Fairfax 2023

[SafetyinNumbers]

5 minutes ago, glider3834 said:

Something I just picked up from Markel's Q4 results

 

'While these measures, considered independently of other factors, fall below our internal targets, we remain confident in the strong operating performance of our businesses. In addition, we give consideration to the following information in assessing our compound annual growth in book value per common share:

• Amortization expense - As we grow through acquisitions, our intangible assets grow. GAAP requires that we amortize a portion of these acquired intangible assets, which is a non-cash charge to net income. Amortization of acquired intangible assets for the five-year period ended December 31, 2022 totaled $763.2 million.'

 

In 2021, Fairfax recorded an approx $97M non-cash amortization expense for customer & broker relationships. It has averaged around $100M for FFH over the last 4 years. This expense is largely included in corporate overhead & other and related to acquisitions of Allied World & Crum & Forster

 

'Conversely, the concept of recording charges against other intangibles, such as customer relationships, arises from purchase-accounting rules and clearly does not reflect economic reality.' ( Buffett)

 

Given the significant growth in their insurance/reinsurance subs since acquisition, I think there is a strong case to argue this expense doesn't reflect economic reality or true 'owner earnings'.

 

Also we added back this expense for last 6 years (2016-21) , FFH's book value would increase by around US$500M and pre-tax earnings by around US$100M per year.

 

Cheers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The net effect of the current accounting policy is to increase long term ROE which should result in a higher P/B given the strong and logical historical correlation between the two.

[giulio]

https://www.wsj.com/articles/jerome-powell-to-testify-to-congress-on-outlook-for-rates-inflation-e4e7f1e3?mod=itp_wsj&mod=djemITP_h

 

"The yield on the two-year Treasury note climbed above 5% for the first time since July 2007. The yield on the 10-year Treasury slid to 3.974% from 3.981% Monday"

 

Not too bad...this constant upward revision of interest income is making it harder to keep my emotions in check! I am going to read a couple of Howard Marks memos to refocus on being emotionless and rational.

 

G

[giulio]

FWIW

[dartmonkey]

6 hours ago, giulio said:

FWIW

 

Insurance company boilerplate:

"...industry forsakes underwriting discipline and overly focuses on topline growth even as rate decreases accelerate. This is where <insert insurance co. name here>'s culture of underwriting discipliune is most apparent, as we cut exposure and prepare for the return of Stage 1."

[nwoodman]

56 minutes ago, dartmonkey said:

 

Insurance company boilerplate:

"...industry forsakes underwriting discipline and overly focuses on topline growth even as rate decreases accelerate. This is where <insert insurance co. name here>'s culture of underwriting discipliune is most apparent, as we cut exposure and prepare for the return of Stage 1."

Made my morning

[Viking]

20 hours ago, giulio said:

https://www.wsj.com/articles/jerome-powell-to-testify-to-congress-on-outlook-for-rates-inflation-e4e7f1e3?mod=itp_wsj&mod=djemITP_h

 

"The yield on the two-year Treasury note climbed above 5% for the first time since July 2007. The yield on the 10-year Treasury slid to 3.974% from 3.981% Monday"

 

Not too bad...this constant upward revision of interest income is making it harder to keep my emotions in check! I am going to read a couple of Howard Marks memos to refocus on being emotionless and rational.

 

G

It certainly will be interesting to see what Fairfax does with their fixed income portfolio in Q1. Mr Market is giving them a wonderful opportunity to increase both the yield and duration. And if the Fed funds rate goes closer to 6% in Q2, as some now project, that would be icing on the cake. The jobs report Friday and the inflation report on Tuesday will likely be key to the path for interest rates for the remainder of March. 
 

Here is how i see the bull case for Fairfax currently:

1.) rising interest rates: resulting in higher interest and dividend income. 
2.) continuing hard market in insurance: driving increasing operating income
3.) spiking ‘high quality’ operating earnings (1 and 2 above): leading Mr Market to bump Fairfax’s market multiple a little higher - perhaps to 1.1 x BV

[glider3834]

Just a reminder

 

'the company's annual 2022 annual report, which will include the Chairman's letter to shareholders will be posted on the company's website after 05:00 P.M. on March 10, 2023.' 

[drzola]

I made it my families largest holding last  6 months so better be good.

[vinod1]

Almost! 20 percent! increase! in! exclamation! points! from! 2021 AL!

 

27 to 32!!!!!!!!

[racemize]

50 minutes ago, vinod1 said:

Almost! 20 percent! increase! in! exclamation! points! from! 2021 AL!

 

27 to 32!!!!!!!!

This is by far the most important metric to track.  

[Daphne]

I’d give them 100% increase for their achievements this past year!!!

[nwoodman]

Superb letter.  Loved the call-out on Exco and Foran.  Small holdings for now but considerable upside IMHO.  Also so good to see Prem call out Andy Barnard and the “presidents”.  

 

Only parroting the more thoughtful posters here but but what an amazing transformation! (Got to get one exclamation mark in).  

 

Will be re-reading this one again

[glider3834]

A few snippets that caught my eye

 

- the increase in FFH's ownership of Sporting Life & Thomas Cook (India)

 

- the $650M Increase in subs dividend capacity from $2B to 2.65B - if they achieve their $3B Op income target over next few years this could increase meaningfully.

 

- their private mortgages investment with Kennedy Wilson look to be on a $190M annualised interest run-rate

 

'we have $2.4 billion invested through Kennedy Wilson in well-secured first mortgages, primarily on high quality residential apartment buildings, at a floating rate (currently 7.9%).' (2022 AR) compared to '$1.6 billion in first mortgages with Kennedy Wilson at an average rate of 4.5%, with an average term of three years.' (2021 AR.)

 

- Atlas take private idea came from David Sokol - interesting ...

 

- AGT had meaningful jump in EBITDA in 2022 

 

- non-insurance subs are achieving meaningful EBITDA & pre-tax income of close to $300M

 

 

 

 

 

 

 

 

 

 

 

 

Edited March 11, 2023 by glider3834

[glider3834]

 

 

their high weighting in treasuries no surprise given PW's view - recent SVB failure definitely casualty of higher rates - impact on credit market is a wait & see

Edited March 11, 2023 by glider3834

[glider3834]

Eurobank recorded significant hedging gains in 2022 helping to offset increase in interest rates & Atlas has now fixed around 70% of its debt maturity interest cost - I just wonder how closely does Fairfax get involved/influence investees in asset liability strategy management because both Eurobank & Atlas appear to have handled higher rates - SVB has been a big casualty of higher rates and IMHO it would make sense for Fairfax to use their fixed income expertise to protect their equity investments in investees - I just wonder if that might be one reason why for some of their largest positions in financial services type businesses they would want control/influence at a board level...just a thought?

 

 

Edited March 11, 2023 by glider3834

[nwoodman]

15 minutes ago, glider3834 said:

I just wonder if that might be one reason why for some of their largest positions in financial services type businesses they would want control/influence at a board level...?

Every chance in my opinion.  I am sure it is not lost on all just what it means to be in a strong position  at this point in time.  There is going to be some remarkable opportunities for Fairfax and subs.  

[Munger_Disciple]

On pages 20 & 21, why is Watsa comparing intrinsic value (book) growth in USD to stock price appreciation in CDN? Doesn't make any sense to me. Both should be in the same currency, preferably USD.

Edited March 11, 2023 by Munger_Disciple

[Viking]

1 hour ago, Munger_Disciple said:

On pages 20 & 21, why is Watsa comparing intrinsic value (book) growth in USD to stock price appreciation in CDN? Doesn't make any sense to me. Both should be in the same currency, preferably USD.

i agree it makes little sense. (Most shareholders are perhaps Canadians and anchored to the stock price in Can$?) I view it as a historical quirk.

 

Fairfax India is listed on the TSX but only trades in US$.

 

Weird. But whatever. Small potatoes. As long as they keep delivering stellar results i don’t really care.

[SafetyinNumbers]

4 hours ago, Viking said:

i agree it makes little sense. (Most shareholders are perhaps Canadians and anchored to the stock price in Can$?) I view it as a historical quirk.

 

Fairfax India is listed on the TSX but only trades in US$.

 

Weird. But whatever. Small potatoes. As long as they keep delivering stellar results i don’t really care.

USDCAD was about the same level as now at the beginning of 1986 so arguably it’s an apples to apples comparison. 

[Santayana]

Are there other TSX listed companies that do all their financial reporting in USD?    Since that's what they report, it makes sense they'd use the USD number in the report, and it would seem a little strange to use the FRFHF price instead of the FFH price.

[modiva]

The annual letter is a great read and is why Fairfax is my core holding at >50% (including Fairfax India).  

 

The table below shows how impressive the performance in the last 5 years has been.  The % change in the equity/share at 46% is the lowest compared to other metrics.   It would have been higher if the leverage was lower.  I am hoping that they make it a priority to bring it down over time.  

 

[Munger_Disciple]

If they quoted Fairfax stock price in Zimbabwean dollars the results will be even more amazing! 

 

But seriously Watsa should quote stock price appreciation in USD since BV is always quoted in USD. He can add a CAD column for price as the third column.  

Edited March 11, 2023 by Munger_Disciple

[Thrifty3000]

In the annual report’s historical performance chart they’ve been using USD for book value and CAD for share price for at least 10 years. I’m not sure why they do it that way, but I can’t fault them for doing it again this year. I would be irked if this was the first year they had done that.

[SafetyinNumbers]

2 hours ago, modiva said:

The annual letter is a great read and is why Fairfax is my core holding at >50% (including Fairfax India).  

 

The table below shows how impressive the performance in the last 5 years has been.  The % change in the equity/share at 46% is the lowest compared to other metrics.   It would have been higher if the leverage was lower.  I am hoping that they make it a priority to bring it down over time.  

 

 

Can you expand on why you think leverage hurts the increase in equity/share? Usually leverage accelerates returns as long as they are above the cost of debt, which they certainly have been for the past 5 years.

[Viking]

“Success is when opportunity meets planning.” Success in investing is also all about getting the big rocks right. We are learning in real time the genius of the management team of Fairfax. At least the last few years. Genius is a big word. But i think it applies in this case.

 

What are the big rocks at Fairfax?

1.) insurance

2.) investments: fixed income

3.) investments: equities

 

The positioning of Fairfax’s massive $38 billion fixed income portfolio on Dec 31, 2021 was absolute genius:

• significant sales as interest rates bottomed locking in large realized gains: “During 2021, we sold $5.2 billion in corporate bonds, mainly acquired in March/April of 2020, at a yield of approximately 1%, for a gain of $253 million.”
• duration of the portfolio was shortened and composition of portfolio was shifted to higher credit quality holdings, mostly treasuries: “At the end of 2021, our fixed income portfolio, inclusive of cash and short term treasuries, which effectively comprised 72% of our investment portfolio, had a very short duration of approximately 1.2 years and an average rating of AA-.”
• part of the fixed income portfolio was hedged: “To economically hedge its exposure to interest rate risk (primarily exposure to certain long dated U.S. corporate bonds and U.S. state and municipal bonds held in its fixed income portfolio), the company held forward contracts to sell long dated U.S. treasury bonds with a notional amount at December 31, 2021 of $1,691.3 (December 31, 2020 – $330.8).

 

In 2021 Fairfax realized significant gains, improved the credit quality, reduced the duration and hedged their fixed income portfolio. They did all this right before hell was unleashed by the Fed. That… was… genius.

 

What’s the big deal? With the Fed spiking interest rates higher in 2022, Fairfax has benefitted as follows:

 

1.) low duration (part 1): Fairfax has already been able to reinvest a large portion of its fixed income portfolio into securities with much higher yields and this is resulting in an immediate and significant increase in interest income:

- 2019 = $826 million

- 2020 = $717

- 2021 = $568

- 2022 = $874

- 2023E = $1.5 billion

 

2.) low duration (part 2): Fairfax has experienced only modest mark-to-market loss on its fixed income portfolio in 2022. This loss was absorbed by the business and Fairfax actually saw an increase in book value in 2022. Most P&C insurers saw book value fall 10-20% in 2022. And as we have just learned with Silicon Valley Bank, large unrealized losses sitting on your balance sheet usually don’t matter… but sometimes they do. 

 

3.) credit quality: there is a good chance the US could enter recession later in 2023. Should this happen, credit spreads will likely blow out and holders of lower quality (corporate) bonds will see the value of their bonds fall leading to more unrealized losses. This in turn will lower the book value of some insurers even more. My guess is Fairfax is well positioned here compared to other insurers (given Prem has warned about this risk). 

 

Bottom line: Fairfax is exceptionally well positioned in the current rising/high interest rate and increasingly stressed economic environment. Especially compared to other P&C insurers. As Peter Lynch would say “the story” for Fairfax continues to get better. 
 

It could be argued that Fairfax today is actually a safer investment than most other P&C insurers. It also has one of the best earnings growth profiles looking out the next couple of years (probably THE best). Lower risk AND much better profit growth.

 

So given how well it is positioned today, Fairfax must trade at a premium multiple compared to other P&C insurers. Right? No. Not even close. Fairfax currently trades under 1 x book value. Most of its P&C peers trade at 1.5 to 2 x book value. 

 

Fairfax’s stock significantly outperformed the market averages  in 2021. And again in 2022. My guess is Fairfax’s stock is going to make it a three-peat in 2023. 

 

—————

 

Prem’s Letter 2021: Our interest and dividend income continued to drop from $880 million in 2019 to $769 million in 2020 to $641 million in 2021, reflecting declining interest rates and the fact that we have 50% of our investment portfolio in cash and short term investments. During 2021, we sold $5.2 billion in corporate bonds, mainly acquired in March/April of 2020, at a yield of approximately 1%, for a gain of $253 million. At the end of 2021, our fixed income portfolio, inclusive of cash and short term treasuries, which effectively comprised 72% of our investment portfolio, had a very short duration of approximately 1.2 years and an average rating of AA-. Rising rates in 2021 resulted in a small unrealized bond loss of $261 million. During the last two years, we were able to invest $1.6 billion in first mortgages with Kennedy Wilson at an average rate of 4.5%, with an average term of three years.

 

————-

 

2021AR: To economically hedge its exposure to interest rate risk (primarily exposure to certain long dated U.S. corporate bonds and U.S. state and municipal bonds held in its fixed income portfolio), the company held forward contracts to sell long dated U.S. treasury bonds with a notional amount at December 31, 2021 of $1,691.3 (December 31, 2020 – $330.8). These contracts have an average term to maturity of less than six months, and may be renewed at market rates. During 2021 the company recorded net gains of $25.7 (2020 – net losses of $102.0) on its U.S. treasury bond forward contracts.

Edited March 12, 2023 by Viking