Fairfax 2023

[SafetyinNumbers]

On 6/7/2023 at 3:29 PM, Santayana said:

And/or close out the TRS position.

That's the last thing I would do. It's a sizable buyback where we have already paid the premium. Might as well wait, buy stock on the NCIB and enjoy the higher weighting in the index. I think the closet indexers will be the big driver for the stock over the next five years as they are way underweight and Fairfax is now 80bps of the index which is about what CSU was when they started chasing it in 2018. 

 

There are a lot of similarities between Fairfax now and CSU in 2018 like market cap, share price, shares outstanding, price momentum i.e. stuff that matters to closet indexers. The big difference is CSU starting valuation looked optically expensive 5 years ago which is what active managers had to overcome to get back to market weight. Fairfax meanwhile, is exceptionally cheap on every measure so in theory it should be easier to convince PMs to go to market weight or even overweight but we also have more jaded PMs to overcome as many stayed overweight FFH long after the outperformance ended.

 

On the same note we likely have more willing sellers as Mark Leonard has achieved god status over the past 5 years while mostly everyone is waiting for Prem to make a mistake so are much more likely to take profits as price goes up even if valuation and technicals are screaming buy.

 

 

[A_Hamilton]

13 hours ago, SafetyinNumbers said:

That's the last thing I would do. It's a sizable buyback where we have already paid the premium. Might as well wait, buy stock on the NCIB and enjoy the higher weighting in the index. I think the closet indexers will be the big driver for the stock over the next five years as they are way underweight and Fairfax is now 80bps of the index which is about what CSU was when they started chasing it in 2018. 

 

There are a lot of similarities between Fairfax now and CSU in 2018 like market cap, share price, shares outstanding, price momentum i.e. stuff that matters to closet indexers. The big difference is CSU starting valuation looked optically expensive 5 years ago which is what active managers had to overcome to get back to market weight. Fairfax meanwhile, is exceptionally cheap on every measure so in theory it should be easier to convince PMs to go to market weight or even overweight but we also have more jaded PMs to overcome as many stayed overweight FFH long after the outperformance ended.

 

On the same note we likely have more willing sellers as Mark Leonard has achieved god status over the past 5 years while mostly everyone is waiting for Prem to make a mistake so are much more likely to take profits as price goes up even if valuation and technicals are screaming buy.

 

 

I'd close out, was a great trade at a silly price, less attractive now. The other thing is that TRS are priced at SOFR + a spread, so this isn't necessarily cheap capital.

[SafetyinNumbers]

11 minutes ago, A_Hamilton said:

I'd close out, was a great trade at a silly price, less attractive now. The other thing is that TRS are priced at SOFR + a spread, so this isn't necessarily cheap capital.

Do you know how the SOFR + spread compares to the cost of other borrowing or the returns on alternative investments including buying their own shares back? 

[gfp]

19 minutes ago, SafetyinNumbers said:

Do you know how the SOFR + spread compares to the cost of other borrowing or the returns on alternative investments including buying their own shares back? 

 

SOFR moves with the Fed Funds rate - it's around 5% now and has moved up similarly to other overnight rates.  It's just a secured (collateralized) overnight rate.

[Viking]

30 minutes ago, A_Hamilton said:

I'd close out, was a great trade at a silly price, less attractive now. The other thing is that TRS are priced at SOFR + a spread, so this isn't necessarily cheap capital.

The key is what Fairfax thinks:

- fair value is for their stock is today (1.3 x BV?)

- what the prospects are for earnings over the next 12, 24, 36 months (my base case is $120/year)

- what the plan is for share buybacks (as the hard market ends, share buybacks could increase materially to reduction of +4% per year if they wanted)

 

Fairfax, of course, has better information than we do. I would continue to hold the TRS.

[TwoCitiesCapital]

55 minutes ago, A_Hamilton said:

I'd close out, was a great trade at a silly price, less attractive now. The other thing is that TRS are priced at SOFR + a spread, so this isn't necessarily cheap capital.

 

I'm not quite ready for them to close it out yet. 5-6% is still cheap financing if they're buying mortgages at 10% and taking out the shares that own those mortgages below book value. 

 

The bigger deal to me is the cash drag for when shares fall - it makes their liquidity very pro-cyclical to have to deliver hundreds of millions on cash as the share price is falling at the same time all other stocks are falling (or as catastrophes hit). 

 

Fairfax bucked the trend over the last two years of weak equity markets so am willing to give a little grace here, but I do think it would be prudent to begin reducing the position if there is another 10-15% pump in the stock. 

Edited June 9, 2023 by TwoCitiesCapital

[Thrifty3000]

Seems to me we're getting closer to the point where it makes sense to cash in the TRS gains and focus on buying back the $1 billion Odyssey position from OMERS. Not sure if we ever nailed down the interest rate FFH is paying OMERS for that deal, but it sounded like an $80 or $90 million annual interest expense. Given FFH's expected earnings power it sounds to me like a risk-weighted break even point might be in the neighborhood of $800 to $1,000 USD per FFH share. (Of course this depends on the TRS interest rate and, more importantly, on how FFH sees its growth prospects. The more growth expected the higher they'll let the TRS run.)

 

In fact, I think the point at which they cash out the TRS will be a pretty strong signal for how FFH sees its growth prospects. If they were to cash out the TRS now I'd think it's a signal they expect normal earnings to remain flat beyond the 3 year horizon. However, if the shares run up to $1,000 USD and they still hold the TRS then that seems like pretty strong conviction favoring growth.

 

^ PS. "cash in the TRS gains" is the wrong terminology. I should have said "exit the TRS position". TRS gains have already been booked.

 

 

Edited June 9, 2023 by Thrifty3000

[maplevalue]

4 minutes ago, Thrifty3000 said:

Seems to me we're getting closer to the point where it makes sense to cash in the TRS gains and use the proceeds to buy back the $1 billion Odyssey position from OMERS. Not sure if we ever nailed down the interest rate FFH is paying OMERS for that deal, but it sounded like an $80 or $90 million annual interest expense. Given FFH's expected earnings power it sounds to me like a risk-weighted break even point might be in the neighborhood of $800 to $1,000 USD per FFH share. (Of course this depends on the TRS interest rate and, more importantly, on how FFH sees its growth prospects. The more growth expected the higher they'll let the TRS run.)

 

In fact, I think the point at which they cash out the TRS will be a pretty strong signal for how FFH sees its growth prospects. If they were to cash out the TRS now I'd think it's a signal they expect normal earnings to remain flat beyond the 3 year horizon. However, if the shares run up to $1,000 USD and they still hold the TRS then that seems like pretty strong conviction favoring growth.

 

IMO the most likely scenario is when they close out the TRS they end up buying back the stock (i.e. there will be no 'cashing in of the TRS gains'). I think of it as FFH owns that amount of stock represented by the TRS, but it just sits on the balance sheet of a bank for now.

[gfp]

4 minutes ago, Thrifty3000 said:

where it makes sense to cash in the TRS gains and use the proceeds to buy back the $1 billion

 

I believe the cash moves between counter-parties each month or each quarter, so Fairfax is getting the profits approximately in real time in cash.  There isn't a cash payoff when they close the contracts.

[Thrifty3000]

21 minutes ago, gfp said:

 

I believe the cash moves between counter-parties each month or each quarter, so Fairfax is getting the profits approximately in real time in cash.  There isn't a cash payoff when they close the contracts.

 

 Wow! Duh, I don't know where my head is today. Thanks for clarifying! So, it's really just a simple calculation of expected growth vs. the TRS interest expense. I trust Hamblin Watsa to handle that one. It will still be an interesting signal whenever they decide to exit the TRS, but that's true of any share related transaction. (I added a correction to my post.)

Edited June 9, 2023 by Thrifty3000

[glider3834]

check out Lauren Templeton comments on Fairfax culture from 16 min 20 s mark 

 

 

 

[jbwent63]

News:

 

Westaim Raises US$87.4 Million in Secondary Offering of Skyward Specialty Shares; Redeems Preferred Shares

02:55 PM EDT, 06/12/2023 (MT Newswires) -- The Westaim Corp (WED.V) on Monday it closed a secondary offering of its shares in Skyward Specialty Insurance Group (SKWD), raising US$87.4 million.

The private-equity company said it sold 3.99-million shares priced at US$23.00 in the offer, including the underwriters' over-allotment option.

Westaim said it will use C$50 million of the proceeds to redeem all five million of its 5% subordinate preferred securities held by "certain affiliates of Fairfax Financial Holdings (FFH.TO)". It will also terminate a 2017 governance agreement with Fairfax, which will return an unspecified number of warrant to Westaim for cancellation.

Westaim shares were last seen down C$0.03 to US$3.56 on the TSX Venture Exchange

[Viking]

Capital allocation is the most important responsibility of a management team. Why? Capital allocation decisions drive the long term performance of the company. Stuff like reported earnings, growth in book value and return on equity. And this in turn drives share price and investment returns for shareholders.

 

Capital allocation, when done well, does two fundamental things. It delivers a solid return and, over time, improves the quality of the company. Therefore, the fundamental task for an investor is determining if management, over time, is making intelligent decisions regarding capital allocation.

 

What is capital allocation?

Capital allocation is the process of determining how capital is raised, managed and disbursed by a company. Capital allocation decisions often play out with a lag, sometimes years in length. So an investor needs to take a multi-year approach with their analysis.

 

How does Fairfax do capital allocation?

Internal capabilities: Capital allocation at Fairfax is managed by the senior leadership team, lead by CEO Prem Watsa. Since 2010, the insurance business has been lead by Andy Barnard. The investment business is managed by the large team at Hamblin Watsa. The fixed income team is lead by Brian Bradstreet, who has been with Fairfax almost from day 1. The equities team is lead by Wade Burton, who joined Fairfax in 2009 from fund manager Cundill Investments, and Lawrence Chin, who also joined from Cundill in 2016. In India, Fairfax has Fairbridge, a boots on the ground investment team. Fairfax also leverages the knowledge of the CEO’s of its many equity holdings.

 

From Fairfax’s web site: “Since 1985, investments have been centrally managed for all of the Fairfax group companies by Hamblin Watsa Investment Counsel Ltd. (www.hwic.ca), a wholly-owned subsidiary of Fairfax. Hamblin Watsa emphasizes a conservative value investment philosophy, seeking to invest assets on a total return basis, which includes realized and unrealized gains over the long-term.”

 

Below is a slide from the Fairfax’s annual meeting held April 2023.

 

 

Fairfax has a large internal team with expertise across many different asset classes and geographies. They are a long-tenured group with experience managing through many different market cycles, including the high inflation period of the 1970’s. They are also a battle tested team. They have established a strong long term track record.

 

External capabilities: Fairfax has actively been cultivating relationships with a large network of individuals/companies in the investment world for decades. They have established partnerships and expertise across many different asset classes (real estate, private equity, commodities) and geographies (India, Greece, Africa, Middle East). These external partnerships have been an important source of ideas and diversification while also delivering solid returns to Fairfax over the years. This important external capability allows Fairfax to leverage the knowledge and skills of a much larger group of people and organizations.

 

Over decades, Fairfax has built out a large team and network of highly skilled internal and external capital allocators. In a world where active management is back, this has become a big tailwind for Fairfax. Fairfax is well positioned at exactly the right time.

 

In general, what are the basic capital allocation options available to management?

1. reinvest in the business - grow organically: support slow and steady growth of existing operations.
2. acquisitions/mergers/sales - higher risk, but can be transformative.
3. pay down debt: most predictable option as cost of repaid debt is known.
4. pay dividends: although tax-inefficient, usually indicates financially healthy, shareholder-friendly business.
5. share buybacks: impactful, if purchased below intrinsic value, by improving per-share financial metrics: EPS & BVPS.

What has Fairfax done?

The management team at Fairfax has been extremely active on the capital allocation front. Every year they typically make between 5 to 10 meaningful decisions. So much has been happening on the capital allocation front it is hard for shareholders to keep up - especially understanding the impact on current and future business results. Below we are going to take a quick look at 15 of Fairfax’s bigger decisions made in recent years to see what we can learn.

 

Reinvest in the business:

1.) 2019-2022, hard market in insurance: Net written premiums increased 68% over the past three years from $13.3 million in 2019 to $22.3 million in 2022, an average increase of 19% per year. Fairfax is now delivering record underwriting profit of $1.1 billion (at 95CR).

2.) in 2017, seeded start-up Go Digit in India: at a cost of $150 million and a fair value today of $2.3 billion. This investment has turned into a home run, with a possible IPO coming in 2023 (more upside).

 

Acquisitions / sales: insurance:

3.) in 2017, purchased Allied World, with the help of minority partners, for $4.9 billion (1.3 x book value). Price paid was not an overpay. Net written premiums have increased from $2.37 billion in 2018 to $4.46 billion in 2022, an increase of 88% in 4 years. With the onset of hard market in 2019, the timing of this purchase was perfect.

4.) in 2017/2019, sale of ICICI Lombard for $1.7 billion: realized a $1 billion pre-tax investment gain. Due to regulations in India, Fairfax had to sell down its position in ICICI Lombard to be able to invest in Digit. Brilliant strategic shift of insurance business in India.

5.) in 2020/2021, sold Riverstone UK (runoff) for $1.3 billion (plus $236 million CVI). At a time when they needed the cash, Fairfax sold their UK run-off business at a much higher price than expected at the time.

6.) in 2022, sale of pet insurance business to JAB Holding Co. for 1.4 billion: realized a $1 billion after-tax gain. This sale was a home run for Fairfax as the sale price was far in excess of what anyone thought possible.

7.) in 2023, the pending purchase of Kipco’s 46% stake in Gulf Insurance Group for $860 million, payable over 4 years.  Great strategic purchase will solidify Fairfax’s presence in MENA region for insurance.

 

Acquisitions/sales: investments

8.) in 2018, made initial investment in Poseidon/Atlas/Seaspan. Fairfax partnered with David Sokol (formerly Buffett’s heir apparent at Berkshire). Today Fairfax owns 45.5% stake valued at $2 billion. Poseidon is entering significant growth phase.

9.) in late 2018, purchased 13% of Stelco for $193 million. Fairfax partnered with Alan Kestenbaum. Investment has already delivered close to a 150% investment gain.  Today, Fairfax owns 23.6% of Stelco (having invested no new money).

10.) in 2020/21, initiation of total return swap position giving exposure to of 1.96 million FFH shares at an average cost of $372/share. With Fairfax shares trading today at $745, this investment has already delivered an investment gain of +$750 million in 30 months. This has been another home run.

11.) in Dec 2021, reduced average duration of $37 billion bond portfolio to 1.2 years (as interest rates bottomed); followed by pivot in 2022/23 and extension of average duration to 2.5 years (after interest rates had spiked). Protected the balance sheet.  And today the fixed income portfolio is delivering record interest income of more than $1.4 billion per year. This string of decisions over less than 24 months was nothing short of brilliant and delivered billions in gains to Fairfax shareholders.

12.) in 2020 and 2023, partnership with Kennedy Wilson. Phase 1, in 2020, was establishment of $3 billion real estate debt platform. Phase 2, in 2023, was purchase of $2 billion of PacWest loans yielding a fixed rate to maturity of 10%. Fairfax, through long term partner Kennedy Wilson, taking advantage of severe temporary market dislocation.

13.) in 2022, sold Resolute Forest Products for $626 million (plus $183 million CVR) at top of lumber cycle.

14.) in 2023, sold Ambridge Partners for $400 million: delivered a $255 million pre-tax investment gain.

 

Dividend: Fairfax has continuously paid a $10 dividend since 2011.

 

Share buybacks: Effective shares outstanding have decreased 16% over the past five years from 27.8 million in 2017 to 23.3 million in 2022, an average decrease of 3.2% per year.

15.) in 2021, re-purchased 2 million shares at $500/share. Fairfax’s book value is $803/share (Q1) and the stock is trading today at $745. This repurchase was another home run.

 

The list above captures only the largest capital allocation decisions made by Fairfax in recent years. We could easily add another 15 smaller examples of transactions that are also proving to be material to Fairfax.

 

For a more complete list, i have attached my Excel file to the bottom of this post. See tab 2 in the Excel file - titled ‘Moves’ - where I have document many of Fairfax’s moves for each year going back to 2010.

 

Important: asset sales are one part of capital allocation that really separates Fairfax from its peers. In selling an asset, Fairfax is essentially trading a stream of future cash flows for a lump sum today.

 

Why sell an asset?  Sometimes another company - who is willing to pay up - values an asset at a much higher value than you do. The sale of the pet insurance business is a great insurance example of this. The sale of Resolute Forest Products is a great non-insurance example. There also can be important strategic reasons to sell an asset. Like if a sale allows the company to better focus on its other businesses - which should lead to improved results. The sale of APR to Atlas in 2019 is a good example of this. Asset sales have been an very important part of Fairfax’s capital allocation framework, realizing significant value for Fairfax and its shareholders over the years.

 

Is Fairfax’s capital allocation record perfect?

No, of course not. I see two notable misses:

• Taking until late 2020 to exit last short position and not exiting earlier.
• Not finding a way to unload Blackberry during the wallstreetbets mania that caused the stock price to spike for a very short period of time in 2021. Fairfax says they were unable to act due to being in a blackout period at the time.

Looking at everything they have done over the past 5 or so years, it is clear Fairfax has been executing exceptionally well.

 

Peter Lynch: “In this business, if you are good, you’re right 6 out of 10 times. You’re never going to be right 9 out of 10.” In recent years, Fairfax has been right with their capital allocation decisions at a rate much higher than 6 out of 10.

 

In Druckenmiller parlance, Fairfax has been on a multi-year ‘hot streak’. Or in Buffett parlance, Fairfax has been hitting the ball like Ted Williams the past couple of seasons.

 

Has Fairfax simply been lucky? Did Prem give the team at Fairfax a sip of ‘liquid luck’ back in 2018? Some luck likely has been involved. But I like this definition of luck: what happens when preparation meets opportunity. That describes what has happened at Fairfax beautifully: looks to me like they made their own luck.

 

So what did we learn?

 

Here are the words i would use to describe Fairfax’s approach to capital allocation:

• Flexible - use the full suite of options available
• Opportunistic - taking advantage of opportunities as they arise
• Countercyclical - act contrary to prevailing investment trends
• Speed - act quickly when necessary
• Conviction (position sizing) - go big when risk/reward is highly compelling/asymmetrical
• Creative - be open minded during the process
• Long term focus - generate above-market returns
• Strategic - make the company stronger - both insurance and investments
• Rational - capital goes to the best (risk adjusted) opportunities
• Equally capable in executing across both insurance and investment businesses

What has been the financial impact of Fairfax’s capital allocation decisions?

 

Operating Income:

Let’s start by looking at operating income given it is viewed by analysts as the most important part of an insurers total earnings. For the 5-year period from 2016-2020, operating income at Fairfax averaged $1 billion per year or $39/share. Compared to the 5-year averaged from 2016-2020:

• in 2021, operating income doubled to $1.8 billion or $77/share.
• in 2022, operating income tripled to $ 3.1 billion or $132/share
• in 2023, operating income is on track to quadruple to $3.8 billion or $167/share
• in 2024 and 2025, operating income is poised to grow even more, although at a slower rate.

The run rate for operating income is now 4 times larger than it was just a few short years ago. The reason? The spike higher is due in large part to the exceptional capital allocation decisions made by the management team at Fairfax, primarily over the past 5 years.

 

 

Investment Gains:

The other important part of earnings is investment gains. This lumpy part of earnings has historically been a strength for Fairfax - the pet insurance and Resolute sales in 2022, and the Ambridge Partners sale in 2023, being three recent examples. We should expect Fairfax to continue to deliver solid (but lumpy) investment gains moving forward.

 

My current estimate has Fairfax on track to deliver earnings of $150/share in 2023.

 

Return On Equity:

For the 5-year period from 2016-2020, ROE averaged 5.2% per year. For the period 2021-2023, ROE is tracking to average 14.2%. Given expected trend in operating earnings, this is likely a good target for 2024 and 2025 as well.

 

 

Driven by strong capital allocation decisions, all important financial metrics at Fairfax have been materially improving in recent years. This strong performance looks set to continue in 2023, 2024 and 2025 (as far out as our crystal ball looks).

 

How is the strategic positioning of Fairfax’s businesses?

 

Insurance

• Significant expansion by acquisition 2015-2017 - build out of global platform is complete.
• Significant expansion by organic growth 2019-2023 - hard market
• Ongoing bolt-on acquisitions, like Singapore Re, has further strengthened the business.
• Ongoing buy-out of minority partners, like Eurolife in 2021 and Allied World in 2022, has further strengthened the business.
• quality of insurance business has never looked better.
• delivering record net written premiums and record underwriting profit.

Investments - fixed income

• 2021: shortened duration of portfolio to 1.2 years and primarily government bonds in late 2021, to protect the balance sheet.
• 2023: extended duration to 2.5 years in Q1, to lock in much higher rates.
• 2023: capitalizing on dislocations in financial markets to lock in even higher rates - with Kennedy Wilson, purchased $2 billion in PacWest real estate loans yielding a fixed rate of 10%.
• positioning of fixed income portfolio has rarely looked better.
• delivering record interest and dividend income.

Investments - equities

• Total return swaps, giving exposure to 1.96 million Fairfax shares, looks well positioned.
• Eurobank - balance sheet is fixed, earnings are strong. Greece is expected to be a top performing economy in Europe.
• Poseidon / Atlas - is currently in rapid growth mode.
• India is expected to be a top performing global economy.
• rest of portfolio looks well positioned.
• quality of collection of equities owned has never looked better.
• delivering record share of profit of associates and sold investment gains.

Bottom line, the strategic positioning of each of Fairfax’s three engines (insurance, fixed income and equities) have all steadily improved over the past 5 years. In fact, in terms of quality they have never looked better. And it is extremely rare to have all three engines performing at a high level at the same time, like is happening today.

 

Conclusion

• strong management team.
• executing exceptionally well over the past 5 years.
• record financial results across all important metrics (EPS, growth in BV and ROE).
• both businesses, insurance and investments, are exceptionally well positioned.

Fairfax is nailing the dual core objectives from capital allocation:

1.) deliver good/great returns on capital deployed

2.) over time, improve the quality of each of the businesses - insurance and investments

 

As a result, i think we can fairly conclude that the management team at Fairfax have demonstrable best-in-class capital allocation skills. And not just within their peer group in P&C insurance.   

 

Are Fairfax’s capital allocation abilities reflected in the price of its stock?

 

Given the glide path of operating earnings, total earnings are expected to be very strong in 2023, 2024 and 2025. A management team - with proven skills in capital allocation - is about to get… a record amount of free cash flow to allocate over the next three years.

 

Fairfax’s stock is trading today at $745/share (June 15, 2023). Book value is $803 (Q1, 2023). Earnings for 2023 are estimated to be $150/share (my estimate as of today).

• PE =  5 (2023E earnings)
• price to book value = 0.93
• return on equity is 17% (2023E earnings)

The stock is trading today at a historically low valuation (if you ignore the covid low). The stock price does not yet reflect the significant improvement in fundamentals that we are seeing.

 

Fairfax’s stock has dramatically outperformed the market over the past 29.5 months. Mr. Market is clearly warming to the Fairfax story. My guess is the outperformance by Fairfax will continue.

 

 

 

• Best-in-class capital allocators + record earnings + bear market + power of compounding + time = exceptional returns for shareholders.

 

Fairfax Equity Holdings May 23 2023.xlsx

Edited June 17, 2023 by Viking

[Haryana]

 

Not sure if this was shared on this thread before but it reads like a good summary of what is being discussed here - 

 

https://www.edgepointwealth.com/article/Q4-2022-EdgePoint-commentary/

 

"

While long-memory stocks exist in every market, the dynamic is magnified in Canada. The Canadian stock market is very narrow since there’s only a small group of companies to pick from. Institutional and retail investors have an opinion of just about every business. If you have been burned on a Canadian stock in the past, it can take years before you ever look at it again.

Fairfax is the ultimate long-memory stock. It went from market darling to pariah. What should have been a comeback story was missed by investors afraid of getting hurt again.

For the first 15 years of Fairfax’s life, it was one of Canada’s shining stars. The company grew its book value per share (BVPS), a proxy for the change in intrinsic value, from US$1.52/share to US$155.55/share for a compound annual growth rate of 39%.ⁱⁱ The CEO, Prem Watsa, was described by many as “Canada’s Warren Buffett”. By the late 1990s, the stock was trading at 5x BV (an unheard-of valuation for an insurance company).

Just like the internet companies discussed at the value conference, high expectations in the stock market are often a recipe for disappointment. Fairfax was no exception.

The company had a series of self-inflicted issues – first on the insurance side and then later with its investments. While BVPS has grown from US$155/share to US$570/share today,ⁱⁱⁱ the multiple compression (from 5x BV to under 1x BV) has erased almost all the returns for investors.

Fast-forward almost 25 years, the stock price finally surpassed its 1999 peak! An entire generation of investors had a painful experience. Imagine explaining to your clients that after years of losing money with Canada’s Warren Buffett…why this time is different. To avoid the pain, investors have vowed to stay away.

"

 

[nwoodman]

1 hour ago, Haryana said:

 

Not sure if this was shared on this thread before but it reads like a good summary of what is being discussed here - 

 

https://www.edgepointwealth.com/article/Q4-2022-EdgePoint-commentary/

 

 

Thanks for the link.  The final line was gold

“While adding Fairfax in would have made their story even stronger, we can’t blame them as we’re sure they only included the Canadian insurance companies they could remember.”

[John Hjorth]

Yet again an absolutely awesome post just above by you, @Viking!,

 

Thank you very much, and thank you for all the hard work on FFH you have shared with us within the last few years or so here in this forum.

 

[I am one of those guys who got it wrong with FFH in the first place, meaning in the past, one had to be trading in and out of it, like you, @Crip1 and @bearprowler6 [among others, nobody forgotten here] have said, but I also really did not give up on FFH [likely because of modest position size] at any time, where a lot of other shareholders did.]

Edited June 17, 2023 by John Hjorth

[jbwent63]

2 hours ago, John Hjorth said:

Yet again an absolutely awesome post just above by you, @Viking!,

 

Thank you very much, and thank you for all the hard work on FFH you have shared with us within the last few years or so here in this forum.

 

[I am one those guys who got it wrong with FFH in the first place, meaning in the past, one had to be trading in and out if, like you, @Crip1 and @bearprowler6 [among others, nobody forgotten here] have said, but I also really did not give up on FFH [likely because of modest position size] at any time, where a lot of other shareholders did.]

+1

[Viking]

10 hours ago, John Hjorth said:

Yet again an absolutely awesome post just above by you, @Viking!,

 

Thank you very much, and thank you for all the hard work on FFH you have shared with us within the last few years or so here in this forum.

 

[I am one of those guys who got it wrong with FFH in the first place, meaning in the past, one had to be trading in and out of it, like you, @Crip1 and @bearprowler6 [among others, nobody forgotten here] have said, but I also really did not give up on FFH [likely because of modest position size] at any time, where a lot of other shareholders did.]

@John Hjorth and @jbwent63, you are welcome. Over the years, I have learned lots from others on this board (much of which makes it into my posts) so it really is a group effort. 
 

FYI, I am doing less trading with Fairfax these days. Sentiment is improving (delivering stellar results will do that). And company fundamentals keep improving. So I do not want to get too cute with my position and have the stock run away from me.
 

Fairfax has a long history of being a very streaky stock - in both directions. The streaks can last for years and back-to-back +30% gains can happen. 
 

Fairfax is an investors dream stock today. Stock is cheap. Show me another mid cap stock (large cap for Canada) trading at a 5 PE ($150 in earnings and $745 stock price). Earnings are real, high quality and durable (maybe $130 in 2024 and 2025). And company is positioned exceptionally well (it is not impaired). It makes no sense if you actually take the time to think about it. 
 

And with Fairfax we are getting the trifecta, all happening at the same time:

1.) much higher earnings

2.) increasing multiple

3.) lower share count
 

Fairfax will be generating an obscene amount of earnings over the next three years. If they continue to make very good capital allocation decisions i think the stock price could double from current levels over the next three years.

—————
One possible path to a double in the share price over the next three years (June 2026):

- $390 in earnings ($130/year average)

- multiple increases to 1.2 x BV

- share count reduced by 8%

Edited June 17, 2023 by Viking

[Haryana]

This upcoming youtuber is going pretty anal on Fairfax (if you can handle the accent) -

 

 

 

[This2ShallPass]

On 5/28/2023 at 9:52 AM, This2ShallPass said:

Which other public insurance companies closely resemble Fairfax (from an insurance exposure to major hurricane standpoint)? 

To the insurance experts on the board, can you pls suggest 2-3  companies that are close to Fairfax from hurricane exposure standpoint? 

 

I'm giddy about Fairfax prospects over the next few years as well. But it's ~30% of my pf and I want to be prudent, so planning to take small otm hedge to reduce my losses in a worst case event.

 

[Daphne]

Don’t have an informed answer to your question but if looking to hedge you might want to consider construction products and services

[gfp]

I don't really advocate trying to hedge a specific sub-risk like that for an insurance company, but cheap out of the money call options on Generac used to be an effective pairing for hurricane season.  I still think it's not worth doing and haven't kept up with GNRC since I sold it several years ago.  Actually, looking it up the share price has come way down from its peak.

 

[Viking]

The Big Short - Fairfax Edition

 

“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” Stan Druckenmiller

 

In the book/movie, ‘The Big Short’, bestselling author Michael Lewis profiles three firms who made a financial killing from the bursting of the US housing bubble in 2008. How did they do it? They bought credit default swaps (CDS) in 2005 and 2006. Lewis describes it as “One of the best trades in Wall Street history.”

 

From ‘The Big Short’: “It’s been called the worst financial crisis in modern times. Certainly the largest financial disaster in decades in this country, and perhaps the end of an era in American business. In the end, Lewis Ranieri’s mortgage-backed security mutated into a monstrosity that collapse the whole world economy. And none of the experts and leaders or talking heads had a clue it was coming…. But there were some who saw it coming. While the whole world was having a big old party, a few outsiders and weirdos saw what no one else could… These outsiders saw the giant lie at the heart of the economy. And they saw it by doing something the rest of the suckers never thought to do. They looked.”

 

The three firms profiled in ‘The Big Short’ were: Scion Asset Management (Dr. Micheal Burry), FrontPoint Partners (Steve Eisman) and Brownfield Capital (Charlie Gellar and Janie Shipley). A small Canadian P&C insurer could also have been included in Lewis’ book as a 4th participant. Yes, Fairfax Financial.

 

What was the trade?

 

They bought a financial derivative called a credit default swap.

 

In ‘The Big Short’, a large investor in Burry’s fund at Scion summed up the trade perfectly: “In other words, we lose millions until something that has never happened before happens?” Burry replied: “That’s right.”

 

From Fairfax’s 2005AR, Prem’s Letter: Just a brief overview for you on our credit default swaps, which are 5-year to 10-year fixed income derivatives, which fluctuate with credit spreads, that we have purchased from major banks. Here is an example. To purchase a 5-year $100 million credit default swap on a company that sells at a 30 basis point spread over treasuries, one has to invest 150 basis points (30 basis points/year × 5 years), so $1.5 million purchases protection on an underlying $100 million of credit exposure of the chosen company over the next five years. The maximum loss to the purchaser in 5 years is $1.5 million if the credit spread stays at 30 basis points or tightens even further. On the other hand, if the credit spread on this company doubles to 60 basis points, the credit default swap can be worth as much as $3 million, and if the company goes bankrupt, that swap can be worth up to $100 million. We have a diversified list of companies, mainly financial institutions, with respect to which we have paid approximately $250 million to purchase protection on underlying credit exposures. Accounting rules require these credit default swaps to be marked to market (similar to our S&P500 hedges) on a quarterly basis and the resulting valuation adjustment to be treated as a realized gain or loss.”

 

Credit default swap definition: “A credit default swap is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default (by the debtor) or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, may expect to receive a payoff if the asset defaults.” Wikipedia

 

A CDS is insurance on ‘something’. It offers a big payout (as much as 20 to 1) if that ‘something’ defaults/goes bust. Burry bought CDS on MBS. Fairfax bought CDS on a variety of financial and insurance companies.

 

Why did Fairfax do it?

 

Fairfax bought the credit default swaps as a hedge - to protect the "investment portfolios from a potential (though low probability) financial market disaster."

 

From Fairfax’s 2005AR: “The company has invested approximately $250 in 5-year to 10-year credit default swaps on a number of companies, primarily financial institutions, to provide protection against systemic financial risk arising from financial difficulties these entities could experience in a more difficult financial environment.”

 

When did Fairfax start buying?

 

Fairfax initiated their CDS position in 2005, investing $250 million. They were in about the same time as Burry (early). How did it go initially? Not very well. Like Burry, Fairfax booked large investment losses the first two years: $101.6 million in 2005, and another $76.4 million in 2006.

 

In The Big Short, a realtor describes the US housing market in 2006 as follows: “The markets in an itsy-bitsy little gully right now.”

 

But early in 2007, the US housing market began to quickly unravel and it just kept getting worse from there. Fairfax added to their CDS position in early 2007. During the rest of the year the CDS worm began to turn and by the end of 2007, Fairfax was suddenly sitting on a $1 billion gain. Then 2008 saw Fairfax book another $1 billion gain. Fairfax sold most of their CDS positions in 2008 and early 2009, locking in sizeable gains.

 

How much did everyone make over the life of the trade?

• Scion = $2.69 billion
• FrontPoint = around $1 billion
• Brownfield = $50 million ($80 - $30 million initial investment)
• Fairfax = 2.1 billion (original acquisition cost was $318 million).

For perspective, in 2008, common shareholders equity at Fairfax was only $4.9  billion.

 

I would love to hear the inside story of what actually happened at Fairfax from 2005-2009. It would make a great documentary. Some aspiring Canadian producer should get on it. The story would make a compelling addendum to ‘The Big Short’ (kind of like the recent documentary on YouTube titled ‘Luc Longley and the missing chapter of the Last Dance’).

 

How did Fairfax’s share price perform?

 

Fairfax shareholders were big, big winners. For the 4 year period from 2005 to 2009, Fairfax shares increased 174%. During this same 4 year period, the S&P500 decreased 11%. So on a relative basis, from 2005-2009, Fairfax’s shares had close to 200% outperformance over the S&P500. Not too shabby.

 

 

Lots of Corner of Berkshire and Fairfax members made a killing on Fairfax stock over the 4 years from 2006-2009. In mid-2006, Fairfax’s stock briefly traded below $100. It traded over $300/share in early 2008.

 

And a few board members made their own trade of the century: they purchased Fairfax leaps (2006?) and made millions (at the time Fairfax was traded on the NYSE so derivatives were available).

 

What does all this mean for Fairfax today?

 

Does something that happened around 15 years ago matter all that much today? I am not sure.

 

Of interest, a few of the people who were deeply involved with the CDS trade are still with the company. However, Fairfax - the company - is a completely different animal today. Most importantly, its insurance business is much larger and of much higher quality. Its bond portfolio is positioned perfectly. And its equity portfolio is high quality. As a result, Fairfax will be generating record underwriting profit, record interest and dividend income, record share of profit of associates and solid investment gains in 2023, 2024 and 2025 - in short, the quality of the earnings stream Fairfax is generating today has never been better, and it is durable.

 

What is missing from my analysis?

 

The CDS trade was just one piece in the bigger picture of what Fairfax was doing at the time. Over the same time period, Fairfax also had significant equity hedges on (this time it worked). And in 2006, the dirty and viscous short campaign against Fairfax reached its climax (driving the stock briefly below $100 in June of that year). Not spending more time on ‘the bigger picture’ is perhaps the biggest flaw with my long-form posts. Readers need to keep this in mind. 

 

—————

Here is a quick trip down memory lane of some of the more memorable economic and financial events:

• in 2006, house prices peak
• in early 2007, house sales collapse
• April 2007, New Century Financial Corporation, the largest subprime lender, files for bankruptcy
• Sept 2007, Fed cuts interest rates and the stock markets peak
• Jan 2008, Bank of America agrees to buy Countrywide (terrible decision in hindsight)
• March 2008, fire sale of Bear Stearns to JP Morgan
• Sept 2008, government nationalizes Fannie and Freddie
• Sept 2008, Lehman Brothers files for bankruptcy - the largest in US history
• Sept 2008, Fed bails out AIG (one days after Lehman bankruptcy)
• Sept 2008, big banks get bailed out with Troubled Asset Relief Program (TARP)
• Jun 2008 to March 2009, S&P500 falls 50%
• Nov 2008, Fed initiates quantitative easing - an effort to push down interest rates and boost economic activity

—————

From Fairfax’s 2009AR, Prem’s Letter

 

Edited June 20, 2023 by Viking

[This2ShallPass]

2 hours ago, gfp said:

but cheap out of the money call options on Generac used to be an effective pairing for hurricane season.

This is exactly what I'm planning to do, since we cannot do it on Fairfax want a couple of close proxies. I'm not overthinking it, my exposure to Fairfax is really large and paying cheap insurance is worth it (for me).

 

I'll look at Generac. Any other insurance companies? Or any relevant source that shows hurricane exposure by company, I'll try to do some research and post here as well.

 

[Xerxes]

@Viking

 

i haven’t read your whole post but it seems you have missed Paulson in your list. He took a $20 billion scalp … and then proceeded to miss one of the greatest bull market in history.
 

There is book on it that I read covering the 2008-09 trade.
 

actully I have not read Big Short yet. 
 

https://www.businessinsider.in/stock-market/news/billionaire-john-paulson-who-netted-20-billion-from-the-2008-big-short-crisis-quits-the-hedge-fund-world/amp_articleshow/76748909.cms