Fairfax 2024

[modiva]

51 minutes ago, Viking said:

@modiva I included the numbers since inception because those are the numbers that Fairfax has actually delivered. Having said that, i did not include those numbers to suggest that is the performance that they will deliver (across all metrics) moving forward. I think Fairfax can deliver mid to high teens growth in BV in the coming years.  Float? No, not that high. 
 

I do think the numbers Fairfax delivered from 2010-2020 are artificially low. If we think it makes sense to throw out the numbers from the early years (because they are artificially high) then i think it might also makes sense to throw out the numbers from 2010-2020. The numbers from 2010-2020 contain so much noise (like $5.4 billion in losses from the equity hedge/short positions that won’t be repeated in the future) that it affects their usefulness as a baseline to project what might happen in the future.

 

But i do get your point.

Thanks @Viking for generously sharing excellent insights, very much appreciated!

[Viking]

2 hours ago, petec said:

 

Yes - and one that would have been laughed at on here 5 short years ago!

@petec, as is usual, you make a very insightful point. 
 

There has been an enormous amount change in the results that Fairfax is delivering today compared to 5 short years ago. I thought it was refreshing to hear Prem at the AGM say even Fairfax did not see it coming (the magnitude of the change). 
 

To capitalize on Fairfax the past 5 years, an investor has needed to:

- stay inquisitive

- keep an open mind

 

These are two traits Stan Druckenmiller said he looks for in new hires. 
 

Investors who were unable ‘stay inquisitive’ and ‘keep an open mind’ completely missed the opportunity that has unfolded with Fairfax over the past 5 years. They probably still are.
 

I started to get interested in Fairfax as an investment again (in a big way) back in 2019. I had no idea this is how things would play out. It has been an absolutely crazy ride (in a good way). Many long-term Fairfax watchers have made similar comments in the recent past.

 

The ‘facts’ have been changing at a mind-boggling pace pretty much every year for the past 5 years. So much so, it has been hard to keep up.
 

External events certainly helped. You have highlighted this in the past. 
- Hard market in insurance.
- Interest rates normalizing at much higher levels.

- Record bull markets in steel and lumber. 

- Wicked volatility in bond and stock markets.
 

And Fairfax’s execution has been unbelievable. They have hit the ball out of the park on numerous occasions. 
 

The end result is we are now in uncharted territory with Fairfax.
1.) What is a ‘normalized’ level of earnings?

2.) How much will earnings grow in the comings years?

3.) What is the intrinsic value of the company as it exists today? 
 

Of the three questions i ask above, i think we are probably able to answer the first with some accuracy. Because we have 2023 in the books. The second question? This is where i think investors are way off base today (too low). And this is then resulting in a big miss with question 3 (also too low).
 

Looking ahead another 5 years… I can’t wait to see how things play out.

 

—————

 

Looking 5 years into the future (2028), what will Fairfax deliver?

 

1.) Float per share?

2.) Investments per share?

3.) 5 year average return on investments?

4.) Net Premiums written per share?

5.) 5 year average combined ratio?

6.) Earnings per share?

 

For each of the measures above, ‘amounts accruing to common shareholders.’

Edited June 3 by Viking

[Dinar]

According to Heard on the Street column in the WSJ, reinsurance pricing is down 5% on same risk basis.  

[StubbleJumper]

2 hours ago, Dinar said:

According to Heard on the Street column in the WSJ, reinsurance pricing is down 5% on same risk basis.  

 

Ouch.  Is the market finally turning? 

 

We are three days into the 2024 hurricane season, which the experts say will have a larger number of named storms and perhaps stronger than usual storms.  

 

Not sure that I like the sound of all of this.

 

 

SJ

[Dinar]

25 minutes ago, StubbleJumper said:

 

Ouch.  Is the market finally turning? 

 

We are three days into the 2024 hurricane season, which the experts say will have a larger number of named storms and perhaps stronger than usual storms.  

 

Not sure that I like the sound of all of this.

 

 

SJ

You are right, but the question is what is priced in?  One can plausibly argue that Fairfax will earn its market cap over the next five to six years, so it seems to me that the market is pricing in some softness in the reinsurance space.

[petec]

23 hours ago, Viking said:

To capitalize on Fairfax the past 5 years, an investor has needed to:

- stay inquisitive

- keep an open mind

 

For me it was:

• Understanding of the fact (and I do think it was a fact) that FFH was a curate's egg of underappreciated value, and
• Something approaching blind faith in Prem.

The latter is something I have thought about a lot. I was probably one of Prem's bigger defenders on this board during the dark years, and in particular defended his approach to macro. I was clearly totally wrong about that. But I also felt that a lot of the criticisms of his personal conduct and morals were wrong, and I felt he had built a culture that would win out in the end. It is interesting to see others come round to that view *after* results have improved. I have no idea whether I was smart or lucky. But I clearly wasn't as smart as those who didn't own this during the dark decade and then timed their re-entry well. 

 

[Cigarbutt]

8 hours ago, Dinar said:

You are right, but the question is what is priced in?  One can plausibly argue that Fairfax will earn its market cap over the next five to six years, so it seems to me that the market is pricing in some softness in the reinsurance space.

People who seem to follow the industry comment that, even if pricing has gone down slightly, contract and term conditions have remained tight, which is a subjective input that remains to be seen.

Anyways, historical perspective may be helpful:

Edited June 4 by Cigarbutt
spelling

[Dynamic]

This Watsa interview from 2011's first edition of the Fairfax Newsletter was interesting, posted here on Twitter/X by FindingComputers.

 

I'm afraid it's only in text as image format so you may need to zoom in and/or rotate a phone if reading it there.

[Viking]

If you wanted to understand the 'transformation' that has happened at Fairfax over the past 4 years in one chart this would probably be it. 

 

Note: my original chart had a calculation error which has been corrected in the chart below. I will talk to quality control to review what happened

 

The 5 income streams below flow into Fairfax's earnings:

1.) The total from all 5 income streams has increased from $1.8 to $5.7 billion.

- from $68/share to $259/share or 282%.

2.) Operating income has increased from $1 billion to $4.5 billion.

- from $39/share to $204/share or 426%.  

 

High quality operating income now represents 79% of all income streams, up from 55%. That is a game changer.

 

 

 

Edited June 6 by Viking

[Gamma78]

10 hours ago, Viking said:

If you wanted to understand the 'transformation' that has happened at Fairfax over the past 4 years in one chart this would probably be it. 

 

The 5 income streams below flow into Fairfax's earnings:

1.) The total from all 5 income streams has increased from $1.8 to $5.9 billion.

- from $68/share to $267/share or 293%.

2.) Operating income has increased from $1 billion to $4.87 billion.

- from $39/share to $219/share or 466%.  

 

High quality operating income now represents 82% of all income streams, up from 55%. That is a game changer.

 

 

 

Wow that is a really great way to capture the change. The thing I take away really is that while some believe there is a risk of results reverting to the previous time period's averages, the reality is that in that world of 0% interest rates float was worthless and interest/dividends were unrewarding. So even in a softer insurance market results should still on average be better than the past. Let alone the stellar results we are seeing now in a hard market. 

 

Someday that will be reflected fully in the price. Someday. 

[Viking]

4 hours ago, gamma78 said:

 

Wow that is a really great way to capture the change. The thing I take away really is that while some believe there is a risk of results reverting to the previous time period's averages, the reality is that in that world of 0% interest rates float was worthless and interest/dividends were unrewarding. So even in a softer insurance market results should still on average be better than the past. Let alone the stellar results we are seeing now in a hard market. 

 

Someday that will be reflected fully in the price. Someday. 

When you compare Fairfax’s income streams to traditional P/C insurers there are big differences.
 

Here is the split for most traditional P/C insurers:

- underwriting = 50%

- interest and dividends = 45%

- misc = 5%

 

A soft market in insurance will impact Fairfax’s earnings much less than it will impact traditional P/C insurers. Fairfax’s split for underwriting income is 20 to 25%. Fairfax is way more levered to investments. 
 

Fairfax’s significant share buybacks are also important. It is meaningfully increasing all the per share metrics:

- investments per share

- float per share

- earnings per share

 

I hope Fairfax continues to be aggressive with share buybacks. They are generating so much cash. The stock is cheap. It is such an easy / beneficial use of capital.

 

Edited June 6 by Viking

[dartmonkey]

15 hours ago, Viking said:

If you wanted to understand the 'transformation' that has happened at Fairfax over the past 4 years in one chart this would probably be it. 

 

The 5 income streams below flow into Fairfax's earnings:

1.) The total from all 5 income streams has increased from $1.8 to $5.9 billion.

- from $68/share to $267/share or 293%.

2.) Operating income has increased from $1 billion to $4.87 billion.

- from $39/share to $219/share or 466%.  

 

High quality operating income now represents 82% of all income streams, up from 55%. That is a game changer.

 

 

 

It looks like you wanted to add the effective shares outstanding for the 5 years 2016 to 2020. 

 

2016: 23.1m

2017: 27.8m

2018: 27.2m

2019: 26.8m

2020: 26.2m

Average, 2016-2020: 26.2m

 

2024e: 22.2m

Change, 2016-2020 to end 2024: -15%

 

By the way, looking at annual reports to compile these numbers, I noticed how often the word 'outstanding' is used in the annual letter, apart from referring to shares outstanding. A lot!! 

 

2016: 17

2017: 13

2018: 14

2019: 9

2020: 23

Average, 2016-2020: 15

 

2023: 29

Increase: almost 100%

 

In retrospect, 2020 would have been a pretty nice time to invest, with a sharp uptick in the outstandings, and the trend is still favourable. Maybe this technical indicator performs as well or better than the exclamation point indicator, what do you think?

[LC]

16 minutes ago, dartmonkey said:

In retrospect, 2020 would have been a pretty nice time to invest, with a sharp uptick in the outstandings, and the trend is still favourable. Maybe this technical indicator performs as well or better than the exclamation point indicator, what do you think?

Outstanding find, dartmonkey  

[MMM20]

29 minutes ago, dartmonkey said:

In retrospect, 2020 would have been a pretty nice time to invest, with a sharp uptick in the outstandings, and the trend is still favourable. Maybe this technical indicator performs as well or better than the exclamation point indicator, what do you think?

 

Probably better than Google Trends but worse than Prem buying $150mm personally

[Viking]

Earnings Estimates – Two Year Summary for 2024 & 2025

 

Below is my updated two-year earnings estimate for Fairfax. This forecast includes learnings from Fairfax’s Q1, 2024 earnings release and ‘new news’ from the past couple of months (since the last update). 

 

Summary

 

My current estimate is Fairfax will earn about $155/share in 2024 and about $160/share in 2025. I think both of these estimates have been constructed using mildly conservative assumptions. 

 

 

Will retained earnings be re-invested in a way that builds value for shareholders?

 

Perhaps the hardest piece to forecast with Fairfax today is what they will be doing with the substantial amount of earnings that they are currently generating (more than $4 billion per year). And the impact the re-investment of current earnings will have on future earnings. Both the size - how much. And the speed - how fast. 

 

When it comes to re-investing earnings, Fairfax has lots of very good options:

• Grow insurance (continuation of the hard market; bolt-on acquisitions)
• Buy out minority partners in insurance?
• Buy equities or fixed income securities?
• Buy back a meaningful amount of Fairfax stock? 
• Other?

Looking at the last 5 years, the management team at Fairfax has done an outstanding job with capital allocation. My guess is they will continue to make good decisions (on balance) and this will benefit shareholders in the coming years – likely providing a tailwind to my forecasts for 2024 and 2025.

 

What are current analyst’s earnings estimates for Fairfax?

 

Using Yahoo Finance as a guide (June 3, 2024), analysts estimate that Fairfax will earn:

• US$138/share (C$188) in 2024
• US$152/share (C$208) in 2025 

From what I can see, most analysts are assigning little benefit to the reinvestment of Fairfax’s significant earnings and the company’s proven capital allocation skills. My read is most analysts will include these benefits into their earnings estimates only after Fairfax has announced something.

 

Interest rates: I am assuming interest rates remain roughly at current levels (at June 3, 2024). Of course, this will likely not be the case. Given the duration of the fixed income portfolio (a little under 3 years?) is now closer to the duration of the insurance liabilities (a little under 4 years?), changes in interest rates might roughly balance out (in ‘net gains/losses on investments’ and ‘effects of discounting and risk adjustment- IFRS 17’).

 

Below is a 5-year snapshot of earnings for Fairfax.

 

It communicates in a concise manner the dramatic transformation that has happened at the company, beginning around 2021. There has been a spike in operating income per share – from an average of $39/share from 2016-2020, to $192/share in 2023. This much higher amount now looks like the new baseline for the company. For 2024, my estimate has operating income increasing to $199/share, which is a 400% increase from the average from 2016-2020. ‘Normalized earnings’ at Fairfax have moved to a much higher level – and, importantly, this higher level looks durable/sustainable.

 

 

What are the key assumptions built in to the forecast?

 

1.) Underwriting profit: Estimate = $1.24 billion in 2024.

• Net premiums written growth of 12% in 2024 and 3% in 2025. This is being driven by:
  • Continuation of the hard market, which we estimate will add $1 billion of NPW. 
  • The Gulf Insurance Group (GIG) acquisition, which will add $1.7 billion of NPW.
• Combined ratio (CR) of 95% in both 2024 and 2025.
  • Catastrophe losses: 2024 will be a more normal year (higher than 2023).
    • Fairfax continues to modestly shrink their total catastrophe exposure.
  • Reserve releases: continuation of the positive trend observed in 2023.

2.) Interest and dividend income: Estimate = $2.38 billion in 2024.

• Interest and dividend income in Q1 2023 was $590 million; this provides a good baseline.
  • GIG added $2.4 billion to the total investment portfolio in late 2023.
• Rate cuts by global central banks could be a headwind in 2H, 2024.

3.) Share of profit of associates: Estimate = $900 million in 2024.

• Earnings at Eurobank and Poseidon/Atlas should continue to chug along.
• Stelco (steel) EXCO (nat gas prices) results will be volatile. 
• GIG will be a small headwind as it is now a consolidated holding.

4.) Effects of discounting and risk adjustment (IFRS 17):

• The two key drivers for this bucket are the trend in net written premiums of the insurance business and changes in interest rates.
• Net written premiums growth of 12% in 2024 should be a tailwind. 
• This bucket is difficult to model – my confidence level in my estimates is low. 

5.) Life insurance and runoff: Estimate = $250 million in 2024.

• This combination of businesses lost about $348 million in 2023 (not including investment returns). I expect 2024 to be a little better, with life insurance being a modest tailwind.

6.) Other (revenue-expenses) - non-insurance subsidiaries: Estimate = $150 million in 2024.

• Recipe, Dexterra, AGT, Grivalia Hospitality, Boat Rocker etc.  
• This combination of businesses earned $46 million in 2023. 
• This bucket is poised to grow nicely in the coming years. Yes, the results will be lumpy.

7.) Interest expense: Estimate = $610 million

• An increase to prior year which was $510 million.

8.) Corporate overhead and other: Estimate = $435 million in 2024.

• A modest increase to prior year which was $430 million.

9.) Net gains on investments: Estimate = $1.075 billion in 2024.

• The big driver will be the FFH-TRS position. $250/share x 1.96mn shares = $500 million?
• Remaining mark to market holdings of $7 billion x 7% return = $500 million?

10.) Gain on sale/deconsol of insurance sub: Estimate = $0 in 2024. Simply being conservative.

• This is where I put the large asset sales/revaluations. These items are difficult to forecast. I will add these items to my forecast when they happen.
• 2023 transactions: sale of Ambridge and the revaluation of GIG = total of $550 million.

Bottom line, this bucket is a wild card. But Fairfax has a long history of surfacing significant value hidden on its balance sheet. When they do, we see significant realized gains (from both insurance and non-insurance holdings).

 

11.) Income taxes: Estimate = 19% (historical average rate)

 

12.) Non-controlling interests: I am expecting Fairfax to take out one of its minority partners in 2024. From my perspective, the leading candidate looks like Brit. My second choice would be increasing their ownership in Allied World to perhaps 90% (from 83.4% today). 

• In the past, I used an average rate of 11% (amount of net earnings that was allocated to non-controlling interests). This has been reduced to 9.5% in 2024 and 7.5% in 2025. 
• This change increases the amount of net earnings going to Fairfax shareholders (the numerator in the EPS calculation).

13.) Shares Outstanding: Estimate = 22.2 million effective shares outstanding (Dec 31, 2024).

• This would be a reduction of 800,000 shares in 2024 (3.5%). A significant number.
• To May 10, effective shares outstanding have been reduced by 561,102 to 22.44 million.

Notes:

• Underwriting profit’: Includes insurance and reinsurance; does not include runoff or Eurolife life insurance.
• Interest and dividends’ and ‘share of profit of associates’: Includes insurance, reinsurance and runoff.

—————

Return on Equity Calculation

 

Return on equity (ROE) is calculated using ‘average equity’ which is:

• (PY ending BV/share + CY ending BV/share) / 2

I think most of the industry (other P/C insurance companies, analysts) calculates ROE using an average number for equity. This should make my ROE estimates comparable with industry numbers.

Edited June 8 by Viking

[Gamma78]

@Viking this may be a silly question - but apart from the repurchase of shares in your model (which I think is about $700 million or so at today's prices) the residual earnings from the forecasted years are accumulating cash on balance sheet? Or what else? I mean, if all invested in bonds wouldn't that itself throw off a couple of hundred million per year incremental in interest & dividends? Am I missing something?

[Viking]

58 minutes ago, gamma78 said:

@Viking this may be a silly question - but apart from the repurchase of shares in your model (which I think is about $700 million or so at today's prices) the residual earnings from the forecasted years are accumulating cash on balance sheet? Or what else? I mean, if all invested in bonds wouldn't that itself throw off a couple of hundred million per year incremental in interest & dividends? Am I missing something?

 

@gamma78 You ask the question I am grappling with the most these days: "What will Fairfax do with the significant earnings they are currently generating." But more specifically, what will be the impact on Fairfax's different income streams in 2024 and 2025. 

 

We have some answers:

1.) dividend = $15 

- this is about 10% of Fairfax's earnings.

2.) share buybacks = $1 billion?

- this is about 30% of earnings

3.) buy out minority partners in insurance = $500 million?

- this would be about 15% of earnings

- this hasn't happened

 

The three items above 'account' for about 55% of earnings - and are built into my 2024 forecast.

 

The remaining 45% of earnings? This is probably a good example of where my forecast is too conservative. Especially when compounded over a couple of years. 

 

I am forecasting modest organic growth in net premiums written. And small growth in the investment portfolio (including fixed income). 

 

I am not including any large, one time investment gains in my forecast for 2024 or 2025. We know there will likely be some (at some point over the next 24 months) - we just don't know what they will be, their size and the timing. I keep waffling on whether to keep these in the forecast... I removed them from the latest.

 

I would appreciate how other board members are thinking about this same question:

"What will Fairfax do with the significant earnings they are currently generating."  

 

And what will be the impact on Fairfax's different income streams in 2024 and 2025. 

----------

Eurobank dividend: Earlier this year I had assumed Eurobank's dividend would show up in 'interest and dividend income.' But at the AGM the people I talked to said because Eurobank is an associate holding the dividend will not be reported in interest and dividend income but instead will show up in the cash flow statement. Perhaps those who have an accounting background can comment further.

---------

The impact of the Digit IPO will be something to monitor. Especially once Fairfax gets their ownership position confirmed. There may be a realized gain (I am not sure how everything will play out from an accounting perspective). I am not concerned. 

 

Edited June 8 by Viking

[Gamma78]

Ok noted so there are about $4bln over 2 years of unallocated cash earnings which should allow faster compounding if invested (even if invested in boring old bonds), net of any one time investment gains. 

 

Yes this is likely to be conservative, so book growth should beat the 15% mark. Depending on externalities, perhaps even handily. 

[ValueMaven]

Would you rather Chubb at 12x EPS and 1.7x BV, or FFH at 7x EPS and 1.0x BV ?  

[Thrifty3000]

8 hours ago, gamma78 said:

Ok noted so there are about $4bln over 2 years of unallocated cash earnings which should allow faster compounding if invested (even if invested in boring old bonds), net of any one time investment gains. 

 

Yes this is likely to be conservative, so book growth should beat the 15% mark. Depending on externalities, perhaps even handily. 

Sounds like it might conservatively add another $4 or $5 ish per share of earnings annually to what @Viking is projecting.

[Crip1]

14 hours ago, ValueMaven said:

Would you rather Chubb at 12x EPS and 1.7x BV, or FFH at 7x EPS and 1.0x BV ?  

i do not have an answer to this question as I have more knowledge of FFH and Chubb, but taking a step back, this is not the first time we've encountered a "would you rather have X or Y?" in our investing lives. Assuming that the analyses on both show both to be good investments and we can't figure out which is better, it makes more sense to buy both and continue to monitor both. If one of the two look to be executing better than the other (business performance, not necessarily the price of the stock), then sell the underperformer and double down on the other one. This makes a lot more sense to me than an "all or nothing" choice between two good investments.

 

-Crip

[Tommm50]

21 hours ago, gamma78 said:

Ok noted so there are about $4bln over 2 years of unallocated cash earnings which should allow faster compounding if invested (even if invested in boring old bonds), net of any one time investment gains. 

 

Yes this is likely to be conservative, so book growth should beat the 15% mark. Depending on externalities, perhaps even handily. 

 

 Agreed, since we don't know where they'll invest but will assume they'll place it an investment to earn more than

 boring old bonds wouldn't a short term bond return be a good placeholder? Sorry for the run on sentence.

[Thrifty3000]

6 hours ago, Tommm50 said:

 

 Agreed, since we don't know where they'll invest but will assume they'll place it an investment to earn more than

 boring old bonds wouldn't a short term bond return be a good placeholder? Sorry for the run on sentence.

Simply buying back their own shares yields a double digit return, so if they’re investing in something other than buybacks it has to be a pretty high conviction bet with a high probability of outperforming buybacks. That’s a great problem to have.

 

In other words, what would be the rationale for buying short term bonds yielding 4 to 5% when they know with an unprecedented level of certainty that their own shares will be churning out >10% returns for 3 years and beyond?

 

I think it’s perfectly reasonable to set a 10% placeholder for returns on reinvested capital as long as the stock trades at current levels relative to book value.

Edited June 9 by Thrifty3000

[TwoCitiesCapital]

I don't disagree with 

42 minutes ago, Thrifty3000 said:

Simply buying back their own shares yields a double digit return, so if they’re investing in something other than buybacks it has to be a pretty high conviction bet with a high probability of outperforming buybacks. That’s a great problem to have.

 

In other words, what would be the rationale for buying short term bonds yielding 4 to 5% when they know with an unprecedented level of certainty that their own shares will be churning out >10% returns for 3 years and beyond?

 

I think it’s perfectly reasonable to set a 10% placeholder for returns on reinvested capital as long as the stock trades at current levels relative to book value.

 

I don't disagree with your logic of using the share repurchases as a floor for their incremental capital, but there's already a thread here discussing if FFH will break $2,000/sh by then. And it's a good probability it just might. 

 

So am not sure we can just assume that all repurchases will be done at prices or multiples available today. 

 

Either way - debating the return on their return is such a small part of the big picture that I'm not sure it really matters if we get this piece right. 

[Gamma78]

7 hours ago, TwoCitiesCapital said:

I don't disagree with 

 

I don't disagree with your logic of using the share repurchases as a floor for their incremental capital, but there's already a thread here discussing if FFH will break $2,000/sh by then. And it's a good probability it just might. 

 

So am not sure we can just assume that all repurchases will be done at prices or multiples available today. 

 

Either way - debating the return on their return is such a small part of the big picture that I'm not sure it really matters if we get this piece right. 

 

"not sure we can just assume that all repurchases will be done at prices or multiples available today"

 

They better hurry up then!