# Fairfax 2023

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I ll do the honors for this year.

"Fairfax Financial Holdings Limited (TSX: FFH and FFH.U) (“Fairfax”) announces that it has declared a dividend of US\$10.00 per share on its outstanding multiple voting and subordinate voting shares, payable on January 26, 2023 to shareholders of record on January 19, 2023. Applicable Canadian withholding tax will be applied to dividends payable to non-residents of Canada."

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Price/Book vs. BRK / MKL... don't mind me...

Edited by MMM20
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1 hour ago, MMM20 said:

don't mind me...

@MMM20 great chart. BV was US\$570/share at end of Q3. My guess is earnings in Q4 will come in around \$70/share (the pet insurance sale by itself is +\$40). If my estimate is accurate then BV at Dec 31, 2022 is about \$640. Shares are trading today at \$597, so P/BV = 0.93.

One on my questions for Fairfax for 2023 is what multiple will the shares trade at? As your chart outlines very well, pre-pandemic (2014-2019), Fairfax shares generally traded in a band between 1.1 and 1.3 x BV. Post pandemic, Fairfax shares have generally traded between 0.8 and 0.9 x BV. As i outlined above, as of today they are trading at about 0.93 X BV.

My guess is Fairfax will earn about US\$100/share in 2023. This would put 2023 year end BV at about \$730 (adjusting for the \$10 dividend). Here is where Fairfax shares would trade Q1 2023 based on various P/BV assumptions:

1.) 0.9 = \$660 = +10% from stock price today of \$597

2.) 1.0 = \$730 = +22%

3.) 1.1 = \$800 = +33%

4.) 1.2 = \$870 = +45%

My guess is Fairfax could start to trade back at a 1.1 x multiple in 2023. The primary reason is the \$100 in earnings i am modelling are very high quality… coming primarily from underwriting profit, interest and dividend income and share of profit of associates. Only a modest amount is coming from investment gains. (Large investment gains will push my \$100/share earnings estimate higher).

So it will be very interesting to see if Fairfax starts to trade closer to its pre-pandemic P/BV multiple in 2023. Growing earnings AND multiple expansion = very good returns for shareholders.

Edited by Viking
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Depends also who are we talking about, (1) long-term current/would-be-holders, or (2) those trade-in with a 12-24 month window.

Most discussions in the past 12 months on FFH has always been on the merit of the company itself and not the investor side of it.

Who are the investors ?

For me, as I fall in category (1), the movement from 0.90 to 1.1 to BV is just noise, given that i am not selling when it goes to 1.1 (it has to go really parabolic high against BV for me to sell).

Going from 0.65 to 1.0, was the real juice both for category (1) and (2), but going forward as a long term holding, I am holding it not because of it going from 0.9 to 1.1 but rather the NAV (or BV) compounding because of whatever better secular trend.

For those in category (2), easy money has been made. They may wish to trade 0.90 to 1.1 to BV is just noise, if that is their forte.

Edited by Xerxes
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1 hour ago, Xerxes said:

Depends also who are we talking about, (1) long-term current/would-be-holders, or (2) those trade-in with a 12-24 month window.

Most discussions in the past 12 months on FFH has always been on the merit of the company itself and not the investor side of it.

Who are the investors ?

For me, as I fall in category (1), the movement from 0.90 to 1.1 to BV is just noise, given that i am not selling when it goes to 1.1 (it has to go really parabolic high against BV for me to sell).

Going from 0.65 to 1.0, was the real juice both for category (1) and (2), but going forward as a long term holding, I am holding it not because of it going from 0.9 to 1.1 but rather the NAV (or BV) compounding because of whatever better secular trend.

For those in category (2), easy money has been made. They may wish to trade 0.90 to 1.1 to BV is just noise, if that is their forte.

Perhaps it will be the category (2) investors that will sell to the category (3) earnings momentum investors who get book value growth of 15%/yr on average over a few years and multiple expansion from 1x to 1.3x. They can then sell to category (4) quality stocks investors who will be convinced by the 5 year track that it's finally safe to buy. Category (4) currently own all of the other P&C names that trade over 1.5x book.

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I think the key variable affecting PE multiple for any company is narrative. Narrative is closely tied to type of investor. I remember when Apple traded at a PE under 10 (2013?). Everyone hated Apple. Steve Jobs had passed. Tim Cook was no visionary. Samsung was going to rule the world. I think the PE for Apple was over 30 last year. Everyone loved Apple last year. No price was too high for the stock. Set and forget. But at its core, Apple was essentially the same company in 2022 that it was in 2013.

The big US banks in 2016 were still hated… investors could not get the great financial crisis narrative out of their heads. Even though the big US banks were completely different animals by 2016 and operating in a very different regulatory regime.

My view is Fairfax is a turnaround play that had has turned around. But most investors do not understand it or believe it. I think the turnaround really got going in 2018. More good things happened in 2019. In 2020 covid hit and their equity portfolio got crushed. This is when sentiment in Fairfax (and the stock price) hit a multi-year low. Performance (BV growth, stock price) over the previous decade had been terrible. Trust in management was gone. The last of the long term investors in the company capitulated and sold their shares. The narrative in Q2/Q3 2020 was that Fairfax was a broken company. How did the management team actually perform in 2020? Pretty well.

2021 was one of the best years in Fairfax’s history. 2022 was a very good year (although you wouldn’t know it by just looking at earnings or growth in BV). Looking at the 5 year span from 2018-2022, the management team at Fairfax has done an outstanding job with both insurance and investment businesses. i think the narrative for Fairfax has slowly started to shift over over the past year. The negativity on this board towards Fairfax is largely gone. Most now grudgingly think it might do ‘ok’ moving forward.

2023 is looking like it will be another very good year for Fairfax. If Fairfax executes well, my guess is the narrative will continue to shift and start to reflect the current earnings power of the business. But narratives take years to change - it is a very slow process. So i am not expecting the PE multiple to expand a great deal in 2023. I hope it does - that could provide rocket fuel to the stock price.

Edited by Viking
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Given the very hard insurance market - supposedly 50% price increases, shouldn't profits be higher?

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All I care is that multiple to BV remain very modest for the long term so that I don’t have to make any hard decision.

Edited by Xerxes
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10 hours ago, Viking said:

My guess is Fairfax will earn about US\$100/share in 2023. This would put 2023 year end BV at about \$730 (adjusting for the \$10 dividend). Here is where Fairfax shares would trade Q1 2023 based on various P/BV assumptions:

1.) 0.9 = \$660 = +10% from stock price today of \$597

2.) 1.0 = \$730 = +22%

3.) 1.1 = \$800 = +33%

4.) 1.2 = \$870 = +45%

That's what is so silly about the current FFH situation.  The "bad" scenario gives a 1.6% divvy plus a 10% unrealised capital gain, which is a perfectly good annual return in my book.  You have to invent some sort of ridiculously catastrophic scenario to envision losing money.

SJ

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10 hours ago, Viking said:

My guess is Fairfax will earn about US\$100/share in 2023. This would put 2023 year end BV at about \$730 (adjusting for the \$10 dividend). Here is where Fairfax shares would trade Q1 2023 (<== did you mean Q4 2023)based on various P/BV assumptions:

1.) 0.9 = \$660 = +10% from stock price today of \$597

2.) 1.0 = \$730 = +22%

3.) 1.1 = \$800 = +33%

4.) 1.2 = \$870 = +45%

Just for clarity as I think there is a typo here.

Edited by Xerxes

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Quote

Martin Thompson, CEO of Brit, commented: “Jess and Jeff have built a great business in Ambridge and, with the combination with BGSU in 2021, established a highly regarded and fast-growing international MGA. While we are proud of what we have helped to create, we believe now is the appropriate time for Brit to realise the value of its investment as we focus our strategic priorities on our core underwriting capabilities across our broad distribution networks and our investment in building out market leading digital capabilities to support this. In Amynta we were pleased to find the perfect owners to take Ambridge forward, in particular as they are building a high quality MGA business. Importantly, Ambridge and Amynta remain key partners for Brit, and we look forward to a long and deep relationship with them as an independent MGA.”

Edited by gfp
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\$400M here and \$400M there, pretty soon we'll be talking about some real money.

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2 hours ago, gfp said:

The sale of Ambridge for \$400 million should result in a sizeable realized gain for Brit/Fairfax. Brit purchased 50% of Ambridge in 2015 (shortly after Fairfax purchased Brit). Brit purchased the remaining 50% in 2019 for \$46.6 million. In 2021, Brit combined their US operations (not sure size) with Ambridge.

Brit is the weakest large insurance operating unit of Fairfax. This sale should result in a a meaningful realized gain for Brit. What will Brit/Fairfax use the proceeds for?

1.) dividend to FFH?

2.) Brit uses to grow business in current hard market?

3.) Brit uses to buy back minority interest held my OMERS?

Bottom line, Fairfax looks to be monetizing an asset at a very good price. With lots of great opportunities to re-invest the proceeds at a very attractive prices. The management team at Fairfax continues to execute exceptionally well.

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Of interest, Fairfax purchased Brit for \$1.657 million in 2015. Ambridge is being sold for \$400 million.

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FFH 2015AR: In December, Brit made an investment in Ambridge Partners, one of the world’s leading managing general underwriters of transactional insurance products. These products insure losses as a result of breaches or inaccuracies in warranties and indemnities relating to M&A, restructuring activities, business financing and tax issues. Ambridge, which has been a partner of Brit for the last nine years, produces \$128 million of premiums and is highly profitable. We welcome Jesseman Pryor (CEO), Jeffery Cowhey (President) and their team of 29 employees to Fairfax.

FFH 2016AB: In 2015 Brit purchased 50% of Ambridge Partners, one of the world’s leading managing general agencies of transactional insurance products. In 2016 Ambridge produced gross premiums written of \$32 million for Brit at a combined ratio well below 100%.

FFH 2019AR: On April 18, 2019 Brit acquired the 50.0% equity interest in Ambridge Partners LLC (‘‘Ambridge Partners’’) that it did not already own for \$46.6, remeasured its existing equity interest to fair value for a gain of \$10.4, and commenced consolidating Ambridge Partners.

From Brit 2021 YE Press Release: In 2021, we combined our US operations to create a single operation under the Ambridge brand. It now operates as a global MGA, managing over \$600m of premium in the US and internationally. Our clients have the benefit of the well- recognised Ambridge MGA model giving them better access to products and enhanced service, and our underwriting teams are better able to capitalise on business opportunities.

Edited by Viking
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Very good news for Fairfax on the reinsurance renewal front. Cha ching...

Here is RBC's Summary:

January 1 reinsurance renewal observations: January 1 saw a banner renewal period for reinsurers. For property classes, it was a true hard market rate with property catastrophe reinsurance rates up +37%, the largest rate gain since 1992. Casualty and specialty reinsurance rates were up around mid-single-digits and far higher for loss-impacted accounts. Reinsurers were able to secure better terms & conditions (retentions, deductibles, losses covered) and held back capacity in some areas. A vintage year alongside 2013 and 2006.

There are few times we can say this but we think reinsurers got what they wanted (and possibly even more) at 1/1 renewals. That may not be true in every line or geography but it was as strong an outcome as we have seen since at least 2013 and probably back to 2006.

Howden reported that global property catastrophe rates averaged +37% at this past 1/1, which was the largest percentage increase since 1992 (post Andrew). For comparison sake, property cat rates were up a solid +9% at last year’s 1/1 renewal period. Howden also noted +45% average rate increases for direct & facultative business and +50% for retrocessional cover.

For casualty and specialty lines, it was more of a routine and normal renewal period with rates up around single digits give or take. The word “stable” came up consistently in the commentary we have heard thus far. Rates were generally described as being up somewhere in the mid- single digits so not that different from what is happening in the primary market and certainly nothing that is overly disruptive. Overall, appetites to write casualty reinsurance seemed high at this past renewal period and we expect capital was willing to be deployed to a fair number of accounts and risks...

In all, this renewal period was everything that reinsurers had hoped for after so many years of high hopes but no material pricing actions. While last year’s 1/1 renewal period was constructive, this year was a true hard market for many classes and not just property cat risks. High cats, inflation, reserving concerns, and lower capacity drove measured changes in pricing as well as terms & conditions.

We will be interested to see the extent to which our covered companies with reinsurance books (AIG, Arch, Fairfax, and W.R. Berkley in particular) pressed on the accelerator and aggressively grew their reinsurance books at 1/1. For now, reinsurance is having its day in the sun.

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Thanks Viking for the RBC summary.

Here is a video with the Guy Carpenter chairman David Priebe talking about the hectic 1/1 renewals

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5 hours ago, Viking said:

FFH 2019AR: On April 18, 2019 Brit acquired the 50.0% equity interest in Ambridge Partners LLC (‘‘Ambridge Partners’’) that it did not already own for \$46.6, remeasured its existing equity interest to fair value for a gain of \$10.4, and commenced consolidating Ambridge Partners.

Looks like they bought original 50% stake for \$28.6M - so \$75.2M original cost

On December 9, 2015 Brit completed the acquisition of a 50% ownership interest in Ambridge Partners for \$28.6.

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4 minutes ago, glider3834 said:

Looks like they bought original 50% stake for \$28.6M - so \$75.2M original cost

On December 9, 2015 Brit completed the acquisition of a 50% ownership interest in Ambridge Partners for \$28.6.

\$75.2m plus whatever the value of Brit's US operations that were contributed to the Ambridge business was.  I believe they refer to this business as "BGSU" in the press release.

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9 minutes ago, gfp said:

\$75.2m plus whatever the value of Brit's US operations that were contributed to the Ambridge business was.  I believe they refer to this business as "BGSU" in the press release.

cheers good pick up

Ambridge Partners LLC, our New York based MGA, generated \$420.8m of premium for Brit (2020: Ambridge and BGSU combined: \$317.5m). This reflects the increase in corporate transactional activity which was impacted in 2020 COVID-19 and other factors such as Brexit uncertainty. The remodelled BGSU portfolio, now rebranded Ambridge Specialty Casualty and Ambridge Re

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This looks like another home run!

Am I understanding this correctly - in 2021 Ambridge generated \$420.8MM of premium and they sold it for \$400MM. Assuming premium stayed flat in 2022 - they sold it for 1x premium.

Is that correct?

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So this business is an MGU "Managing General Underwriter" - sort of like an insurance broker with the authority to bind coverage directly (make the underwriting decision).  My understanding is that Ambridge placed business not only with Brit but also with other global reinsurers.  After this deal closes, they will still have a close partnership with Brit to place business with them.  But Brit would no longer participate in the brokerage commission portion of that business.

No idea how this differs from an "MGA" (Managing general agent) but I think they are essentially the same.

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Below is an update of my net earnings estimates for Fairfax for full year 2022 and 2023.

My guess is Fairfax will finish full-year 2022 with net earnings of about US\$35/share. To Sept 30, 2022, Fairfax had a net loss of \$35/share so my guess is they will earn about US\$70/share in Q4. The closing of the pet insurance deal will be the big driver. We should also see solid results from underwriting, interest and dividend income, share of profit of associates and investment gains (driven by equities).

My guess is Fairfax can earn a ‘normalized’ US\$100/share in 2023. This is not an aggressive number. My estimate assumes:

1.) underwriting achieves a 95 combined ratio

2.) the fixed income portfolio delivers an average yield of 3.7%

3.) share of profits of associates delivers similar results to 2022

4.) investment gains rebound modestly from 2022 levels

The 2 big wild cards for 2023 are:

1.) level of catastrophes

2.) financial market volatility (stocks and bonds)

Fairfax’s stock is trading today at about US\$600. If Fairfax earns \$100/share in 2023 that would put the forward PE multiple at 6 times earnings. Crazy cheap. Fairfax stock is like a coiled spring.

Notes:

• Underwriting profit: includes insurance and reinsurance; does not include runoff or Eurolife life insurance.
• Interest and dividends: includes insurance, reinsurance and runoff.

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Below are more detailed updates to the first three buckets:

1.) underwriting profit

2.) interest and dividend income

3.) share of profit of associates

Edited by Viking
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Fairfax: Sources of Net Earnings

1.) Net premiums and underwriting profit

At its core, Fairfax Financial is an insurance company. The size of Fairfax's insurance business has increased dramatically over the past 9 years (2014-2022). Net premiums written have increased from \$6.1 billion in 2014 to \$22 billion in 2022 (my estimate) for a compounded growth rate of 17.3% per year over the past 9 years. On a per share basis, Fairfax has grown net premiums written from \$289/share to \$940/share for a compounded growth rate of 16% per year. The share count is up 10.4% over this time period (2014 to 2022). Fairfax is now one of the 25 largest P&C insurers in the world.

What has driven this significant growth? Two very different factors have been responsible:

1.) For the first 5 years (2014-2018) growth was driven mostly by acquisitions: Brit (2015), International (2016) and Allied World (2017).

2.) For the past 4 years (2019-2022) growth has been mostly organic and driven by the hard market.

Looking back, Fairfax timed their large insurance acquisitions perfectly - right before the hard market started.

The hard market in insurance looks set to continue in 2023 and is spreading to reinsurance - which is a big business for Fairfax. 2023 could see net premiums written increase to \$24.6 billion, up \$2.6 billion, or 12%, from 2022.

Why do we care what net premiums are? Because this is a key input in determining underwriting profit. And underwriting profit is a key input in determining what an insurance company will earn in a year. And earnings ultimately determine what a company is worth.

Assuming a combined ratio (CR) of 95, Fairfax is on pace to earn an underwriting profit of \$970 million in 2022 (\$41/share). A new record for one year. The previous record was \$801 million in 2021 (\$31/share). Assuming another CR of 95, my estimate for 2023 is for Fairfax to earn an underwriting profit of \$1.1 billion (\$48/share). Another record.  Bottom line, the combination of significant growth in net premiums and solid underwriting is resulting in Fairfax earning record underwriting profit.

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Important: My numbers do NOT include runoff (to keep them consistent with how Fairfax reports them). My guess is the cost of runoff will come in at \$100 to \$150 million per year.

Edited by Viking
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Fairfax: Sources of Net Earnings

2.) Interest and Dividend Income

Of all of the many positive developments at Fairfax in 2022, the increase in interest rates (and interest income) is one of the most exciting.

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Summary: Fairfax earned \$641 million (\$27/share) in interest and dividend income in 2021. For 2022, my estimate is \$914 million (\$39/share), or +43% year over year. This will be a new record. For 2023, my estimate is \$1.444 billion (\$63/share), or +58% year over year. Yes, this will be a new record. These are significant increases in both 2022 and 2023.

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Interest & dividend income = interest income + dividends - investment expenses.

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A.) Interest Income: In 2021, Fairfax earned \$568 million in interest income = 1.5% yield on their \$36.8 billion fixed income portfolio. In 2022, Fairfax is on track to earn \$830 million in interest income = 2.3% yield on their \$36.3 billion fixed income portfolio. In 2023, my estimate is Fairfax will earn \$1.37 billion in interest income = 3.7% yield on their \$37 billion fixed income portfolio.

What has driven this significant increase in interest income?

1.) spiking interest rates: see table of ‘US Treasury Rates’ below.

2.) extremely low duration of bond portfolio: 1.2 years at Dec 31, 2021.

3.) steadily growing size of fixed income portfolio: increased from \$17.7 billion in 2014 to \$36.2 billion in 2022.

Fairfax timed their move to short duration in their fixed income portfolio exceptionally well. With rates spiking higher, the low duration allows Fairfax to roll their significant fixed income portfolio more quickly into higher yielding securities. Most P&C insurers have an average duration on their fixed income portfolio of closer to 4 years on average.

B.) Annual dividend income: Fairfax currently earns about \$110-\$120 million in dividends from its equity holdings.

C.) Annual investment expenses: Fairfax incurs investment expenses of about \$36 million per year.

When it reported Q2 results, Fairfax said the then run-rate for interest and dividend income was about \$950 million/year. When it reported Q3 results, Fairfax said the current run-rate for interest and dividend income was about \$1.2 billion. This is a significant increase of \$250 million in just 3 months. Of the \$1.2 billion total, about \$1.1 billion is interest income = 3.0% yield on \$36.2 billion fixed income portfolio. So at the end of Q3 Fairfax was tracking to a 3% yield on its fixed income portfolio which is double what it was in 2021.

Of interest, Fairfax confirmed with Q3 results that they are starting to extend the duration of their fixed income portfolio. At the end of Q2 it was 1.2 years. At the end of Q3 it was 1.6 years. Fairfax said they were buying primarily 3 to 5 year US treasuries in Q3. This will be something to watch in the future. Extending the duration will allow Fairfax to lock in current high yields for years into the future.

Where will interest rates go in 2023? Current expectations are for the Fed Funds rate to get close to 5.25% in Q1, 2023. If this happens my estimated 3.7% yield on Fairfax’s fixed income portfolio for 2023 could be low.

Edited by Viking
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Fairfax: Sources of Net Earnings

3.) Share of profit of associates

Fairfax has a number of significant tailwinds driving earnings higher. I have already posted on two: underwriting profit and interest and dividend income. There is a third item that is also spiking higher in 2022: share of profit of associates.

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Over the 5 year period, from 2017-2021, ‘share of profit of associates’ averaged about \$200 million per year for Fairfax. This year (2022) it should come in at around \$1 billion for the full year. This surprised me. That is a big increase over the trend from the past few years. 2022 MUST BE an outlier and Fairfax should settle back to something closer to \$200 million in 2023… right? Wrong. My guess is ‘share of profits of associates’ should be able to deliver around \$900 million in 2023 and this number should grow nicely in the coming years.

That is a significant increase in one year. What happened? Put simply, the earnings power of the equity holdings captured in the ‘associates-equity accounted’ bucket are beginning to shine through.

Four companies make up 85% of total ‘share of profits of associates’.

• After 8 years, the turnaround at Eurobank is complete. Eurobank is also benefitting from higher interest rates and also one of the strongest economies in the Eurozone (yes, Greece).
• Atlas is growing rapidly driven by its aggressive new-build strategy. a significant number of new-build deliveries are expected to happen in 2023 and 2024. A consortium, lead by David Sokol and supported by Fairfax and the Washington family, is attempting to take Atlas private in 2023.
• Energy is the best performing sector in 2022 and EXCO Resources, a US natural gas producer, is well positioned to continue to benefit.
• The commodity bull is running and this will benefit Stelco in the coming years. Fairfax sold Resolute Forest Products and the deal is expected to close in 1H 2023.

Over the past 5 years, Fairfax has quietly built out another significant source of passive earnings that will benefit shareholders for years to come.

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