Fairfax 2023

[racemize]

Saw this on twitter—any insurance insiders have any comments?

 

 

[Parsad]

1 hour ago, racemize said:

Saw this on twitter—any insurance insiders have any comments?

 

 

 

Dino has no idea what he's talking about.  Knows little actually about underwriting or what type of policies FFH is underwriting.  17 years of 100% or better CR isn't an indication if they are pricing premiums appropriately?! 

 

If FFH doesn't write good business, how did they know that other insurers were writing shit business on several occasions in the last 35 years?  You don't write crappy business while calling out your competitors underwriting.  They've also run surpluses on claims for a couple of decades...that isn't an indicator of appropriate pricing or risk management?

 

Go back and read the annual reports...which I bet Dino has not done!  Cheers!

[glider3834]

full disclosure guys thats me dino was replying to

cheers

 

[nwoodman]

Not an insurance insider, but the issue I have with this sort of "industry gossip" is that it is never specific. What long tail lines are they actually talking about?  Riverstone? Are they  pre/post Andy Barnard?   At least give us a hint or STFU.  If anything it sounds like a view that is about 13 years out of date.

 

When they picked up Allied World, Rivett actually named Med Mal as a potential issue but that those policies were all written prior to Fairfax's involvement

 

https://www.canadianunderwriter.ca/insurance/how-fairfaxs-allied-world-acquisition-is-working-out-1004163093/

 

If the perception that there is an insurance "sword of Damoclese" hanging over the company I hope it persists for  another few years and they retire 15-20% of shares outstanding in the meantime.

 

If they are talking about Riverstone then there may well be some skeletons but from my perspective the run-off business is idling

 

From the 2023 AR

"RiverStone, our run-off operation, ....... The industry continues to be challenging, especially in the United States with the plaintiff bar, armed with third-party litigation funding, continuing an aggressive push to create new mass torts. We continue to see development on asbestos claims as well as recent emerging claims such as molestation and opioids. Given

the nature of these claims, the results can be lumpy, with significant uncertainty around the eventual exposures and potential outcomes. RiverStone has been kept very busy focusing on our own latent claims and has not entered into any traditional third-party run-off acquisitions over the last number of years other than some small, very successful captive insurance deals. "

 

What is a runoff operation?

In insurance, a runoff operation refers to the process of managing a block of policies that a company has decided to stop writing or renewing. Essentially, the insurer continues to service the policies in the block (by paying claims, for example) until they expire, are cancelled, or all potential claim obligations have been settled.

During the runoff period, the insurer does not write new business or renew existing policies in that block. The decision to put a block of business into runoff might be due to various strategic reasons, such as a change in the company's risk appetite, a decision to exit a particular market, or a response to regulatory changes or shifts in the business environment.

 

[MMM20]

4 hours ago, nwoodman said:

If the perception that there is an insurance "sword of Damoclese" hanging over the company I hope it persists for  another few years and they retire 15-20% of shares outstanding in the meantime.

 

Exactly. And could be higher with the sorts of cash flows they've lined up and the auction buyback playbook.

[MMM20]

Value of BRK Float

By the way, a while back, my big thing was that Buffett and others kept saying their float is more like equity, and some even proposed to add float into the valuation of BRK stock. Like, literally, take book value of BRK, and then add to it the amount of float as if it were equity etc. I thought this was interesting, but sort of nuts. My argument then was that this “float” was actually never even invested in stocks or even their operating businesses as, up until that time, the amount of cash and fixed income on BRK’s balance sheet was always around what their float was, and never below it. This was true, by the way, only post Gen Re.

 

And with interest rates so low, I argued that the float is not worth all that much to BRK in that case. It adds some incremental income for sure, but nothing big enough to value all of float as equity. But now, with rates rising, the value of float is increasing.

 

Float at BRK as of the end of 1Q 2023 was around $164 billion, and cash / fixed income was around $150 billion, so it is still very close to the amount of float. But what has changed since my last post about all of this stuff is that interest rates are now in the 4-5% range. OK, so on the short end, let’s say it’s 5%. Assuming all of the cash / fixed income can earn 5%, that’s $8.2 billion in additional pretax income for BRK, or $6.5 billion after tax (assuming 21%). With $500 billion in shareholders equity, that adds 1.3% of incremental return on equity to BRK. If you value BRK at 20x P/E, this float earning 5% will add $130 billion to the value of BRK ($6.5 billion x 20). Well, this is kind of circular; assuming something earns 4% after tax, revaluing it back at 20x P/E etc… Anyway, $130 billion comes to 26% of BRK’s book value. That’s a nice bump compared to when interest rates were 0-1%.

 

https://brklyninvestor.com/2023/07/04/value-of-brk-float-buffett-market-view-etc/

 

 

 

Sorry about another float post…but the market is still way behind the curve on this for Fairfax. The impact of this alone is ~3-4x higher for FFH than for BRK — by my math something like +75-100% to fair value on book value. ~+$1-1.5B of net income = ~+$50 of EPS * low-to-mid teens fair multiple = +$600-800/share vs. prior fair value at 0% short term rates = ~US$2000 IVPS.
 

Maybe normalized short term rates are only 2-3%… but that’s still a few hundred dollars per share incremental to FFH fair value, and then they’re still getting zero credit for the many other recent positive developments. 

 

Edited July 9, 2023 by MMM20

[Luke]

Whats remarkable to me is the low volume of FFH shares, 31k of average volume, Berkshire would need to buy 60 days straight of all shares to get to a reasonable 1.3b USD position. If even possible, shooting up the price. Talking about available universe of stocks...

Edited July 9, 2023 by Luca

[SafetyinNumbers]

18 minutes ago, Luca said:

Whats remarkable to me is the low volume of FFH shares, 31k of average volume, Berkshire would need to buy 60 days straight of all shares to get to a reasonable 1.3b USD position. If even possible, shooting up the price. Talking about available universe of stocks...

It trades a bit more when including all the ATS besides just the TSX but your point is well taken. The link below lets one look at the last three months. 

 

https://www.stockwatch.com/Quote/Detail?C:FFH&snapshot=SX

[Thrifty3000]

12 hours ago, nwoodman said:

Not an insurance insider, but the issue I have with this sort of "industry gossip" is that it is never specific. What long tail lines are they actually talking about?  Riverstone? Are they  pre/post Andy Barnard?   At least give us a hint or STFU.  If anything it sounds like a view that is about 13 years out of date.

 

When they picked up Allied World, Rivett actually named Med Mal as a potential issue but that those policies were all written prior to Fairfax's involvement

 

https://www.canadianunderwriter.ca/insurance/how-fairfaxs-allied-world-acquisition-is-working-out-1004163093/

 

If the perception that there is an insurance "sword of Damoclese" hanging over the company I hope it persists for  another few years and they retire 15-20% of shares outstanding in the meantime.

 

If they are talking about Riverstone then there may well be some skeletons but from my perspective the run-off business is idling

 

From the 2023 AR

"RiverStone, our run-off operation, ....... The industry continues to be challenging, especially in the United States with the plaintiff bar, armed with third-party litigation funding, continuing an aggressive push to create new mass torts. We continue to see development on asbestos claims as well as recent emerging claims such as molestation and opioids. Given

the nature of these claims, the results can be lumpy, with significant uncertainty around the eventual exposures and potential outcomes. RiverStone has been kept very busy focusing on our own latent claims and has not entered into any traditional third-party run-off acquisitions over the last number of years other than some small, very successful captive insurance deals. "

 

What is a runoff operation?

In insurance, a runoff operation refers to the process of managing a block of policies that a company has decided to stop writing or renewing. Essentially, the insurer continues to service the policies in the block (by paying claims, for example) until they expire, are cancelled, or all potential claim obligations have been settled.

During the runoff period, the insurer does not write new business or renew existing policies in that block. The decision to put a block of business into runoff might be due to various strategic reasons, such as a change in the company's risk appetite, a decision to exit a particular market, or a response to regulatory changes or shifts in the business environment.

 

Something concerning related to this that I flagged in the annual report…

 

Asbestos provisions and amount paid:

 

2021 provision: $840 million

2021 paid: $150 million

 

2022 provision: $839 million (really?)

2022 paid: $132 million

 

2023 provision: $820 million!!

 

Anyone else see a problematic pattern there?!

[Thrifty3000]

7 hours ago, Luca said:

Whats remarkable to me is the low volume of FFH shares, 31k of average volume, Berkshire would need to buy 60 days straight of all shares to get to a reasonable 1.3b USD position. If even possible, shooting up the price. Talking about available universe of stocks...

Ha, what happens when the population of potential buyers of an asset consists only of value investors that will never pay full price?

[Viking]

56 minutes ago, Thrifty3000 said:

Something concerning related to this that I flagged in the annual report…

 

Asbestos provisions and amount paid:

 

2021 provision: $840 million

2021 paid: $150 million

 

2022 provision: $839 million (really?)

2022 paid: $132 million

 

2023 provision: $820 million!!

 

Anyone else see a problematic pattern there?!

@Thrifty3000 can you please tell me what the ‘problematic pattern’ is? We have know for years that runoff is a drag of $150 to $200 million per year. I don’t consider known events that are baked into historical results (and future estimates) to be ‘problems’. Is there something new here that is now emerging that is making this a bigger issue? Not speculation but something concrete?

 

With interest rates spiking, my guess is the runoff fixed income portfolio will be earning much higher interest income. This tells me runoff portfolio will likely be less of a drag on earnings for Fairfax in 2023 and future years than in recent years when interest rates were zero. But as i constantly say… i am not an insurance guy and so I remain open minded. 

Edited July 9, 2023 by Viking

[newtovalue]

@Viking - any estimate where you see Q2 2023 Book value standing when FFH reports later this month?

[SafetyinNumbers]

I’m going with $850

[Thrifty3000]

5 hours ago, Viking said:

@Thrifty3000 can you please tell me what the ‘problematic pattern’ is? We have know for years that runoff is a drag of $150 to $200 million per year. I don’t consider known events that are baked into historical results (and future estimates) to be ‘problems’. Is there something new here that is now emerging that is making this a bigger issue? Not speculation but something concrete?

 

With interest rates spiking, my guess is the runoff fixed income portfolio will be earning much higher interest income. This tells me runoff portfolio will likely be less of a drag on earnings for Fairfax in 2023 and future years than in recent years when interest rates were zero. But as i constantly say… i am not an insurance guy and so I remain open minded. 

I’m not suggesting this is a deal breaker concern. And, I don’t know whether FFH is handling it differently than other insurers.

 

But, back in 2015 FFH had reserved $896 million for asbestos. In my mind that suggests FFH expected to eventually pay $896 million. However, since 2015 they’ve actually paid something like $1.2 BILLION and they are still showing reserves of over $800 million.

 

If FFH has historically not discounted their reserves then it seems pretty clear to me they are intentionally under-reserving.

 

Let’s say in 2020 they had reported more realistic asbestos reserves - of maybe $1.5 or $2 billion - wouldn’t this have put even more pressure on their credit line covenants?

 

I’m trusting how they are handling asbestos reserves is above board with regulators, but there appears to be a strong incentive to under-reserve here, so I’ve flagged this as an area that I need to look into more.

Edited July 10, 2023 by Thrifty3000

[SafetyinNumbers]

Value investors already own their shares and are likely the sellers near a $1000 because it’s a big figure and we are entering hurricane season. Investors are trying to avoid drawdowns but there seems to be decent demand keeping the stock close to all time highs. I think the buyers are the vast majority of closet indexers and index enhancers. That’s most of actively managed institutional capital benchmarked to the S&P/TSX Composite. The market cap of the benchmark is 3.1T but I’m not sure how much is benchmarked to it. Some estimates suggest 8% is owned directly by ETFs. For Fairfax, I think another 18% is owned between Prem and the TRS. I think FFH is pretty tightly held since the share turnover is relatively low vs the average stock but that could change if the stock gets closer to intrinsic value. 

 

I don’t have access to the data but I think this might have happened with FFH from 1995-1998. The stock went up 6x from C$98 to almost C$600 ending above 3x book at the end of 1998. The share count went up at the time and book value was growing fast at the time going from US$39 to US$112. The P/B multiple went up a lot too.

I think the current situation is an analog except, the starting valuation is incredibly low, it’s very cheap on earnings and while book value is growing quickly it’s not growing as quickly as 95-98. 

[Viking]

Is the stock priced properly?

 

Efficient market hypothesis: “The efficient market hypothesis (EMH) is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices…” Investopedia

 

A lot has happened at Fairfax over the past 30 months. Let’s do a quick review and see what we can learn. Most importantly, is the stock priced correctly, as the EMH would suggest?

 

How has Fairfax’s stock performed over the past 30 months?

 

First, let’s get some context. Fairfax has been one of the best performing stocks over the past 30 months both in absolute and relative terms. The outperformance has been remarkably consistent each year.

 

 

Fairfax’s stock has outperformed the S&P500 by 95% over the past 30 months. That outperformance must make Fairfax one of the top performing large cap (in Canada) stocks over the past 30 months.

 

Does this mean the stock is now expensive? The proverbial ‘big fish that got away’ from investors? Let’s find out. Let’s try and keep an open mind. What do the numbers tell us? And what about management? And future prospects?

 

Let’s start by looking at the traditional valuation tools:

 

Price to earnings ratio (PE)

 

My current estimate has Fairfax earning about $145/share in 2023 and $135 in both 2024 and 2025. I view this as a mildly conservative estimate for the next three years. I’ll provide more details in my 3-year earnings forecast for Fairfax - coming in the next week or so.

 

Importantly, the quality of the earnings being delivered by Fairfax are the highest in the company’s history; it is primarily being delivered by record operating earnings (underwriting profit + interest and dividend income + share of profit of associates). All three individually are at record levels.

 

 

We learn in the chart above that Fairfax is trading today at a forward PE multiple of 5.4 times. That is crazy cheap, especially given the quality and durability of earnings.

 

What is the PE multiple of the overall market?

 

The forward PE multiple of the S&P500 is 20. Fairfax’s stock is trading at a SIGNIFICANT discount to the S&P500. Fairfax’s stock price could double from here and it would still be trading at a 50% discount to the S&P500 multiple.

 

How about compared to some P&C insurance peers?

 

 

Looking at PE, Fairfax is trading at 48% (Chubb) to 70% (Markel) below peers. Fairfax’s stock looks dirt cheap. But let’s keep digging.

 

Price to book value multiple (P/BV) and return on equity (ROE)

 

Let’s now look at the price-to-book value (P/BV) and return-on-equity (ROE). These two are the preferred metrics used to value insurance companies. Let’s start with P/BV.

 

How does Fairfax stack up compared to peers?

 

 

Looking at P/BV, Fairfax is trading 36% (Markel) to 61% (WR Berkley) below peers. How about ROE?

 

 

Looking at ROE, Fairfax is poised to deliver an exceptional 16.8%, at the high end compared to peers.

 

What can we conclude after looking at the valuation metrics?

 

Looking at PE and P/BV, Fairfax’s stock is exceptionally cheap compared to the market and peers. At the same time Fairfax is delivering best-in-class ROE.

 

This makes no sense. Let’s keep digging.

 

What about management?

 

I recently did a long-form post where I reviewed capital allocation at Fairfax over the past 5 years. Bottom line, it can be argued that Fairfax currently has a best-in-class management team (compared to peers).

 

The mystery deepens.

 

What about the future prospects of Fairfax?

 

Fairfax has three engines driving its business:

1. Insurance: Fairfax has grown net premiums written by 400% over the last 9 years. At a 95CR, underwriting profit is on track to be a record $1 billion in 2023.
2. Investments - fixed income: Fairfax has navigated the spike in interest rates masterfully in their $40 billion fixed income portfolio, moving to 1.2 years average duration in Dec 2021 and then pivoting and moving to 2.5 years average duration in Q1 2023, locking in higher yields. As a result interest and dividend income is expected to be a record +$1.5 billion for each of 2023, 2024 and 2025.
3. Investments - equities: Fairfax’s $16 billion equity holdings have been performing very well, lead by Eurobank and total return swaps on 1.96 million FFH shares.

Most importantly, all engines are performing very well at the same time, perhaps for the first time in the company’s history. Significant asset sales over the past 12 months have been icing on the cake: pet insurance ($1.4 billion), Resolute ($626 million+$183 million CVR), Ambridge Partners ($400 million).

 

In short, Fairfax’s prospects have never looked better.

 

What are external groups saying?

 

AM Best, the credit ratings agency who specializes in insurance companies, just upgraded Fairfax’s ratings (including those of its two largest subs - Odyssey and Allied) because of its much improved financial profile.

 

Most sell-side analysts have been warming to Fairfax over the past year, repeatedly increasing their estimates and target prices. Most have Fairfax as ‘outperform’ and a few have it as a ‘top pick’.

 

Conclusion

 

What did we learn about Fairfax?

• The stock price is unambiguously cheap in absolute terms and when compared to peers.
• The quality of the earnings are high and durable.
• The management team is best-in-class.
• Future prospects have never been better.
• Ratings agencies are drinking the Kool-Aid, with upgrades.
• Sell side analysts are drinking the Kool-Aid, with upgrades.

The cheap stock price stands out like a sore thumb.

 

How do we explain it?

 

The answer is simple: Mr. Market is wrong. Now I know, according to EMT, this is not supposed to happen. What we have today is a real life example of where the efficient market hypothesis is bullshit. At least in the short run.

 

We have situation where Mr. Market is grossly mis-pricing a stock. Now I do think the EMT is generally accurate over the medium to long term… the mis-pricing usually does not last for long.

 

The disconnect with Mr. Market is fundamentals. The fundamentals have been improving at Fairfax for the past couple of years but are just now showing up in earnings.

 

It’s like Mr. Market has been standing on the beach the last couple of years wondering why the water is running out to sea. The answer is we have a tsunami of earnings coming from Fairfax in the coming quarters and years. Mr. Market will figure it out. But in usual fashion, only when the wall of water comes crashing in (wiping out all the wrong-headed thinking on the company in the process). "What a shocker!" everyone will say. "Who could have known?" A similar thing happened to Fairfax in the 2006-2009 period.   

 

The coming spike in earnings is not a surprise to those who follow the company closely. So we are in this surreal environment where the future is kind of knowable (a spike in earnings leading to a spike in the share price).

 

What to do? Trust the analysis (be right). Get the correct position size. Have patience (sit tight).

—————

“And right here let me say one thing: after spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets . I’ve known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.” Reminiscences of a Stock Operator

Edited July 10, 2023 by Viking

[Luke]

If one wants to see why many could be hesitant about Fairfax and which past mistakes @Viking sometimes refers to, this looked like a decent write-up: 

 

http://azvalue.blogspot.com/2014/04/fairfax-and-their-bets-now-looking-in.html?m=1

[Luke]

The author of the article also did not include the dividends in the Berkshire Fairfax comparison, there was one comment about it: 

 

You exclude the nearly $125 in dividends paid by FFH over the past 13 years. Adjust the book value to account for the dividends and the returns are: 5 year = 8.1%, 10 year = 10.4%, 15 year = 9.7%, 20 year = 15.3%, 25 year = 17.4%. Now the comparison to BRK doesn't look quite as impressive. FFH outperforms BRK in all categories except the last 5 years.

[nwoodman]

Financial DD underway for IDBI bank

 

“Kotak Mahindra Bank and Canadian billionaire Prem Watsa-led Fairfax India Holdings have shown interest in acquiring majority stake in IDBI bank. The other bidders are said to be Sumitomo Mitsui Financial Group and Emirates NBD.”

 

“The process is expected to conclude by September and the final bids may be in by December.”

 

“The government is keen to wrap up the transaction by March 2024, according to sources.”

 

https://www.thehindubusinessline.com/money-and-banking/financial-due-diligence-underway-at-idbi-bank/article67059941.ece/amp/

[Haryana]

1 hour ago, Luca said:

The author of the article also did not include the dividends in the Berkshire Fairfax comparison, there was one comment about it: 

 

You exclude the nearly $125 in dividends paid by FFH over the past 13 years. Adjust the book value to account for the dividends and the returns are: 5 year = 8.1%, 10 year = 10.4%, 15 year = 9.7%, 20 year = 15.3%, 25 year = 17.4%. Now the comparison to BRK doesn't look quite as impressive. FFH outperforms BRK in all categories except the last 5 years.

 

Most self-acclaimed investment experts fail to include dividends in return calculations.
Dividends make an unexpectedly extraordinary difference to total return due to compounding.
Since Berkshire never paid a dividend, those making these comparisons get yet more Buffett brainwash.

 

Prem had to write the following in 2022 letter (page 31) to remind us for our own benefit:
"Don’t forget the dividends in your return calculation!"

[MMM20]

On 7/9/2023 at 2:56 PM, Thrifty3000 said:

Ha, what happens when the population of potential buyers of an asset consists only of value investors that will never pay full price?

With a high earnings yield, a stable/growing stream of earnings, and reasonable capital allocation, you get a compounder… a real compounder, not just a stock that went from 15x to 50x P/E as interest rates went to 0...

 

Edited July 12, 2023 by MMM20

[SafetyinNumbers]

3 hours ago, Haryana said:

 

Most self-acclaimed investment experts fail to include dividends in return calculations.
Dividends make an unexpectedly extraordinary difference to total return due to compounding.
Since Berkshire never paid a dividend, those making these comparisons get yet more Buffett brainwash.

 

Prem had to write the following in 2022 letter (page 31) to remind us for our own benefit:
"Don’t forget the dividends in your return calculation!"

I did the math to solve for the DRIP and the multiple expansion for BRK and contraction for FFH. The spread narrows quite a bit. That’s what I call margin of safety.

 

 

[Thrifty3000]

3 hours ago, MMM20 said:

With a stable/growing stream of earnings and reasonable capital allocation you get a compounder… a real life compounder, not just a stock that went from 15x to 50x earnings as interest rates went to 0...

 

Yes! The asset price will correlate with intrinsic value long term. Multiple expansion is not guaranteed, but it’s a nice bonus that’s likely to happen.

[MMM20]

On 7/10/2023 at 10:44 AM, Thrifty3000 said:

Yes! The asset price will correlate with intrinsic value long term. Multiple expansion is not guaranteed, but it’s a nice bonus that’s likely to happen.

If earnings roughly match free cash flow and are at least stable for the next 3 years (as @Viking and others here have argued is a reasonable assumption) then they’ll retain earnings of about 60% of the current market cap depending on the dividend and incremental ROIC (and assuming no buybacks).
 

If they agree the stock is too cheap and keep buying it back, that’s theoretically ~US$10B of buybacks using free cash flow alone over the next few years. If at an average cost of ~US$1000/share that’s ~10M shares.  
 

Then even if earnings are flattish vs current as we exit year 3, ok, that’s ~$3.5B / ~12M shares = ~$300 EPS.
 

Even at still just a ~5-6x multiple, that’s a ~$1500+ stock or a ~2x+ from here even with flat earnings. 
 

That gets at the power of FFH's now structurally higher earnings yield and good capital allocation. 

 

Edited July 12, 2023 by MMM20

[John Hjorth]

8 minutes ago, MMM20 said:

If earnings roughly match free cash flow and are at least stable for the next 3 years ...

 

@MMM20,

 

I think, you'd better be careful such presumptions about the implications of such assumptions for an insurer - not much is static in that space of business for such a period. That does not change the fact that FFH looks really compellng right now.