Fairfax 2023

[Haryana]

9 minutes ago, backtothebeach said:

Do we know when the TRS expires?

 

Quoting from that detailed post by Viking:

 

Q1 2020 Conference Call

 

Prem: "They are one year swaps and we've historically been able to extend it for as long as we like."

 

—————

Amounts recorded in net realized gains (losses) include net gains (losses) on total return swaps where the counterparties are required to cash-settle monthly or quarterly the market value movement since the previous reset date notwithstanding that the total return swap positions remain open subsequent to the cash settlement.

—————

[Viking]

Norm Rothery has a nice write-up on Fairfax in the Globe & Mail (sorry, for subscribers). Title is goofy, but that is picked by the editor.

 

Why this money manager favours the oil patch over Silicon Valley
- https://www.theglobeandmail.com/investing/markets/inside-the-market/article-why-this-money-manager-favours-the-oil-patch-over-silicon-valley/

 

A strange travelling festival moves from annual meeting to annual meeting each spring as investors gather to seek wisdom from famous investors.

 

Along the way, the revellers stop to hear from Prem Watsa, the chief executive of Fairfax Financial, who holds forth at the firm’s annual meeting in Toronto. It moves on to culminate in Nebraska at the Berkshire Hathaway meeting, where Warren Buffett and Charlie Munger entertain a gathering of thousands.

 

As it happens, Mr. Watsa followed Mr. Buffett’s example to grow Fairfax into one of the largest insurance-based conglomerates in the world. The journey has been a profitable one because Fairfax’s stock changed hands at $3.25 a share when Mr. Watsa gained control of the firm in 1985 and it’s now near the $1,000-a-share mark. Despite the gains, the firm is a relative bargain near 0.9 times book value.

 

The Fairfax festivities provide the opportunity to catch up with old friends. This year I had the pleasure of sitting down with U.S. money manager James East, who I hadn’t seen since the year before the COVID-19 pandemic.

 

He’s a big fan of Fairfax, which, after its recent surge, accounts for roughly 30 per cent of his fund’s assets. Mr. East runs a multifamily office and the ACI Partnership Fund LP (modelled after the partnerships Mr. Buffett offered in the 1960s) from his home base in Charlotte, N.C. The fund has been operating since the waning days of 2007, when Mr. East moved on from designing engine parts for NASA’s space shuttles to managing money for his friends and colleagues.

 

…The market also hasn’t fully recognized the global insurance powerhouse Fairfax has become and Mr. East points to its insurance operations as being better than many of its “top tier” competitors – including Markel (MKL-N) and Berkshire Hathaway. (I hope he’s right, because Fairfax is currently my largest personal holding.) …

 

[backtothebeach]

3 hours ago, Haryana said:

Quoting from that detailed post by Viking:

 

Q1 2020 Conference Call

 

Prem: "They are one year swaps and we've historically been able to extend it for as long as we like."

 

Thank you I had missed that.

 

"The payments made by the total return receiver are equal to LIBOR +/- an agreed-upon spread."

 

When the TRS was entered the timing was perfect. LIBOR in 2020 was around 1%. One year ago it was ~2.7%. However right now the 12-month LIBOR is 5.6%. I would think the rate paid by Fairfax adjusts year by year - unless the original contract locked the rate long-term. 5.6+% may still be ok, but not quite the home run it was 2020-2022.

 

Can we deduce the effective rate paid by Fairfax to the counterparty from the published numbers?
 

Edited May 29, 2023 by backtothebeach

[Parsad]

6 hours ago, SafetyinNumbers said:

I met a smart investor at the Markel AGM a few weeks ago who sold his Fairfax because he was scared away by the TRS, thinking it was too aggressive. I told him it wasn’t too late to get back in!

 

Can't be that smart!    Cheers!

[Xerxes]

8 minutes ago, Parsad said:

 

Can't be that smart!    Cheers!

 
haha indeed. 
 

$1,012 CAD is my magic number. That is when my FFH position would have doubled on an average cost basis of $506 CAD. I think most of it bought post March 2020. 

[Parsad]

11 minutes ago, Xerxes said:

 
haha indeed. 
 

$1,012 CAD is my magic number. That is when my FFH position would have doubled on an average cost basis of $506 CAD. I think most of it bought post March 2020. 

 

I'm close to you...average cost is $522 CDN.  Original purchases were around $480 CDN...but I kept buying till about $600 CDN then stopped.  Cheers!

[SafetyinNumbers]

3 hours ago, Parsad said:

 

Can't be that smart!    Cheers!

I think lots of successful investors have heuristics they live by. Complicated derivatives on their own stock while brilliant and positive signalling for me, probably rules out a bunch of potential shareholders for Fairfax. That’s what makes a market!

[valuesource]

9 hours ago, backtothebeach said:

Do we know when the TRS expires?

I think they said a few times the TRS is renewable.  I took that to mean they could keep renewing it as long as they wanted.  BTW, I also feel strongly that the counterparty is a Canadian Bank.  If I had to guess I'd say BMO or CIBC.

[Jaygo]

3 minutes ago, valuesource said:

If I had to guess I'd say BMO or CIBC.

For what reason? Is a TRS a bet in a way? I guess I dont understand if there is a situation where the bank will lose and FFH will gain in this case.

[Santayana]

Whoever the counterparty is, I can't imagine they're not hedged. 

[SafetyinNumbers]

9 minutes ago, Santayana said:

Whoever the counterparty is, I can't imagine they're not hedged. 

Almost certainly the counterparties are just long the stock and short the TRS to Fairfax. I assume, they will just buy back the shares when they are ready to close it out making it “risk-free” to the counterparties. 

[Thrifty3000]

6 hours ago, Parsad said:

 

I'm close to you...average cost is $522 CDN.  Original purchases were around $480 CDN...but I kept buying till about $600 CDN then stopped.  Cheers!

My cost basis is $400 USD, which is around $540 CAD.

[nwoodman]

6 minutes ago, SafetyinNumbers said:

Almost certainly the counterparties are just long the stock and short the TRS to Fairfax. I assume, they will just buy back the shares when they are ready to close it out making it “risk-free” to the counterparties. 

The ultimate hedge.  The TRS payer typically owns the stock and is renting both the upside and downside exposure to Fairfax. 

[Haryana]

On 5/16/2023 at 3:20 PM, alexmiddle said:

Most people on this thread are fairly optimistic on FFH's future, as am I since approximately 2018, but has anyone come across a short thesis or a negative write-up on Fairfax recently?  With all the positive results being announced, the stock really is not getting much attention still.  I couldn't find any article on BNN after the recent quarterly's were announced.  Fairfax does not seem to be finding its way into many hedge fund portfolios...  

 

https://www.morningstar.com/stocks/fairfax-earnings-both-sides-business-show-strength

 

"Fairfax FFH reported a strong first quarter, with attractive results on both the underwriting and investment sides of the business. As a result, book value per share, adjusted for dividends, increased 7% from the year-end figure. However, we see nothing to alter our long-term view, and will maintain our CAD 730 per share fair value estimate for the no-moat company."

 

[nwoodman]

19 hours ago, Haryana said:

 

https://www.morningstar.com/stocks/fairfax-earnings-both-sides-business-show-strength

 

"Fairfax FFH reported a strong first quarter, with attractive results on both the underwriting and investment sides of the business. As a result, book value per share, adjusted for dividends, increased 7% from the year-end figure. However, we see nothing to alter our long-term view, and will maintain our CAD 730 per share fair value estimate for the no-moat company."

 

Thanks for that.  Morningstar's Brett Horn also posted an update on the 19th of May that I think sums up where a lot of analysts are at.  Full note attached but some key quotes below:

 

"While its primary business is insurance, Fairfax is in some ways more of an investment fund. Chairman and CEO Prem Watsa has a long history of bold investment bets and has shown a willingness to be unorthodox when it comes to portfolio construction. As a result, compared with other insurers, the company's results tend to be driven more by results on the investment side. We're somewhat skeptical of this approach, as we believe disciplined underwriting is a more reliable path to long-term value creation, and Fairfax's underwriting record is relatively poor."

 

"We think investors attracted to the stock due to a belief in Watsa’s ability to produce alpha should consider his record over the past decade, which includes some big wins but also substantial losses and missed opportunities. Fairfax has seen a lot of ups and downs, but its performance has been trending toward mediocrity."

 

"We believe that Prem Watsa’s investment philosophy, willingness to make outsize bets, and potential to generate alpha are the primary attractions for many investors. Fairfax’s name is often included in discussions about the “mini-Berkshires” that seek to distinguish themselves on the investment side, but we think this narrative is misleading. Watsa has had some dramatic successes on the investment side, with the most impactful being his gain of over $3 billion from credit default swaps and equity market hedges during the financial crisis. But he has had notable misses as well, including a sizable investment in Blackberry, and we don’t think his record could justify framing his investment skills as a structural competitive advantage. The company’s preferred metric is growth in book value per share, which has grown at a 6% CAGR over the past 10 years, a fairly mediocre result even considering the dividends Fairfax has paid."

 

What I think is interesting is that even with the mistakes of the past, FFH has been able to compound book value at a decent rate even while paying out a non-trivial dividend.  We have all argued the merits of the dividend previously, but it is what it is.  

 

When I bought back into the company in 2021, it was under the premise that management would ultimately prove that they could compound over the longer term at a rate of 11% albeit lumpy.  So regression to the mean was the basic premise.

 

Based on this crude assumption, I remember the friendly arguments on the board at the time about whether it was cheaper in 2020 or 2021.  Either way, if you thought the company was a regress to the mean type play, it was possibly worth  $1000 by the end of 2024.  At the time this seemed a little nuts, but it now looks like book value reaching $1000 is a very high probability.  I dug out the graph back then and updated key metrics but not the original estimated regression to the mean line.  The 35% CAGR regression is still intact, and book value is closing in again at 11%.  Importantly share count is coming down with repurchases at prices less than book.

 

For our friendly analyst to arrive at a fair value price of only CAD790 per share assumes some pretty low growth rates and some big cat losses.  However, if FFH is indeed an 11% compounder,  over the longer term, then ultimately even Brett would have to capitulate and reprice Fairfax to at least 1.1x's book.

 

 

 

FFH - Fairfax Financial Holdings Ltd Shs Subord.Vtg Analysis & Rating - XTSE | Morningstar.pdf

Edited May 30, 2023 by nwoodman

[glider3834]

1 hour ago, nwoodman said:

The company’s preferred metric is growth in book value per share, which has grown at a 6% CAGR over the past 10 years, a fairly mediocre result even considering the dividends Fairfax has paid."

Just looking at this quote above from Morningstar.

 

Based on my estimates, over last 9 years (2013-2022) 

- Operating Income has grown at 14% CAGR

- Pre-tax operating income (before investment gains) per share has grown 15% CAGR

 

Pre-tax Operating Income (excluding investment gains) as a percentage of Common Shareholder Equity (start of period) was 15% in 2022 (versus 7% in 2013).

 

If we are looking at what sort of ROE or BVPS growth rate Fairfax can sustain going forward, IMHO I would look to pre-tax operating income (excluding investment gains) as a key driver.

 

If you then consider over 50% of Fairfax's BVPS growth rate since inception has come from investment gains, it doesn't seem unreasonable to expect a positive number here when measured over longer periods.

 

(Table below I put together from 2013 & 2022 Annual reports)   

 

 

Also please always do your own due diligence & don't just rely on my figures. Thanks!

 

Edited May 30, 2023 by glider3834

[Parsad]

It's why I couldn't give two shits about what any analyst says.  At the same time, investors shouldn't fall in love with any stock and ignore valuation.  Cheers!

[dealraker]

This is a terrific thread on a fabulous board!   

[Xerxes]

14 hours ago, SafetyinNumbers said:

I think lots of successful investors have heuristics they live by. Complicated derivatives on their own stock while brilliant and positive signalling for me, probably rules out a bunch of potential shareholders for Fairfax. That’s what makes a market!

some of that I think is about “being too proud and stubborn follower of Church of Omaha” about walking over 1 foot high stand as oppose to jumping over a very high hurdle (in terms of complexity) or the famous line “too hard pile” that many pilgrims to Omaha are so proud to utter etc. 

 

Buffett never said “don’t think, for yourself”

 

that is why Markel has done well in getting a good marketshare of the followers of Church of Omaha by preaching the message of simplicity. Something FFH doesn’t preach nor does.
 

And I am glad it doesn’t. Standing on its own feet. 

 

 

[gfp]

That Morningstar analyst report reads like it was written years ago.

 

On another note, does anybody here know if the profits on the total return swaps on FFH's own shares are tax-free to the company?  I know that usually transactions in an issuers own stock are not taxed (for example if Biglari Holdings were to ever record a profit on their holdings of own shares the "profit" would be tax-free) - but I do not know if that extends to derivatives on an issuer's own stock.

[MMM20]

3 minutes ago, gfp said:

That Morningstar analyst report reads like it was written years ago

 

Yes! If you read his reports going back, it's pretty much been the exact same report for like 5 years now. The analysts will turn bullish when the stock hits $1,500 in a couple years.

 

Edited May 30, 2023 by MMM20

[TwoCitiesCapital]

On 5/28/2023 at 10:02 PM, Viking said:

Good question. I am not sure who it is. Given Fairfax’s experience with the CDS during the housing crash my guess is they have thought this risk through pretty well.

 

During the GFC, they had multiple counterparties. It wouldn't surprise me if it were 2 or 3 here as well. Especially since these wouldn't be centrally cleared. 

 

On 5/29/2023 at 10:14 AM, backtothebeach said:

Do we know when the TRS expires?

 

Prem said each year with the ability to extend. 

 

Hard to say exactly how this was structured, but my guess is there are quarterly "resets" where cash is exchanged between the parties to settle the contract.

 

The notional would adjust higher/lower to reflect the new value of those shares at the reset date and the financing rates would also change. 

 

Functionally speaking, there isn't much difference between a reset and a maturity except that the maturity date gives one or both parties the ability to renegotiate the terms of the contract - this would typically be the counterparties renegotiating the spread they demand over the financing rates, but Fairfax could also renegotiate the notional larger or smaller. 

Edited May 30, 2023 by TwoCitiesCapital

[Haryana]

10 hours ago, nwoodman said:

Thanks for that.  Morningstar's Brett Horn also posted an update on the 19th of May that I think sums up where a lot of analysts are at.  Full note attached but some key quotes below:

 

"While its primary business is insurance, Fairfax is in some ways more of an investment fund. Chairman and CEO Prem Watsa has a long history of bold investment bets and has shown a willingness to be unorthodox when it comes to portfolio construction. As a result, compared with other insurers, the company's results tend to be driven more by results on the investment side. We're somewhat skeptical of this approach, as we believe disciplined underwriting is a more reliable path to long-term value creation, and Fairfax's underwriting record is relatively poor."

 

"We think investors attracted to the stock due to a belief in Watsa’s ability to produce alpha should consider his record over the past decade, which includes some big wins but also substantial losses and missed opportunities. Fairfax has seen a lot of ups and downs, but its performance has been trending toward mediocrity."

 

"We believe that Prem Watsa’s investment philosophy, willingness to make outsize bets, and potential to generate alpha are the primary attractions for many investors. Fairfax’s name is often included in discussions about the “mini-Berkshires” that seek to distinguish themselves on the investment side, but we think this narrative is misleading. Watsa has had some dramatic successes on the investment side, with the most impactful being his gain of over $3 billion from credit default swaps and equity market hedges during the financial crisis. But he has had notable misses as well, including a sizable investment in Blackberry, and we don’t think his record could justify framing his investment skills as a structural competitive advantage. The company’s preferred metric is growth in book value per share, which has grown at a 6% CAGR over the past 10 years, a fairly mediocre result even considering the dividends Fairfax has paid."

 

What I think is interesting is that even with the mistakes of the past, FFH has been able to compound book value at a decent rate even while paying out a non-trivial dividend.  We have all argued the merits of the dividend previously, but it is what it is.  

 

When I bought back into the company in 2021, it was under the premise that management would ultimately prove that they could compound over the longer term at a rate of 11% albeit lumpy.  So regression to the mean was the basic premise.

 

Based on this crude assumption, I remember the friendly arguments on the board at the time about whether it was cheaper in 2020 or 2021.  Either way, if you thought the company was a regress to the mean type play, it was possibly worth  $1000 by the end of 2024.  At the time this seemed a little nuts, but it now looks like book value reaching $1000 is a very high probability.  I dug out the graph back then and updated key metrics but not the original estimated regression to the mean line.  The 35% CAGR regression is still intact, and book value is closing in again at 11%.  Importantly share price is coming down with repurchases at prices less than book.

 

For our friendly analyst to arrive at a fair value price of only CAD790 per share assumes some pretty low growth rates and some big cat losses.  However, if FFH is indeed an 11% compounder,  over the longer term, then ultimately even Brett would have to capitulate and reprice Fairfax to at least 1.1x's book.

 

 

 

FFH - Fairfax Financial Holdings Ltd Shs Subord.Vtg Analysis & Rating - XTSE | Morningstar.pdf 264.07 kB · 8 downloads

 

Thank you for the updated report.

 

He seem overly academic and conservative.

 

I will keep my cost basis below his estimate (CA$790).

 

[Viking]

13 hours ago, nwoodman said:

Thanks for that.  Morningstar's Brett Horn also posted an update on the 19th of May that I think sums up where a lot of analysts are at.  Full note attached but some key quotes below:

 

"While its primary business is insurance, Fairfax is in some ways more of an investment fund. Chairman and CEO Prem Watsa has a long history of bold investment bets and has shown a willingness to be unorthodox when it comes to portfolio construction. As a result, compared with other insurers, the company's results tend to be driven more by results on the investment side. We're somewhat skeptical of this approach, as we believe disciplined underwriting is a more reliable path to long-term value creation, and Fairfax's underwriting record is relatively poor."

 

"We think investors attracted to the stock due to a belief in Watsa’s ability to produce alpha should consider his record over the past decade, which includes some big wins but also substantial losses and missed opportunities. Fairfax has seen a lot of ups and downs, but its performance has been trending toward mediocrity."

 

"We believe that Prem Watsa’s investment philosophy, willingness to make outsize bets, and potential to generate alpha are the primary attractions for many investors. Fairfax’s name is often included in discussions about the “mini-Berkshires” that seek to distinguish themselves on the investment side, but we think this narrative is misleading. Watsa has had some dramatic successes on the investment side, with the most impactful being his gain of over $3 billion from credit default swaps and equity market hedges during the financial crisis. But he has had notable misses as well, including a sizable investment in Blackberry, and we don’t think his record could justify framing his investment skills as a structural competitive advantage. The company’s preferred metric is growth in book value per share, which has grown at a 6% CAGR over the past 10 years, a fairly mediocre result even considering the dividends Fairfax has paid."

 

What I think is interesting is that even with the mistakes of the past, FFH has been able to compound book value at a decent rate even while paying out a non-trivial dividend.  We have all argued the merits of the dividend previously, but it is what it is.  

 

When I bought back into the company in 2021, it was under the premise that management would ultimately prove that they could compound over the longer term at a rate of 11% albeit lumpy.  So regression to the mean was the basic premise.

 

Based on this crude assumption, I remember the friendly arguments on the board at the time about whether it was cheaper in 2020 or 2021.  Either way, if you thought the company was a regress to the mean type play, it was possibly worth  $1000 by the end of 2024.  At the time this seemed a little nuts, but it now looks like book value reaching $1000 is a very high probability.  I dug out the graph back then and updated key metrics but not the original estimated regression to the mean line.  The 35% CAGR regression is still intact, and book value is closing in again at 11%.  Importantly share price is coming down with repurchases at prices less than book.

 

For our friendly analyst to arrive at a fair value price of only CAD790 per share assumes some pretty low growth rates and some big cat losses.  However, if FFH is indeed an 11% compounder,  over the longer term, then ultimately even Brett would have to capitulate and reprice Fairfax to at least 1.1x's book.

 

 

 

FFH - Fairfax Financial Holdings Ltd Shs Subord.Vtg Analysis & Rating - XTSE | Morningstar.pdf 264.07 kB · 8 downloads

 

Morningstar has a fair value for Fairfax of C$730 = US$537/share. Fairfax shares are trading today at US$714. What can we learn from Morningstar's report on Fairfax? Unfortunately, I think we learn much more about Morningstar from this 'report' than we do about Fairfax. And it does not inspire confidence. If this organization can be so out of touch on Fairfax - is this representative of the quality of rest of their research?

----------

Why am I so bullish on Fairfax? Because I am focussed on the present and the future. Graham (the guy who taught Buffett) teaches us a stock is simply worth the present value of its future cash flows. Yes, the past matters... but what matters much more is the future. 

 

The Morningstar report is focussed pretty much solely on the past. 2008. And 2010-2016. And this might generally be ok for most companies. But it does not work for companies where important things have changed. Turnarounds. And lots of important things have changed at Fairfax over the past few years. Things that already had a big, positive impact on earnings in 2021 and 2022. With much more to come 2023, 2024 and 2025.

 

This explains, at least partially, why it takes turnaround type stocks like Fairfax so long to re-rate. It takes years of better/excellent results before analysts and investors get comfortable that things have indeed changed in a sustainable way for the better. Only after the new and improved financial results are embedded in historical results for years does the ‘narrative’ change. This actually makes sense for a company like Fairfax that was so out of favor.

—————

What is Morningstar missing in their report? An analysis of Fairfax as it exists today: a company that is earning:

1.) record underwriting profit

2.) record interest and dividend income

3.) record share of profit of associates

4.) solid investment gains

While also reducing their share count.

 

They do not provide any detailed forward looking information and estimates. No detail of the important building blocks. No math. In sort, their analysis is exclusively backward looking. And as a result, worse that useless for a company like Fairfax (a turnaround). 

----------

Conclusion: Fairfax, as it exists today, is misunderstood. Lots of analysts and investors are stuck in the past. 

 

So what is an investor to do? Patience and time. Fairfax needs to deliver results. The narrative will slowly change and reflect the current reality. And Fairfax shareholders should be rewarded handsomely.

Edited May 30, 2023 by Viking

[Tommm50]

I think we should send Brett Horn Viking's various posts. Maybe he would learn something...