Q3 results

[SafetyinNumbers]

55 minutes ago, Cigarbutt said:

For an idea of the surplus position at end of 2022 (page 93 annual report):

 

Is there anyway to assess midyear or is there only an annual update? 
 

 

[dartmonkey]

(Edit: this is the really important part) “Recently, in October, during spike in treasury yields, we have extended our duration to 3.1 years with an average maturity of approximately 4 years, and yield of 4.9%.”

 

 

Could someone explain to an insurance novice what the differece is between 'duration' (3.1 y) and 'average maturity' (approx. 4 y) ?

 

OK, Google is my friend, right, and I see that duration is an industry-specific notion of how sensitive a portfolio is to interest rate changes. But from an iinvestment point of view, I think I primarily want to know how long we can count on these 4.9% yields, so that would be 4 years. And if interest rates were to drop, say by 1%, then what does duration tell me? Would it be correct to say that I expect about a 3% increase in the value of the bond portfolio, with a 1% drop in interest rates? (Or, inversely, a 3% loss, if interest rates rose by 1%? Can someone give me a numerical example? TIA!

[glider3834]

8 hours ago, SafetyinNumbers said:

 

Is there anyway to assess midyear or is there only an annual update? 
 

 

Yes would be good to know - I suspect they want to finish their actuarial review of y/e reserves before they publish an official number, having said that they probably update this number during the year, as they need to determine what dividends they can pay to the holdco from the insurance subs. 

Edited November 5, 2023 by glider3834

[This2ShallPass]

2 hours ago, glider3834 said:

Yes would be good to know

Based on some deep fundamental analysis, I can confidently say it's going to be a shtload more

[Xerxes]

16 hours ago, dartmonkey said:

(Edit: this is the really important part) “Recently, in October, during spike in treasury yields, we have extended our duration to 3.1 years with an average maturity of approximately 4 years, and yield of 4.9%.”

 

 

Could someone explain to an insurance novice what the differece is between 'duration' (3.1 y) and 'average maturity' (approx. 4 y) ?

 

OK, Google is my friend, right, and I see that duration is an industry-specific notion of how sensitive a portfolio is to interest rate changes. But from an iinvestment point of view, I think I primarily want to know how long we can count on these 4.9% yields, so that would be 4 years. And if interest rates were to drop, say by 1%, then what does duration tell me? Would it be correct to say that I expect about a 3% increase in the value of the bond portfolio, with a 1% drop in interest rates? (Or, inversely, a 3% loss, if interest rates rose by 1%? Can someone give me a numerical example? TIA!

 I am certainly not as nearly knowledgeable as others, but I think with “portfolio maturity” you get that average number of years left, as you indicated. 

 

With “duration of portfolio” you get a that time aspect along with the size of the cash flows. And since that last cash flow at the termination is lumpiness of all, the duration is always back-weighted and always lower than maturity. 
 

an example from Google on how it is calculated.
 

Maturity of this on-the-run single 5-year is “5” but it’s duration is slightly less than 5; which is “4.55” as it is weighted to the size of the cash flow with respect to time. 
 

[Parsad]

On 11/4/2023 at 3:13 PM, glider3834 said:

I am not sure if I have said this before so apologies if I am repeating myself, but I met Brian Bradstreet at the FFH dinner in the year after Fairfax had the big CDS win, he really came across as very down to earth - maybe not what you would expect from someone who had helped Fairfax make $2B or so on their CDS bet. I asked how he knew about the issues at AIG & he said it was there if you read the footnotes. My takeaway from this brief conversation was here is a guy with who doesn't have a big ego & who really does the work & that honestly impressed me.

 

 

 

It was actually Francis Chou and Brian who brought the idea of CDS to Hamblin-Watsa. 

 

They were sitting in one of their team meetings and Prem asked if anyone had any good ideas as good investments weren't readily available at that time for distressed investors.  Francis and Brian had been talking about CDS previously and Francis nudged Brian to say something.  So Brian, said "Well there are credit default swaps"...and that was how Hamblin-Watsa first found out about the idea.  It was the reason why Francis tried to get the MFDA to approve CDS for his mutual funds.  He was approved a little too late and couldn't buy them at the price he wanted...otherwise the Chou Mutual Funds might have made a killing too! 

 

Brian is very down to earth...just like Francis.  I've been saying for the last 15 years that Brian is one of the best fixed income investors of all time.  He keeps burnishing that reputation over time.  I just hope he is able to teach Lawrence and Wade everything he knows.

 

Cheers!

[gfp]

This is another trade publication newsletter that might be interesting to some of the insurance investors here seeking color and market updates.  I guess this is "conference season" for the industry, from Monaco to Baden-Baden and now this APCIA conference.  There have been a dozen or so of these trade publications released multiple times a day out of these conferences.  This one is from this morning at APCIA

 

https://pdf.static.prod.wbm.infomaker.io/d7acfe62-7581-5e24-a1e2-3ed1ac45f801?utm_source=listrak&utm_medium=email&utm_term=Download+issue+two%3a+6+November&utm_campaign=Welcome+to+our+APCIA+2023+Day+Two+edition%3a+Monday%2c+6+November

 

And another free issue released Tuesday, Nov 7th:

https://pdf.static.prod.wbm.infomaker.io/fa81cb8a-3628-5b26-b592-188668fbfe9b?utm_source=listrak&utm_medium=email&utm_term=Download-here&utm_campaign=Welcome+to+our+APCIA+2023+Day+Three+edition%3a+Tuesday%2c+7+November

 

Edited November 7, 2023 by gfp

[MMM20]

On 11/2/2023 at 5:25 PM, MMM20 said:

Should be +30% tomorrow. I’ll settle for +10%.

 

 

It took only another hour this time... call it ~1.1 days. Can we now say Mr Market is waking up to reality at FFH?

 

 

Edited November 6, 2023 by MMM20

[Luke]

Yeah, i still think we are all here only a super nieche forum with not much following, overall market doesnt know or appreciate fairfax. I have pitched the idea to friends who are also seriously investing, so far nobody bought in. They dont trust insurance, stock portfolio looks weird on first glance for them, stock chart too haha, then they saw blackberry, then you read about some of prems mistakes, its easy to put it off.

Edited November 6, 2023 by Luca

[Luke]

Its psychologically difficult to buy a business that had almost 0 optical returns (dividends obviously came in) from 2014 till only last year. Then fairfax is also not the easiest business to understand for people who havent invested in insurers before...

[TwoCitiesCapital]

5 minutes ago, Luca said:

Yeah, i still think we are all here only a super nieche forum with not much following, overall market doesnt know or appreciate fairfax. I have pitched the idea to friends who are also seriously investing, so far nobody bought in. They dont trust insurance, stock portfolio looks weird on first glance for them, stock chart too haha, then they saw blackberry, then you read about some of prems mistakes, its easy to put it off.

 

Same. I pitched the idea to a friend who was an analyst at a very value oriented org and he basically said they could just never get comfortable with Prem and how the money was managed and just wrote it off entirely. This was back in late 2021/early 2022.

 

Even pitched Fairfax India to him too simply for the discount to NAV, but no dice on either. 

[Malmqky]

To add on to the above discourse, I’ve had conversations with friends who work in the insurance industry and are solid value guys. They too dismiss FFH entirely - BlackBerry, Prem’s mistakes, etc.

 

Maybe in a year or two people will appreciate it. The fact that everyone seems to dismiss it without looking into it gives me confidence however. There’s not really any REAL pushback. That tells me we’ve identified a good opportunity, and aren’t missing something.

Edited November 6, 2023 by Malmqky

[Luke]

5 minutes ago, Malmqky said:

To add on to the above discourse, I’ve had conversations with friends who work in the insurance industry and are solid value guys. They too dismiss FFH entirely - BlackBerry, Prem’s mistakes, etc.

 

Maybe in a year or two people will appreciate it. The fact that everyone seems to dismiss it without looking into it gives me confidence however. There’s not really any REAL pushback. 

Yes, the rejection stems from previous mistakes, unknowns in insurance with proper underwriting, previous investing mistakes that shade their reputation, then also the little following (Markel CEO on every podcast, Berkshire on many podcasts too but FFH? Nope....). If they have managed to make 7% even with the mistakes that have been done, if they learned (which i think), investment returns will be significantly above 7%. 

 

Id like to hear how watsa thinks about the stock in an interview, obviously in the earnings call he sounds excited with his 3b+ operating income, its almost as if he is chuckling a bit and hinting on how meaningful the performance actually is. Cheering for the underdog FFH! and as said before, easily thinkable that the market will realize in a couple of years down the road that they are one of the best. 

Edited November 6, 2023 by Luca

[vinod1]

You guys are seriously bitching that market is not recognizing Fairfax after a 100% run up in an year? 

 

Have patience!

 

Give the market some time. It needs 3 dots (3 years earnings data) to then put a line to extrapolate to infinity. Then we might get BV multiple that makes us blush!

 

In the meantime enjoy! (I am sure you guys are smiling ear to ear looking at the share price  )

 

Vinod

[Malmqky]

6 minutes ago, vinod1 said:

You guys are seriously bitching that market is not recognizing Fairfax after a 100% run up in an year? 

 

Have patience!

 

Give the market some time. It needs 3 dots (3 years earnings data) to then put a line to extrapolate to infinity. Then we might get BV multiple that makes us blush!

 

In the meantime enjoy! (I am sure you guys are smiling ear to ear looking at the share price  )

 

Vinod

Just continued to be puzzled by the valuation

 

But yes, perspective is everything. 100% in a year is nothing to sneeze at.

[Parsad]

5 minutes ago, Malmqky said:

Just continued to be puzzled by the valuation

 

But yes, perspective is everything. 100% in a year is nothing to sneeze at.

 

200% over three years...with more to come...definitely nothing to sneeze at!  Cheers!

[Viking]

RBC sent out their research report on Fairfax last night. It was pretty positive on the company - with earnings estimates increased. Price target was increased by US$40 to US$1,020. But there was one head scratcher for me... they feel Fairfax should be valued at 1 x BV. Really? After what we have seen Fairfax deliver over the past 3 years? And how they are poised moving forward? So late last night I decided to ask RBC (Scott) what he is seeing that I am missing. I'll let you know if/how he responds.

----------

RBC increased price target for Fairfax to US$1,020 (based on 1 x 2024YE book value). They forecast EPS of $151 in 2023 (up from $135), $140 in 2024 (up from $130) and $150 for 2025 (new).

From: Viking

Subject: Fairfax Question

Date: November 5, 2023 at 11:57:09 PM PST

To: scott.heleniak@rbccm.com

 

Hello Scott. I am a long time RBC customer. I always enjoy reading your weekly research report on insurance and the companies in the P/C insurance space. It is a sector i have followed for about 20 years. I follow Chubb, WR Berkley and Fairfax pretty closely. Currently I only own shares in Fairfax.

 

I have a question on Fairfax. Why do you have a price target of 1 x 2024YE book value? Clearly you are seeing something that I am missing. And I can’t pick it up reading your report (lots of good news and increases in estimates - similar to past quarters). My experience is P/C insurance companies that receive a 1 x BV multiple are ‘problem children:’ expected to deliver poor returns and are also poorly managed.

 

My math says Fairfax will deliver an ROE of around 20% in 2023. Based on your earnings estimates for 2024 and 2025 (which are not aggressive) the company should deliver a mid-teens ROE. That would put them +15% average over 3 years. In 2022, Fairfax’s performance was best-in-class among P/C insurers (they actually grew BV). Weaving it all together, that type of performance (past and expected) is worth a multiple of 1 x 2024 BV? 

 

Fairfax is trading at a PE of 6 x earnings. With solid earnings expected in 2024 and 2025. That also looks very low (i.e. the stock looks very cheap at $900). Based on your earnings estimate, Fairfax will earn close to 50% of its market cap in three years (2023-2025). That type of actual and expected earnings is ‘worth’ a multiple of 1 x 2024BV?

 

Is the issue poor operating earnings?

• From 2016-2020 the average for operating earnings was $1 billion per year. 
• In 2021 it doubled to $1.8 billion.
• In 2022 it tripled to 3.1 billion.
• In 2023 it is tracking to quadruple to $4.3 billion.
• In 2024 it will likely increase further (driven by interest income) to +$4.5 billion. 

My guess is the increase in operating earnings we are seeing with Fairfax is best-in-class among P/C insurers.

 

Operating income = underwriting profit + interest and dividend income + share of profit of associates

 

Is the issue capital allocation?

• In late 2020 and early 2021 they initiated the total return swap position giving exposure to 1.96 million Fairfax shares. Their average cost was $372/share. This investment has made Fairfax shareholders over $1 billion in less than 3 years. 
• In late 2021, Fairfax bought back 2 million shares at US$500/share. With shares trading today at $900 that is looking like a spectacular move for shareholders. (Total share count has come down more than 16% over the past 5 years.)
• In 2022, Fairfax sold their pet insurance business for $1.4 billion. This delivered shareholders a $992 million after tax gain. another big win for shareholders.
• In 2022, they sold their position in Resolute Forest Products for $626 million (plus $183 million CVR). They sold Resolute at the top of the lumber cycle; great decision for shareholders.
• In 2023, Fairfax announced they will be buying out partner Kipco to take their ownership in GIG to 90%. Smart strategic acquisition. When this transaction closes later this year it will significantly boost Fairfax’s insurance premiums and the investment portfolio. Another significant and solid move.

Fairfax also owns one of the fastest growing insurers in India - Digit. They seeded this company as a start-up in 2017 and their investment of $154 million is now worth over $2 billion. This positions Fairfax very well in what is expected to be the fastest growing economy in the world over the next decade (India).

 

I could list many more examples… but I think you get my point. But wait, here is one more example… 

 

The best ‘capital allocation’ decision they have made in recent years is how they have navigated the bear market in bonds.

 

They moved their $37 billion fixed income portfolio to 1.2 years average duration in late 2021 (sold their corporate bonds at a 1% yield and shifted to short term treasuries). In October of this year they have moved their $41 billion fixed income portfolio to 3.1 years average duration. These two moves were brilliant. They protected the company’s balance sheet (unlike other insurers, book value per share has grown meaningfully at Fairfax the last 2 years). And they now allow Fairfax to spike interest income - which doubled in Q3, 2023 compared to prior year. Fairfax is seeing a much quicker earn through to interest income from higher interest rates than other P/C insurers. A big win for shareholders.

 

Is the issue quality of management? 

 

Well given the most important function for a management team is capital allocation, I can’t see a problem here (given what Fairfax has actually accomplished the past 5 years and especially the past 3 years). 

 

Is the issue Fairfax’s past?

 

Yes, Fairfax messed up pretty badly from 2010-2016. However, it recognized its mistakes and got to work to fix them - and fixed them. It took a couple of years to turn the super tanker. From about 2018 Fairfax has been executing exceptionally well. 

 

When I weave it all together I see a company that is firing on all cylinders (insurance and investments). Most importantly, it is delivering a record amount of quality operating earnings and strong earnings overall - and extending the average duration of the bond portfolio to 3.1 years ensures interest income will be strong for the next three years. Fairfax's prospects have never looked better. Yes, the stock has been one of the best performing financial stocks over the past 3 years (up more than 200%). But the fundamentals have also been significantly improving. So even at US$900, the stock continues to look very undervalued. 

 

So again, I come back to my original question. A company that has delivered all that I quickly outlined above is worth 1 x 2024BV? I think you are a very hard marker Or, more likely, you see something that I am missing. 

 

I try and be inquisitive and open minded. Clearly, I am not understanding something important regarding Fairfax. I would appreciate any feedback you are able to provide. 

 

Regards.

 

Viking

 

----------

 

 

 

 

 

Edited November 6, 2023 by Viking

[Luke]

28 minutes ago, Viking said:

RBC send out their research report on Fairfax last night. It was pretty positive on the company - with earnings estimates increased. Price target was increased by US$40 to US$1,020. But there was one head scratcher for me... they feel Fairfax should be valued at 1 x BV. Really? After what we have seen Fairfax deliver over the past 3 years? And how they are poised moving forward? So late last night I decided to ask RBC (Scott) what he is seeing that I am missing. I'll let you know if he responds.

----------

RBC increased price target for Fairfax to US$1,020 (based on 1 x 2024YE book value). They forecast EPS of $151 in 2023 (up from $135), $140 in 2024 (up from $130) and $150 for 2025 (new).

From: Viking

Subject: Fairfax Question

Date: November 5, 2023 at 11:57:09 PM PST

To: scott.heleniak@rbccm.com

 

Hello Scott. I am a long time RBC customer. I always enjoy reading your weekly research report on insurance and the companies in the P/C insurance space. It is a sector i have followed for about 20 years. I follow Chubb, WR Berkley and Fairfax pretty closely. Currently I only own shares in Fairfax.

 

I have a question on Fairfax. Why do you have a price target of 1 x 2024YE book value? Clearly you are seeing something that I am missing. And I can’t pick it up reading your report (lots of good news and increases in estimates - similar to past quarters). My experience is P/C insurance companies that receive a 1 x BV multiple are ‘problem children:’ expected to deliver poor returns and are also poorly managed.

 

My math says Fairfax will deliver an ROE of around 20% in 2023. Based on your earnings estimates for 2024 and 2025 (which are not aggressive) the company should deliver a mid-teens ROE. That would put them +15% average over 3 years. In 2022, Fairfax’s performance was best-in-class among P/C insurers (they actually grew BV). Weaving it all together, that type of performance (past and expected) is worth a multiple of 1 x 2024 BV? 

 

Fairfax is trading at a PE of 6 x earnings. With solid earnings expected in 2024 and 2025. That also looks very low (i.e. the stock looks very cheap at $900). Based on your earnings estimate, Fairfax will earn close to 50% of its market cap in three years (2023-2025). That type of actual and expected earnings is ‘worth’ a multiple of 1 x 2024BV?

 

Is the issue poor operating earnings?

• From 2016-2020 the average for operating earnings was $1 billion per year. 
• In 2021 it doubled to $1.8 billion.
• In 2022 it tripled to 3.1 billion.
• In 2023 it is tracking to quadruple to $4.3 billion.
• In 2024 it will likely increase further (driven by interest income) to +$4.5 billion. 

My guess is the increase in operating earnings we are seeing with Fairfax is best-in-class among P/C insurers.

 

Operating income = underwriting profit + interest and dividend income + share of profit of associates

 

Is the issue capital allocation?

• In late 2020 and early 2021 they initiated the total return swap position giving exposure to 1.96 million Fairfax shares. Their average cost was $372/share. This investment has made Fairfax shareholders over $1 billion in less than 3 years. 
• In late 2021, Fairfax bought back 2 million shares at US$500/share. With shares trading today at $900 that is looking like a spectacular move for shareholders. (Total share count has come down more than 16% over the past 5 years.)
• In 2022, Fairfax sold their pet insurance business for $1.4 billion. This delivered shareholders a $992 million after tax gain. another big win for shareholders.
• In 2022, they sold their position in Resolute Forest Products for $626 million (plus $183 million CVR). They sold Resolute at the top of the lumber cycle; great decision for shareholders.
• In 2023, Fairfax announced they will be buying out partner Kipco to take their ownership in GIG to 90%. Smart strategic acquisition. When this transaction closes later this year it will significantly boost Fairfax’s insurance premiums and the investment portfolio. Another significant and solid move.

Fairfax also owns one of the fastest growing insurers in India - Digit. They seeded this company as a start-up in 2017 and their investment of $154 million is now worth over $2 billion. This positions Fairfax very well in what is expected to be the fastest growing economy in the world over the next decade (India).

 

I could list many more examples… but I think you get my point. But wait, here is one more example… 

 

The best ‘capital allocation’ decision they have made in recent years is how they have navigated the bear market in bonds.

 

They moved their $37 billion fixed income portfolio to 1.2 years average duration in late 2021 (sold their corporate bonds at a 1% yield and shifted to short term treasuries). In October of this year they have moved their $41 billion fixed income portfolio to 3.1 years average duration. These two moves were brilliant. They protected the company’s balance sheet (unlike other insurers, book value per share has grown meaningfully at Fairfax the last 2 years). And they now allow Fairfax to spike interest income - which doubled in Q3, 2023 compared to prior year. Fairfax is seeing a much quicker earn through to interest income from higher interest rates than other P/C insurers. A big win for shareholders.

 

Is the issue quality of management? 

 

Well given the most important function for a management team is capital allocation, I can’t see a problem here (given what Fairfax has actually accomplished the past 5 years and especially the past 3 years). 

 

Is the issue Fairfax’s past?

 

Yes, Fairfax messed up pretty badly from 2010-2016. However, it recognized its mistakes and got to work to fix them - and fixed them. It took a couple of years to turn the super tanker. From about 2018 Fairfax has been executing exceptionally well. 

 

When I weave it all together I see a company that is firing on all cylinders (insurance and investments). Most importantly, it is delivering a record amount of quality operating earnings and strong earnings overall - and extending the average duration of the bond portfolio to 3.1 years ensures interest income will be strong for the next three years. Fairfax's prospects have never looked better. Yes, the stock has been one of the best performing financial stocks over the past 3 years (up more than 200%). But the fundamentals have also been significantly improving. So even at US$900, the stock continues to look very undervalued. 

 

So again, I come back to my original question. A company that has delivered all that I quickly outlined above is worth 1 x 2024BV? I think you are a very hard marker Or, more likely, you see something that I am missing. 

 

I try and be inquisitive and open minded. Clearly, I am not understanding something important regarding Fairfax. I would appreciate any feedback you are able to provide. 

 

Regards.

 

Viking

 

----------

 

 

 

 

 

 

Excited for the reply, very precise and great email! 

[MMM20]

@Viking have you heard back from these analysts when you’ve contacted them in the past? My understanding is you shouldn’t expect a response (at least not much more than a sentence) unless you’re managing $100mm+ and/or paying RBC a whole lot of commissions. But anyway, that email is a great summary of the situation.

 

Edited November 6, 2023 by MMM20

[Viking]

13 minutes ago, MMM20 said:

@Viking have you heard back from these analysts when you’ve contacted them in the past? My understanding is you shouldn’t expect a response (at least not much more than a sentence) unless you’re managing $100mm+ and/or paying RBC a whole lot of commissions. But anyway, that email is a great summary of the situation.

 

 

@MMM20 , in the past I emailed Mark Dwelle at RBC. He got back to me... and said he was impressed that someone was actually reading his reports on P/C insurance. Cracked me up at the time. I think he retired a couple of months ago. I really enjoyed reading Mark's stuff... he educated readers, was thorough and had a wicked sense of humour. I am wondering if Scott is perhaps US based and just doesn't follow Fairfax. 

[Crip1]

For years my wife earned the reputation of seldom answering her phone when my sons or I would call her. All of us would remark about that to her, either individually or when we all got together. It started to bother her which prompted her to ask me “How can I get you guys to stop saying that?”. My response: “Answer your phone, baby”. Over the past few years her “answer rate” has gone up significantly and when she doesn’t answer, she normally calls back within a couple of minutes (which is just as good as answering). The reputation she had is all but gone, now. To be clear, if she started to answer on the first ring vs the second ring vs the third ring, it would not really matter. The important thing was avoiding NOT answering. 

 

This is analogous to FFH. The concern amongst detractors out there is not that they can make good or better cap allocation decisions, it’s that they still have the reputation of making mistakes, and a few biggies at that. How to lose that reputation? Stop making mistakes. It’s just going to take time to lose that reputation. 

 

-Crip

 

P. S. In the meantime, the company and the individual shareholders can add more at good prices…not a bad thing.
 

[Thrifty3000]

I bought a pretty good chunk of McKesson for $125 per share towards the end of 2018. It was way out of favor because of opioid liability fears. The price declined from my initial purchase before Mr. Market started waking up to how much cash that company generates and how quickly it could overcome even a worst case scenario. Took about 3 years for the price to double, and only another 2 years after that to double again - once the earnings track record was clearly reestablished post-opioid settlements. Mr. Market has fallen in love with MCK again, so it's selling for an aggressive multiple now, despite not really having the most exciting growth prospects. So, after enjoying my ownership of MCK for a looong 5 years, I've lately been selling in favor of cash.

 

I think we're only around mid-way through the FFH turnaround story. I think we're about where McKesson was a couple years ago. I think FFH will have a few more strong legs up as either Mr. Market sees 3 strong years of earnings in a row, or more likely, as Mr. Market begins to more confidently forecast the 3 strong years of earnings while also waking up to FFH's longer term earning power. Each large upward leg in share price will only catch more attention. I don't think we'll have to wait 3 years for Mr. Market to fully value, and very possibly, start to overvalue FFH - especially if earnings forecasts for years 4 and beyond solidly exceed $150 per share.

 

A $2,000 per share price tag for FFH a couple years from now is certainly not out of the question.

Edited November 6, 2023 by Thrifty3000

[Thrifty3000]

6 hours ago, Viking said:

RBC sent out their research report on Fairfax last night. It was pretty positive on the company - with earnings estimates increased. Price target was increased by US$40 to US$1,020. But there was one head scratcher for me... they feel Fairfax should be valued at 1 x BV. Really? After what we have seen Fairfax deliver over the past 3 years? And how they are poised moving forward? So late last night I decided to ask RBC (Scott) what he is seeing that I am missing. I'll let you know if/how he responds.

----------

RBC increased price target for Fairfax to US$1,020 (based on 1 x 2024YE book value). They forecast EPS of $151 in 2023 (up from $135), $140 in 2024 (up from $130) and $150 for 2025 (new).

From: Viking

Subject: Fairfax Question

Date: November 5, 2023 at 11:57:09 PM PST

To: scott.heleniak@rbccm.com

 

Hello Scott. I am a long time RBC customer. I always enjoy reading your weekly research report on insurance and the companies in the P/C insurance space. It is a sector i have followed for about 20 years. I follow Chubb, WR Berkley and Fairfax pretty closely. Currently I only own shares in Fairfax.

 

I have a question on Fairfax. Why do you have a price target of 1 x 2024YE book value? Clearly you are seeing something that I am missing. And I can’t pick it up reading your report (lots of good news and increases in estimates - similar to past quarters). My experience is P/C insurance companies that receive a 1 x BV multiple are ‘problem children:’ expected to deliver poor returns and are also poorly managed.

 

My math says Fairfax will deliver an ROE of around 20% in 2023. Based on your earnings estimates for 2024 and 2025 (which are not aggressive) the company should deliver a mid-teens ROE. That would put them +15% average over 3 years. In 2022, Fairfax’s performance was best-in-class among P/C insurers (they actually grew BV). Weaving it all together, that type of performance (past and expected) is worth a multiple of 1 x 2024 BV? 

 

Fairfax is trading at a PE of 6 x earnings. With solid earnings expected in 2024 and 2025. That also looks very low (i.e. the stock looks very cheap at $900). Based on your earnings estimate, Fairfax will earn close to 50% of its market cap in three years (2023-2025). That type of actual and expected earnings is ‘worth’ a multiple of 1 x 2024BV?

 

Is the issue poor operating earnings?

• From 2016-2020 the average for operating earnings was $1 billion per year. 
• In 2021 it doubled to $1.8 billion.
• In 2022 it tripled to 3.1 billion.
• In 2023 it is tracking to quadruple to $4.3 billion.
• In 2024 it will likely increase further (driven by interest income) to +$4.5 billion. 

My guess is the increase in operating earnings we are seeing with Fairfax is best-in-class among P/C insurers.

 

Operating income = underwriting profit + interest and dividend income + share of profit of associates

 

Is the issue capital allocation?

• In late 2020 and early 2021 they initiated the total return swap position giving exposure to 1.96 million Fairfax shares. Their average cost was $372/share. This investment has made Fairfax shareholders over $1 billion in less than 3 years. 
• In late 2021, Fairfax bought back 2 million shares at US$500/share. With shares trading today at $900 that is looking like a spectacular move for shareholders. (Total share count has come down more than 16% over the past 5 years.)
• In 2022, Fairfax sold their pet insurance business for $1.4 billion. This delivered shareholders a $992 million after tax gain. another big win for shareholders.
• In 2022, they sold their position in Resolute Forest Products for $626 million (plus $183 million CVR). They sold Resolute at the top of the lumber cycle; great decision for shareholders.
• In 2023, Fairfax announced they will be buying out partner Kipco to take their ownership in GIG to 90%. Smart strategic acquisition. When this transaction closes later this year it will significantly boost Fairfax’s insurance premiums and the investment portfolio. Another significant and solid move.

Fairfax also owns one of the fastest growing insurers in India - Digit. They seeded this company as a start-up in 2017 and their investment of $154 million is now worth over $2 billion. This positions Fairfax very well in what is expected to be the fastest growing economy in the world over the next decade (India).

 

I could list many more examples… but I think you get my point. But wait, here is one more example… 

 

The best ‘capital allocation’ decision they have made in recent years is how they have navigated the bear market in bonds.

 

They moved their $37 billion fixed income portfolio to 1.2 years average duration in late 2021 (sold their corporate bonds at a 1% yield and shifted to short term treasuries). In October of this year they have moved their $41 billion fixed income portfolio to 3.1 years average duration. These two moves were brilliant. They protected the company’s balance sheet (unlike other insurers, book value per share has grown meaningfully at Fairfax the last 2 years). And they now allow Fairfax to spike interest income - which doubled in Q3, 2023 compared to prior year. Fairfax is seeing a much quicker earn through to interest income from higher interest rates than other P/C insurers. A big win for shareholders.

 

Is the issue quality of management? 

 

Well given the most important function for a management team is capital allocation, I can’t see a problem here (given what Fairfax has actually accomplished the past 5 years and especially the past 3 years). 

 

Is the issue Fairfax’s past?

 

Yes, Fairfax messed up pretty badly from 2010-2016. However, it recognized its mistakes and got to work to fix them - and fixed them. It took a couple of years to turn the super tanker. From about 2018 Fairfax has been executing exceptionally well. 

 

When I weave it all together I see a company that is firing on all cylinders (insurance and investments). Most importantly, it is delivering a record amount of quality operating earnings and strong earnings overall - and extending the average duration of the bond portfolio to 3.1 years ensures interest income will be strong for the next three years. Fairfax's prospects have never looked better. Yes, the stock has been one of the best performing financial stocks over the past 3 years (up more than 200%). But the fundamentals have also been significantly improving. So even at US$900, the stock continues to look very undervalued. 

 

So again, I come back to my original question. A company that has delivered all that I quickly outlined above is worth 1 x 2024BV? I think you are a very hard marker Or, more likely, you see something that I am missing. 

 

I try and be inquisitive and open minded. Clearly, I am not understanding something important regarding Fairfax. I would appreciate any feedback you are able to provide. 

 

Regards.

 

Viking

 

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Maybe a 1x BV valuation is just another way of saying they don’t have enough reason to expect FFH’s long term ROE to exceed whatever discount rate they’re modeling.

[Thrifty3000]

Maybe they expect 3 or 4 good peak-cycle years to be offset by 3 or 4 trough years. Not an unheard of scenario for FFH historically. (However, I’m in the camp that believes this unusually strong peak-cycle experience for FFH will set it up to take advantage of the trough from a position of strength. But, I have a hunch analysts have little incentive to join our camp.)

[Viking]

26 minutes ago, Thrifty3000 said:

Maybe a 1x BV valuation is just another way of saying they don’t have enough reason to expect FFH’s long term ROE to exceed whatever discount rate they’re modeling.

@Thrifty3000 I could buy that if other P/C insurers were being valued the same way. Other P/C insurers have been significantly underperforming Fairfax for the past 4 years. The multiples RBC is using for companies is largely the same as it was 4 years ago (with some minor modifications). Please note, i am not complaining. How can i complain about a stock being up 200% in 3 years - that is still wicked cheap. Fairfax is climbing the wall of worry right now.