s a slightly false distinction. Buying in the minorities at Allied, Brit, and Odyssey effectively *is* a huge buyback, even if it doesn’t bring the share count down. You still own more of those business per share, and they’re the beating heart of Fairfax. 

True. We know some amount (probably min US$750 million range) will be spent on  buying back a chunk of Allied World. That would be a solid amount. I would like to see another big stock buyback with Fairfax shares trading so low (U$525 today). I do think Fairfax’s stock price is going to pop at some point in the next year or two and likely significantly. So i would like to see another big stock buyback this year (while the stock price is still cheap). I don’t know why Fairfax does not get rolling on the NCIB… perhaps the stock is traded too thinly for them to be able to buy back stock in volume without jacking the price.

—————

And i don’t think it gets more expensive for Fairfax to hold off buying out the minority owners in Allied, Brit and Odyssey. I think they just need to keep making the dividend payments each year. But i could be wrong.

Edited August 25, 2022 by Viking

[petec]

1 hour ago, Viking said:

True. We know some amount (probably min US$750 million range) will be spent on  buying back a chunk of Allied World. That would be a solid amount. I would like to see another big stock buyback with Fairfax shares trading so low (U$525 today). I do think Fairfax’s stock price is going to pop at some point in the next year or two and likely significantly. So i would like to see another big stock buyback this year (while the stock price is still cheap). I don’t know why Fairfax does not get rolling on the NCIB… perhaps the stock is traded too thinly for them to be able to buy back stock in volume without jacking the price.

—————

And i don’t think it gets more expensive for Fairfax to hold off buying out the minority owners in Allied, Brit and Odyssey. I think they just need to keep making the dividend payments each year. But i could be wrong.

Agreed - it’s interesting that they think buying Allied is better value than buying FFH, which isn’t at all obvious to me. I wish we knew more about the economics of the minority stakes. 

[Xerxes]

Is there a major economical distinction between say (1) Allied World itself directly doing a buyback using its own equity to buy the minority (thereby making FFH full owner) and (2) FFH using its balance sheet to buyout the minority thereby making FFH full owner directly. 

 

One is a buyback at a subsidiary level while another is buyout at the group level.

[hobbit]

https://themorningcontext.com/business/the-silent-sure-rise-of-prem-watsa-in-india

[petec]

3 hours ago, Xerxes said:

Is there a major economical distinction between say (1) Allied World itself directly doing a buyback using its own equity to buy the minority (thereby making FFH full owner) and (2) FFH using its balance sheet to buyout the minority thereby making FFH full owner directly. 

 

One is a buyback at a subsidiary level while another is buyout at the group level.

To an FFH shareholder there’s no difference assuming the price paid is the same.

[gfp]

18 minutes ago, petec said:

To an FFH shareholder there’s no difference assuming the price paid is the same.

 

Not exactly.  You can see this dynamic with Berkshire's BHE subsidiary.  So far, each of the BHE share purchases have been BHE repurchasing their own shares - including the recent cash deal with Greg Abel.  

 

If the subsidiary repurchases *all* of the minority interest in a repurchase, there is no difference.  But if a subsidiary only repurchases some of the minority interest, all remaining shareholders get an increase in their interest, not just Fairfax.

[petec]

9 hours ago, gfp said:

 

Not exactly.  You can see this dynamic with Berkshire's BHE subsidiary.  So far, each of the BHE share purchases have been BHE repurchasing their own shares - including the recent cash deal with Greg Abel.  

 

If the subsidiary repurchases *all* of the minority interest in a repurchase, there is no difference.  But if a subsidiary only repurchases some of the minority interest, all remaining shareholders get an increase in their interest, not just Fairfax.

I’m not entirely sure I agree with that, on the assumption that if Fairfax doesn’t sell and the buybacks continue eventually Fairfax owns 100%, but I’d have to do a worked example to be sure. Anyway, I think there’s only one minority in each of the FFH subsidiaries? 

[wondering]

15 hours ago, hobbit said:

https://themorningcontext.com/business/the-silent-sure-rise-of-prem-watsa-in-india

@hobbit, this article is behind a paywall.  If you could give a brief summary of the article, I would appreciate it.  Thanks.

[nwoodman]

 

A summary from the author.  I haven’t see it reported elsewhere that IRDAI had knocked back the conversion of the Digit Prefs.