Fairfax 2024

[Viking]

What is the quality of Fairfax’s equity portfolio?

 

In my last long-form post I posed a question: What is the quality of Fairfax’s equity portfolio?

 

My thesis is as follows: Fairfax’s equity holdings (as a group) have materially improved in quality over the past 6 years. And I don’t think this fact is yet fully recognized by investors today. Moving forward, this could continue to be an important tailwind to earnings.

 

This is the topic we will explore in this post.

 

Now I know for some investors, reading the words ‘quality’ and ‘equity portfolio’ and ‘Fairfax’ all in the same sentence will cause them to laugh uncontrollably out loud. If this is you, try and keep an open mind.

 

I also would appreciate hearing what board members think about this post. Sometimes I get an idea and I have a hard time explaining it (which usually means it is still all jumbled up in my head). So, like spaghetti, I throw it against the proverbial wall at COBF, and see what sticks. The feedback received from other board members helps me flesh out ideas.  Am I on to something important? Or am I out to lunch?

 

Let’s start with the big picture.

 

A quick review: The 3 drivers of earning at Fairfax

 

Insurance + fixed income investments + equity investments = earnings

 

Earnings feeds ROE, which feeds into the multiple, which feeds into the stock price.

 

The important take-away for this post: the return on the equity investments is one of the key drivers of Fairfax’s stock price.

 

Of interest, most investors today likely own Fairfax to get exposure to its insurance business and its fixed income portfolio. Its equity portfolio? Woof! (Not so much.)

 

20 years ago, investors owned Fairfax to get exposure to its equity and fixed income portfolios. Insurance? Woof!

 

How the narrative at Fairfax has changed. But what if the current narrative attached to the equity portfolio is wrong? 

 

Why do we care about the ‘quality’ of the equity portfolio?

 

The ‘quality’ of Fairfax’s equity portfolio will impact two things:

• The return achieved over time
• The volatility of the return

Today investors view Fairfax’s equity portfolio as being of low quality (overall). And they think it is highly volatile. That is what is built into Fairfax’s stock price today.

 

But what if both of these assumptions are wrong?

 

What if Fairfax’s equity portfolio can be characterized as being ‘high quality’ today?  And what if it also has lower volatility moving forward than in the past?

 

If true, this means investors are likely underestimating both the earnings potential of Fairfax and the multiple those earnings deserve (which is tied to volatility).

 

How are we going to measure the quality of Fairfax’s equity portfolio?

 

Let’s open this big can of worms.

 

There is no standard definition of ‘quality’ that can be applied to all companies and industries - this is because every investor has their own definition. The problem with this type of analysis is most people come at it in a subjective way. Not an objective way. So discussing it with others can be like trying wrestle with a greasy pig.

 

How do we remove our own biases from our assessment? Of course, we can’t. Most people don’t even want to. We all have our own investing framework - it’s what allows us to function as investors. And it’s the prism we use when we evaluate the management team at Fairfax.

 

When we look at a stock that Fairfax owns and we comment ‘good’ or ‘bad’ - well, often we are telling others more about our own mental model than about the actual holding or the management team at Fairfax.

 

What about volatility?

 

We can’t really answer the ‘quality’ question without also discussing volatility.

 

Current finance theory states: low volatility = high quality. Potential return matters less.

 

We are going to look to Warren Buffett for guidance on this topic.

 

“Gyrations in Berkshire's earnings don't bother us in the least:  Charlie and I would much rather earn a lumpy 15% over time than a smooth 12%.” Berkshire Hathaway 1996AR

 

From our perspective, if volatility can be reasonably expected to deliver a higher rate of return over time then we can ignore it from the quality discussion.

 

Let’s circle back to our objective.

 

What methodology are we going to use in our analysis?

 

There are a couple of different methods we can use to help us answer the ‘quality’ question:

1. Quantitative - top down/follow the money - focus on the total return being delivered by the equity holdings (as a group).
2. Qualitative/quantitative - bottom up - look at each of the individual holdings and sum our findings into a total.

Quantitative - top down - measure of quality

 

“For a value investor, price has to be the starting point. It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheap enough.” Howard Marks

 

“Price is what you pay. Value is what you get.” Warren Buffett

 

Fairfax has stated they have a pre-tax return target for their equity investments of 15%.

 

Can we use this target as a core input into our ‘quality’ measure?

 

I think we can.

 

I come at the quality discussion in a very simple and selfish way. As an investor in Fairfax, when looking at the equity portfolio (in aggregate), what I want to know is ‘will it deliver a return of 15% per year on average over the next couple of years?’

 

If the equity portfolio has a good chance of delivering a pre-tax return of:

• 15% per year = high quality
• 10% per year = average quality
• 5% per year = below average quality
• Negative return = dog with fleas

Do I really care what Fairfax owns? I kind of do.

 

But what I care about much more is whether or not their portfolio of holdings can hit the stated 15% target.

 

What return would the equity portfolio have to deliver to hit 15%?

 

This number is easy to calculate. The equity portfolio had a market value of about $19 billion at March 31, 2023. (This uses carrying value. And values the FFH-TRS at its notional value).

• $19 billion x 15%  = $2.85 billion

Can Fairfax’s equity holdings deliver a pre-tax return of $2.85 billion in 2024?
 

We have already done this work. It is contained in our earnings estimate for 2024.

 

What do the numbers say?

• Dividends = $170 million
• Share of profit of associates = $1.03 billion
• Other / Non-insurance consolidated holdings = $150 million
• Mark to market investment gains = $1 billion
• Realized one-time investment gains = $300 million
• Change in excess of fair value over carrying value for associate and consolidated holdings = $200 million
• Total = $2.85 billion

Of course, the 6 buckets above do not capture everything. Especially for non-insurance consolidated holdings. And I also cheated a little - I include both insurance and non-insurance holdings when estimating ‘realized one-time investment gains’. But I think my estimate is directionally accurate.

 

Bottom line, my current earnings forecast has Fairfax generating a return of about 15% from its equity holdings in 2024. My guess is this comes as a surprise for most Fairfax shareholders. 

 

Based on our quantitative framework, can we conclude that Fairfax’s equity portfolio is high quality? Yes, I think we can.

 

Let’s now see what our second measure says.

 

Qualitative/quantitative  - bottom up - measure of quality

 

Let’s pivot with our analysis and now look at the individual holdings to see what we can learn. The 80-20 rule applies here. The big holdings are the key - if they perform well then Fairfax’s total return for the equity portfolio will likely be good.

 

Context is also important. How did things look in 2017? How do things look today? Is the trend getting better? If so, how much better?

 

What are some questions we would want to ask when evaluating the individual holdings?

 

To help answer the ‘quality’ question when looking at the individual holdings, here are a few questions that come to mind:

• How good is the management team? Capital allocation?
• Is the balance sheet in good shape? Leverage?
• Is the company profitable? Is growth funded via retained earnings?
• What are the future prospects of the business?
• Other considerations (geography, political/economic situation etc)?
• What has Fairfax’s return been since purchase?
• What is Fairfax’s return potential looking forward?

Back in 2017, Fairfax had a number of large holdings (a majority?) that could be described as follows:

• Poorly managed.
• Stressed balance sheets.
• Not profitable.
• Poor future prospects.
• Past returns for Fairfax were poor.
• Future return potential for Fairfax was poor.

Fast forward to 2024 and it is amazing the turnaround that has been executed by the team at Hamblin Watsa. Over the past 6 years the equity portfolio has seen a complete make-over. The many problems have largely been fixed (run-off, sold, restructured, merged). And capital allocation has been outstanding (new position purchased, buying more of existing positions etc).

 

Let’s look at Fairfax’s top 15 equity holdings:

 

Fairfax has a pretty concentrated equity portfolio. The top 15 positions represent 67% (2/3) of the total portfolio.

 

 

1.) Eurobank

 

Fairfax’s biggest holding today - by far - is Eurobank. It is also the best example of the renaissance that has happened in Fairfax’s equity portfolio over the past 6 years.

 

Back in 2017, Greece was ruled by a far left government and its economy was a mess. Eurobank’s balance sheet was not good (lots of non-performing loans).

 

But look at the transformation that has happened since:

• In 2019, Greece elected a center/right government who got to work reforming the Greek economy.
• Fairfax merged Grivalia Properties with Eurobank to improve its capital position.
• Eurobank’s management team has always been solid - they aggressively shed non-performing loans and shifted capital from Serbia (selling their operations there) to Cypress (buying Hellenic Bank).
• Greece just re-elected the center/right government so the pro-business reforms to the economy will continue. Greece is expected to have one of the top performing economies in Europe in the coming years.
• Bottom line, Eurobank is very well positioned today.

Was Eurobank a quality holding back in 2017? No. It and Greece were turnarounds with an unknown future. Is Eurobank a higher quality holding today than it was in 2017? The answer is an unambiguous yes. And we see this in the return it is delivering to Fairfax.

 

My guess is Eurobank was not earning much money back in 2017. Today? My current forecast is Eurobank will deliver $440 million in share of profit of associates to Fairfax in 2024. Fairfax’s carrying value for Eurobank was $2.1 billion at December 31, 2023. This would deliver a return of 21% to Fairfax. Outstanding.

 

2.) Fairfax - Total Return Swap

 

Fairfax’s second largest equity holding is the FFH-TRS. I include this holding in the ‘equity’ bucket. This holding did not exist is 2017. Fairfax did exit their equity hedge position in late 2016. But in 2017, Fairfax still had significant short positions in place on individual stocks. These positions were not closed out until 2020 and lost about $1 billion in total from 2017-2020. 

 

The ‘swing’ here is enormous - losing $1 billion shorting something you clearly didn’t understand very well - to making +$1 billion on something you understand exceptionally well (your own company). This has been great swing trade for Fairfax and its shareholders.

 

At December 31, 2023 the FFH-TRS position was valued at $1.8 billion. My current forecast is this investment will deliver gains of $500 million in 2024 ($250/share x 1.96 million shares). This would deliver a return of 28% to Fairfax.

 

3.) Poseidon

 

Of all of Fairfax’s largest holdings, Poseidon was the biggest disappointment for me in 2023. The spike in interest rates seemed to catch management at Poseidon flat footed - and thrown a wrench into expected profit growth. Was 2023 the low point for earnings? 2024 will be an important year for Poseidon.

 

My current forecast is Poseidon will deliver $180 million in share of profit of associates to Fairfax in 2024. Fairfax’s carrying value for Poseidon was $1.7 billion at December 31, 2023. This would deliver a return of 10.5% to Fairfax. While below the hurdle rate of 15%, this return is far from being a catastrophe. And it is expected to improve in the coming years.

 

“Poseidon is expected to make net earnings in excess of $400 million in 2024 and $500 million in 2025. We carry our 43% ownership in Poseidon at $1.7 billion – 10x 2024 expected earnings or 8x 2025 expected earnings.” Fairfax 2023AR

 

4.) Fairfax India

 

The key to this holding is BIAL. Is BIAL a higher quality asset today than it was in 2017? The answer is an unambiguous ‘yes’. What BIAL has accomplished over the past 6 years is amazing. It added a second runway and a second terminal. It is perfectly positioned to grow rapidly in the coming years - the runway is long. The management team in place is very good.

 

In 2017, Fairfax owned 48% of BIAL - it did not yet have a control position. Today, Fairfax India owns 64% of BIAL (not adjusting for Anchorage), putting it firmly in control. Today, Fairfax also owns significantly more of Fairfax India (42%) than it did in 2017 (30%). 

 

Modi appears he will be re-elected to a third consecutive term in India. This should cement India’s economic pivot away from a socialist/Soviet model to a more capitalist model. Global capital is exiting China with India being a big beneficiary. India is projected to be the top performing economy in the world over the next decade and Fairfax India is well positioned to benefit from this strong tailwind.

 

Fairfax’s carrying value for Fairfax India is comically low $768 million. A 15% return for Fairfax = $114 million. That is a lay-up.

 

5.) Recipe

 

I have been highly critical of Recipe in the past. Minority shareholders were used like a piggy bank to fund its aggressive and flawed roll-up of restaurant chains in Canada. However, there is a decent business there. Covid was a gut punch - it hit dine-in full service restaurants in Canada especially hard. Spiking inflation, taxes and minimum wages threw more sand in the wheels.

 

Bottom line, Recipe needed to restructure its operations. It got the process started back in 2021 - poorly performing locations/franchisees were closed and debt levels were materially reduced. But that is a hard thing to do as a publicly traded company. In 2022 Fairfax took Recipe private. Fairfax got a great price. And Recipe got the ability to complete its restructuring out of the public/shareholder spotlight.

 

Fairfax’s carrying value for Recipe was $684 million at December 31, 2023. Free cash flow was US$92 million (C$125 million) in 2023 - back to pre-pandemic levels.

 

Price paid matters a lot. Fairfax was able to take Recipe private at a very good price. The company is delivering a solid return to Fairfax.

 

“Recipe, operating in its first full normal year since the pandemic, achieved record system sales in 2023. Sales increased to Cdn$3.7 billion, up 9% from 2022 and 5.6% higher than 2019. Margins also increased by 20 basis points, or 15% in dollars terms, over 2022. Impressively, the company delivered over Cdn$150 million in free cash flow and reduced overall leverage to less than 2.5x. Frank Hennessey, Ken Grondin and his team are focused on continuing to improve the overall margin rate while emphasizing top line growth. Expansion is underway in the United States and India markets as well as organic growth in Canada driven by new restaurants. The company will also be launching new products in its already sizable consumer packaged goods business (where Recipe’s brands are sold in grocery stores). Recipe is carried at 8x enterprise value to EBITDA on our balance sheet or 10x free cash flow.” Fairfax 2023AR

 

The next 5 holdings

 

6.) BDT Capital Partners (private) - this has been an outstanding long-term holding for Fairfax.

 

Who are they? “BDT & MSD Partners is a merchant bank with an advisory and investment platform built to serve the distinct needs of business owners and strategic, long-term investors. We are distinguished by our decades of experience advising at the intersection of founders, families, and businesses, as well as by our differentiated capital base and culture of aligned investing.” https://bdtmsd.com

 

“We continue to invest with Byron Trott through various BDT Capital Funds. Since 2009, we have invested $978 million, have received $979 million in distributions and still have investments with a year-end market value of $683 million. Byron and his team have generated fantastic long-term returns for Fairfax, and we very much look forward to our continued partnership.” Fairfax 2023AR

 

7.) Thomas Cook India (public) - management implemented an aggressive cost cutting plan during Covid. In 2023, people in India started travelling again and revenue at TCIC spiked higher. With a structurally lower cost base, profits have surged. TCIC was a star performer for Fairfax in 2023 - its stock has increased 140% over the past 15 months.

 

“Thomas Cook’s business rebounded in 2023 as travel recovered, with revenues up and a pre-tax profit of $34 million, up from a loss of $2 million last year. Thomas Cook stock price was up 90% in the Indian stock market in 2023. We sold 40 million shares at $1.67 to repay the $60 million we invested last year in the company. Future prospects for Thomas Cook look excellent in the years to come.” Fairfax 2023AR

 

8.) Grivalia Hospitality (private) - this holding gets an ‘incomplete’ from me today. It is a bet on the jockey. George Chryssikos has had the Midas touch for Fairfax in Greece - making them +$1 billion so far. I am inclined to give Fairfax the benefit of the doubt on this one - my guess is it works out ok. We should know much more in 2024 as more resorts come on line.

 

“Grivalia Hospitality, under George Chryssikos, had a strong year of execution as two assets, including its largest, opened for business. The One & Only resort in Athens is a flagship in ultra-luxury hospitality and we are the proud owners. If you haven’t booked your summer vacation yet – you know what to do! 2024 will see one additional asset come into operation – which will take the operating portfolio to five. These include Amanzoe in Porto Heli, ON Residence in Thessaloniki, Avant Mar in Paros, One & Only and 91 Athens Riviera in Athens. Focus now turns to operational and service excellence for these resorts with Greece forecast to receive a record number of tourists in 2024. George has another five high end hotels in development over the next few years. George has an outstanding track record in real estate and as I said last year, he has already made us $1 billion! We expect George to repeat that accomplishment with Grivalia Hospitality over time! At year end we carried Grivalia at €513 million for our 85% stake.” Fairfax 2023AR

 

9.) ShawKwei & Partners (private) - this holding has been a solid long-term performer for Fairfax. The fact Fairfax is adding new capital suggests they like the prospects.

 

“Since 2008 we have invested with founder Kyle Shaw and his private equity firm ShawKwei & Partners. ShawKwei takes significant stakes in middle-market industrial, manufacturing and service companies across Asia, partnering with management to improve their businesses. We have invested $536 million in two funds (with a commitment to invest an additional $64 million), have received cash distributions of $217 million and have a remaining value of $504 million at year-end. The returns to date are primarily from our investment in the 2010 vintage fund, which, though decreasing 8.8% in value in 2023, has generated a 12% compound annual return since 2010. The 2017 vintage fund, which has drawn about 84% of committed capital to date, increased 23.1% in value in 2023 but has a compound annual return of 3.5% since inception. We expect Kyle to make higher returns on monetization of his major assets.” Fairfax 2023AR

 

10.) Micron Technologies (public) - Fairfax materially increased their position in Micron in Q3 of 2022; likely around $60/share. The stock closed today at $128/share so Fairfax is likely up about 100% on its position in less than 2 years. Outstanding.

 

The next 5 holdings

 

11.) EXCO Resources (private): This holding has been a solid performer for Fairfax in recent years. Consolidation seems to be a big trend in oil and gas. My guess is the company gets taken out at some point in the next year or two.

 

“In 2023, Exco Resources (a U.S. oil and gas producer) repurchased 8% of its shares. This increased Fairfax’s ownership of Exco from 44% to 48%. After year end, Exco repurchased another 2% of its shares, increasing our ownership to 49%. Both transactions occurred at steep discounts to intrinsic value. Sometimes, as T. Boone Pickens noted, “it is cheaper to drill for oil (and gas!!) on the stock exchange than it is to drill directly”. Of course, Exco also did plenty of drilling. In 2023, Exco added more than twice as much to its reserves as it extracted through production. With weakness in commodity prices, the present value of proved reserves dropped. However, production volumes increased 3.2% year over year. Exco is well-positioned to navigate commodity price volatility. It has a strong balance sheet, nimble operations and decisive leadership. Chairman John Wilder and CEO Hal Hickey lead Exco. Fairfax’s Wendy Teramoto and Peter Furlan are on its Board. Fairfax is well served by our long-term partners, John and Hal, who transformed Exco into a resilient oil and gas company. Exco is carried on our balance sheet at $418 million or $18.24 per share, approximately 3x net income in 2023, an increase from $12.59 per share last year, due to our share of their 2023 earnings of $5.65 per share.” Fairfax 2023AR

 

12.) Stelco (public): In late 2018, Fairfax paid $193 million for 14.7% of Stelco. Since then Stelco has paid Fairfax $106 million in dividends. Over the past 3 years Stelco has also repurchased 38% of all shares outstanding - so Fairfax now owns 23.6% of Stelco. The CEO of Stelco, Alan Kestenbaum, is a rock star - even Billy Idol would agree. When the next bull market hits the steel market, Stelco and Fairfax are going to make an absolute killing; remember, Fairfax now owns 23.6% of the company. There is also a good chance Stelco gets taken out at a premium valuation by a bigger player.

 

When Fairfax announced their Stelco purchase in late 2018 I hated it. At the time, it screamed ‘old Fairfax’ to me. Boy was I wrong. But I have since updated my view of the holding and I love it today. Facts are facts.

 

But talk to Fairfax detractors - and my guess is they still view Stelco as a shitty investment. It is a commodity producer after all! It cracks me up when I hear the detractors talk about Fairfax’s equity holdings. They usually have no idea what they are talking about. But boy do they ever have a lot of conviction when they express their views.

 

“In a year of volatile steel prices, Stelco performed well, highlighting its competitive cost structure. Stelco’s talented team – led by Alan Kestenbaum, Sujit Sanyal, and Paul Scherzer – continues to be excellent stewards of the business with a keen focus on creating shareholder value. We believe that Stelco owns the best-in-class blast furnace assets in North America, which is highlighted by its industry leading margins. The company’s Lake Erie Works facility has had recent upgrades to its blast furnace, coke battery, a newly constructed co-generation facility and a new pig iron caster. Nippon recently announced an agreement to acquire US Steel at a multiple of 7.8x 2024 EBITDA, a significant premium to Stelco’s trading multiple. We believe the US Steel acquisition highlights the value of blast furnace operations. Stelco continues to have significant net cash on its balance sheet, providing management with flexibility to take advantage of both organic and inorganic growth opportunities. The company rewarded shareholders with a Cdn$3 per share special dividend in addition to its Cdn$1.68 per share regular dividend in 2023. Stelco has raised its regular dividend for 2024 to Cdn$2.00 per share. We believe Stelco has a bright future under Alan Kestenbaum’s leadership. Stelco is carried on our books at $22.44 per share versus a market price of $37.84 per share.” Fairfax 2023AR

 

13.) Commercial International Bank (public): This is a very well run bank. Unfortunately, perpetual currency devaluations in Egypt have made this a tough investment for Fairfax. Fairfax invested $330 million in 2014. As of March 31, 2024, their position was valued at $362 million. Over the past decade, the opportunity cost to Fairfax from this investment has been significant. This holding is one of the last ‘old Fairfax’ positions remaining at Fairfax (that is a decent size).

 

“Commercial International Bank (CIB) results were very strong in 2023 with an ROE of over 40%, net interest margin of almost 8% and loan-loss provision coverage ratio of approximately 230%. There is significant hidden value in the build-up of provisions on the balance sheet which if adjusted for, reduces the price-to-book ratio well below 2x. Since 2014, the bank has continued to compound book value per share and EPS by nearly 20% per annum. The key driver of value to Fairfax and other foreign investors in CIB is the stability of the Egyptian Pound. Fairfax invested the vast majority of its position in CIB in the spring of 2014 when the market cap was less than $5 billion, at exchange rates at the time. During that same time, net profit at CIB in USD terms (at current exchange rates) has more than doubled and the market cap stands at just $7 billion with an estimated 2024 price to earnings ratio of 6x. By comparison, in local currency, the market cap has increased over five times! The Egyptian government has begun a massive asset disposal program to address the country’s high sovereign debt. Execution will be critical to ensure foreign investors more than just tread water on their investments. Hisham Ezz Al-Arab, the Founder of the modern CIB Bank, came back as Chairman in December 2022.” Fairfax 2023AR

 

14.) Occidental Petroleum (public): Initiated in 2022, this is a relatively new position for Fairfax. They increased it meaningfully in 2023. Their average cost is likely around $60/share. Stock closed today at $67. This holding looks well positioned. And it has Warren Buffett’s seal of approval.

 

15.) Mytilineos (public): a global industrial and energy company covering two business Sectors: Energy and Metallurgy. Fairfax initiated their position in Mytilineos in 2012. They more than doubled their position in late 2022 at €18.50/share. Shares closed today at €34. This has turned into another outstanding investment for Fairfax.

 

Summary
 

After all that what have we learned?

 

Can we conclude that Fairfax’s collection of equity holdings are higher quality than what they were in 2017? Yes, i think we can. And by a lot.

 

Fairfax has been hard at work the past 6 years improving the overall quality of its basket of equity holdings. It takes years for that work to show up in reported results. And that is what we are now seeing. We are just now starting to learn what the true earnings power of the equity portfolio is today. 

 

Can we also call the collective holdings ‘high quality’? Given they look poised to deliver a 15% return, yes, i think we can.
 

And my guess is Fairfax is not done with its move up the quality ladder with its collection of equity holdings. This bodes well for higher future returns.

Total Return on Investment Portfolio:

• Fixed income yield = 4.7%
• Equity return = 15%
• Total return on investment portfolio = 7.4%

What about further out - a couple of years into the future? That will depend on the capital allocation decisions that are made. If Fairfax continues to make good capital allocation decisions i don’t see why total return on the investment portfolio can’t stay in the 7.5% range for the next 5 years.

 

Is that baked into the expectations of investors today? No, i don’t think it is.

Edited April 4 by Viking

[giulio]

Here are a couple of things that came to mind while reading your post @Viking. While I agree with parts of it but not all of them, I certainly enjoy the discussion!

 

12 hours ago, Viking said:

There is no standard definition of ‘quality’ that can be applied to all companies and industries

Looking at average ROE, ROIC, ROTCE is a way to measure quality. It's important to understand the normalized earning power over a cycle; more important is ROIIC, that's where the compounding happens.

To answer these questions an investor needs a deep understanding of qualitative aspects (competitive advantage) that cannot be found in reported numbers or excel spreadsheets.

 

This is at the business level. What happens at the "investment level" depends on the price you pay. Here I agree with you and particularly liked the Howard Marks quote.

Overall, I would say that FFH has done better by identifying cheap opportunities (low price) in so-so companies (not great, high-quality companies).

FIH on the other hand, was able to invest in better companies (i.e. NSE, BIAL, IIFL finance, companies that can earn 15%+ ROE and grow long term).

 

When I look at FFH top holdings table and the comments from the AR, it does not flash "quality":

• BDT might be a great relationship to have, but the return from 2009 are sub par. FFH could have easily made 4-5x its money by investing elsewhere (15 years time frame, starting from a low point);
• ShawKwei 12% is not bad at all if they can achieve it consistently;
• Poseidon is probably ok? Double-digit ROE but it takes a lot of debt to get there; it reminds me of BRK investments in utilities  (no homeruns but ok profile with contractual cash flows);
• Eurobank, like all banks, may be a good investment if they do business conservatively and don't need to be recapitalized when the next crisis happens. Maybe their scale and the small number of big banks left in Greece is an advantage. This a perfect example of what I said earlier: by paying a very low price FFH might come out fine with a good CAGR;
• EXCO and Stelco are cyclical and probably enjoyed the good part of their industry cycle, I have no expertise in the area. I recognize Stelco's CEO as a good capital allocator and their lowest cost advantage might help them better navigate a bad industry overall.

CONCLUSION

The question I ask myself more often is how is money going to be invested going forward?

FFH will have a huge amount of capital at its disposal. Higher than any point in the past:

• 1986 to 2022 they received roughly 15B in interest and dividends. over the next 4 years they will receive c. 8B, i.e. more than half of what they got over 36 years!
• the same goes for profit of associates/gains on investment.

Buffett taught us that it's easier to invest bigger amounts of capital in high-quality companies and don't touch them.

When fishing in a lower-quality pool you NEED a low entry price and you must NEVER forget that at some point you must exit the position. You cannot stay indefinitely, or risk doing a round trip with your gains.

This is easier with small positions, way harder if you invest big money and your position is large (% of ownership not portfolio weight).

 

There is a lot to like in the way FFH manages its equities portfolio, e.g. the international exposure, their expertise in foreign markets, strong local relationships, their opportunism in tough times (Templeton's heritage I suppose).

We'll see what happens next, will they tweak their style a bit and adapt? Will they reduce capital via buybacks and higher dividends?

 

G

 

[giulio]

Since I updated my FFH valuation, I'll share it here just in case someone wants to add anything.

I use 3 methods to value FFH

1. Investments + capitalized underwriting profit
   • Starting from the investments portfolio ($65B), I subtract debt (excluding debt @ consolidated equities), preferred shares and NCI
   • I capitalized avg uw profit @ 14x (7%)
   • NAV = $2500
2. Look-through earnings excluding run-off
   • this part relies on more work, estimates and assumptions (e.g. earnings yield on MTM equities of 6%, cash tax rate rather than statutory one, excluding investment gains, ecc)
   • for 2023 I get $5B of EBIT, $4.3B of EBT and $3.2B of net income (a 25% increase YoY)
   • ROE of 16.7% in 2022, 15% in 2023
   • @ P/E of 14x the shares are worth $2000
   • I think 2023 numbers represent a fair, conservative estimate of earning power over the next 4 years (lots of moving parts but they should balance out)
3. P/B
   • if FFH can earn 13-15% on book value, an investor buying @ 1.5 P/B would be paying roughly 12-10x earnings for the company
   • everyone fair multiple would be different but 12x would not strike me as expensive
   • @ 1.5 P/B shares are worth $1500

Overall, I think FFH intrinsic value is closer to $2000 per share and I hope this will prove conservative thanks to strong uw discipline and good capital allocation in the next 4 years.

Book value is probably understated as well.

 

G

[Viking]

3 hours ago, giulio said:

Here are a couple of things that came to mind while reading your post @Viking. While I agree with parts of it but not all of them, I certainly enjoy the discussion!

 

Looking at average ROE, ROIC, ROTCE is a way to measure quality. It's important to understand the normalized earning power over a cycle; more important is ROIIC, that's where the compounding happens.

To answer these questions an investor needs a deep understanding of qualitative aspects (competitive advantage) that cannot be found in reported numbers or excel spreadsheets.

 

This is at the business level. What happens at the "investment level" depends on the price you pay. Here I agree with you and particularly liked the Howard Marks quote.

Overall, I would say that FFH has done better by identifying cheap opportunities (low price) in so-so companies (not great, high-quality companies).

FIH on the other hand, was able to invest in better companies (i.e. NSE, BIAL, IIFL finance, companies that can earn 15%+ ROE and grow long term).

 

When I look at FFH top holdings table and the comments from the AR, it does not flash "quality":

• BDT might be a great relationship to have, but the return from 2009 are sub par. FFH could have easily made 4-5x its money by investing elsewhere (15 years time frame, starting from a low point);
• ShawKwei 12% is not bad at all if they can achieve it consistently;
• Poseidon is probably ok? Double-digit ROE but it takes a lot of debt to get there; it reminds me of BRK investments in utilities  (no homeruns but ok profile with contractual cash flows);
• Eurobank, like all banks, may be a good investment if they do business conservatively and don't need to be recapitalized when the next crisis happens. Maybe their scale and the small number of big banks left in Greece is an advantage. This a perfect example of what I said earlier: by paying a very low price FFH might come out fine with a good CAGR;
• EXCO and Stelco are cyclical and probably enjoyed the good part of their industry cycle, I have no expertise in the area. I recognize Stelco's CEO as a good capital allocator and their lowest cost advantage might help them better navigate a bad industry overall.

CONCLUSION

The question I ask myself more often is how is money going to be invested going forward?

FFH will have a huge amount of capital at its disposal. Higher than any point in the past:

• 1986 to 2022 they received roughly 15B in interest and dividends. over the next 4 years they will receive c. 8B, i.e. more than half of what they got over 36 years!
• the same goes for profit of associates/gains on investment.

Buffett taught us that it's easier to invest bigger amounts of capital in high-quality companies and don't touch them.

When fishing in a lower-quality pool you NEED a low entry price and you must NEVER forget that at some point you must exit the position. You cannot stay indefinitely, or risk doing a round trip with your gains.

This is easier with small positions, way harder if you invest big money and your position is large (% of ownership not portfolio weight).

 

There is a lot to like in the way FFH manages its equities portfolio, e.g. the international exposure, their expertise in foreign markets, strong local relationships, their opportunism in tough times (Templeton's heritage I suppose).

We'll see what happens next, will they tweak their style a bit and adapt? Will they reduce capital via buybacks and higher dividends?

 

G

 

 

@giulio I really enjoyed reading (and thinking) about your post. 

 

Probably the biggest point I have been trying to make with the equity portfolio is the 'change' thing. The end result? I think the equity portfolio is poised to earn a higher rate of return for Fairfax than it has historically.

 

Like you, I have been thinking a lot about the amount of earnings that is being generated by Fairfax, capital allocation and compounding. The set-up today reminds me of a much younger Berkshire Hathaway. There is a good story in there somewhere!

[This2ShallPass]

On 4/3/2024 at 4:49 PM, Viking said:

I come at the quality discussion in a very simple and selfish way. As an investor in Fairfax, when looking at the equity portfolio (in aggregate), what I want to know is ‘will it deliver a return of 15% per year on average over the next couple of years?’

@Viking appreciate the deep dive, it really helped to see each top holding analyzed separately and we can all come to our own conclusions.

 

To me personally, the above is not the definition of quality as even a bad pf could generate >15% in a couple of years if they hit some macro tailwind. If you change the definition to 15% over 10 years, then I agree the only way to achieve that is if underlying investments are higher quality.

 

On the holdings, agree with your analysis on most of them.

• Recipe - It scares me a bit they're actually expanding to US and India. Even US is similar to Canadian market, but I'm pretty sure Indian restaurant market is very different and they have no advantage entering there (the answer to anything India related cannot be "because Prem"). Haven't proven success in home country, poor industry and expanding is not a good combo.

• On 4/3/2024 at 4:49 PM, Viking said:

  Since 2009, we have invested $978 million, have received $979 million in distributions and still have investments with a year-end market value of $683 million.

  BDT, 70% return in 15 years starting from one of the historically low entry points for markets in 2009. I would say definitely unacceptable performance and no reason to stick w them. 

• On 4/3/2024 at 4:49 PM, Viking said:

  We have invested $536 million in two funds (with a commitment to invest an additional $64 million), have received cash distributions of $217 million and have a remaining value of $504 million at year-end.

  That only adds up to 35% cumulative return in 16 years, so not sure how they could have compounded at 12%. Maybe the 2010 fund was a very small inv and the 12% doesn't really matter for overall returns. Same as above unacceptably low returns.

BDT and Shawkwei looks more like old Fairfax to me, stubborn and not willing to admit mistakes or move on. The combined inv is $1.2B which is worrisome. With all the tailwinds and how well Fairfax is positioned for the next 4 years, the slam dunk move seems to be take the $1.2B and buyback shares. Will have much better returns. 

 

On 4/4/2024 at 6:19 AM, giulio said:

Overall, I would say that FFH has done better by identifying cheap opportunities (low price) in so-so companies (not great, high-quality companies).

Very well put @giulio.

 

It's ok if Fairfax feels this is their edge, but some here want to ignore good high quality companies because they screen well (implying price is not cheap), which is a mistake imo. At the huge sums Fairfax will have to invest, getting a predictable 10% will surely get the stock to higher prices than a lumpy 15%..

 

 

[Viking]

1 hour ago, This2ShallPass said:

@Viking appreciate the deep dive, it really helped to see each top holding analyzed separately and we can all come to our own conclusions.

 

To me personally, the above is not the definition of quality as even a bad pf could generate >15% in a couple of years if they hit some macro tailwind. If you change the definition to 15% over 10 years, then I agree the only way to achieve that is if underlying investments are higher quality.

 

On the holdings, agree with your analysis on most of them.

• Recipe - It scares me a bit they're actually expanding to US and India. Even US is similar to Canadian market, but I'm pretty sure Indian restaurant market is very different and they have no advantage entering there (the answer to anything India related cannot be "because Prem"). Haven't proven success in home country, poor industry and expanding is not a good combo.

• BDT, 70% return in 15 years starting from one of the historically low entry points for markets in 2009. I would say definitely unacceptable performance and no reason to stick w them. 

• That only adds up to 35% cumulative return in 16 years, so not sure how they could have compounded at 12%. Maybe the 2010 fund was a very small inv and the 12% doesn't really matter for overall returns. Same as above unacceptably low returns.

BDT and Shawkwei looks more like old Fairfax to me, stubborn and not willing to admit mistakes or move on. The combined inv is $1.2B which is worrisome. With all the tailwinds and how well Fairfax is positioned for the next 4 years, the slam dunk move seems to be take the $1.2B and buyback shares. Will have much better returns. 

 

Very well put @giulio.

 

It's ok if Fairfax feels this is their edge, but some here want to ignore good high quality companies because they screen well (implying price is not cheap), which is a mistake imo. At the huge sums Fairfax will have to invest, getting a predictable 10% will surely get the stock to higher prices than a lumpy 15%..

 

 

 

@This2ShallPass a question:

 

Regarding BDT, when you calculate your total return of 70% are you assuming Fairfax invested the full $978 million in 2009? To calculate a reasonably accurate annual rate of return for Fairfax I think we would need a little more information (like how much Fairfax actually invested in BDT each year since 2009). We would also need to understand what is built into 'market value' of holdings at Dec 31, 2023 (many of the holdings are private companies).

 

For the private holdings we rely heavily on the communication from Fairfax. I don't think Prem is blowing smoke when he says "Byron and his team have generated fantastic long-term returns for Fairfax, and we very much look forward to our continued partnership."

 

Over the past 6 years, it looks to me like Fairfax has been steadily shifting capital from poor performers to stronger performers. If capital allocated to BDT and Shawkwei is increasing it tells me Fairfax sees these two organizations as being solid opportunities moving forward.

 

Why do I give Fairfax the benefit of the doubt? Fairfax's capital allocation track record the past 6 years has been outstanding. For me, they have earned a certain level of trust. 

Edited April 6 by Viking

[This2ShallPass]

 

19 hours ago, Viking said:

Regarding BDT, when you calculate your total return of 70% are you assuming Fairfax invested the full $978 million in 2009?

Yes Viking, I just did a cumulative return but we don't have enough details to calculate time weighted CAGR. It's possible they invested small w BDT at the start. Still 15 years is a long time to get 70%. Unless, they just did a token investment in 2009 and 80-90% of the $978M was invested 5 years ago. In this case, commentary while factually correct is misleading, they shouldn't say we're investing with them for 15 years.

 

Also, in that best case scenario, BDT would have only got Fairfax 15% cagr over the last 5 years. I cannot square with Prem's comments about fantastic long term returns - 15% is good not fantastic, 5 years is not long term and 70% total return is so-so. 

 

Maybe it's ok to give both BDT and Shawkwei few more years to run, we need places to invest the boatloads of cash coming in next few years. I would prefer if Prem becomes Singleton 2.0 and plows every extra dollar not needed by insurance subs into buybacks. Lowest risk and surefire way to get the stock to double in the next 3 years..

 

[Luca]

Id love them to allocate 1-2b into China large caps but I am aware that I am in a minority position with that

[Xerxes]

1 hour ago, Luca said:

Id love them to allocate 1-2b into China large caps but I am aware that I am in a minority position with that

What would that accomplish?

 

Just because of some cheap Chinese technology stocks. A segment that is not even in his wheelhouse. 
 

Concentrating their geographical expertise is key. Only depth of knowledge (undistracted and compounded over decades) can allow them to go heavy in say India when and where it counts.
 

Anything else is a distraction.
Why even bother ?

 

Greece was interesting. If there was no economic depression in Greece, they would have never bothered. Whereas India was a secular growth story. 

 

 

[Luca]

29 minutes ago, Xerxes said:

What would that accomplish?

High returns on invested capital and easy allocation of larger chunks of cash. 

29 minutes ago, Xerxes said:

Just because of some cheap Chinese technology stocks. A segment that is not even in his wheelhouse. 

I think the investment team certainly has some Asia expertise and these companies have very high earnings yields and IMO a lot more upside than downside. 

29 minutes ago, Xerxes said:

Concentrating their geographical expertise is key. Only depth of knowledge (undistracted and compounded over decades) can allow them to go heavy in say India when and where it counts.

I'd prefer them buying chinese technology stocks than cheap mining stocks right now but that's me. I also don't think you need particular geographic expertise with the well-known large caps.

 

 

[Luca]

Would be an interesting question for the annual meeting, considering the huge valuation discrepancy if they see any value in China and/or are willing to allocate some cash there the coming years or if India/West still has enough ideas for them to invest 10b. 

[Xerxes]

I actually think them keeping almost all of their global investment concentrated in just two locations: India and Greece, is a sign of quality of investment managers. 
 

The bets ultimately maybe right or wrong, but one cannot say they didn’t do their homework. 

[petec]

On 4/6/2024 at 11:15 PM, This2ShallPass said:

but some here want to ignore good high quality companies because they screen well (implying price is not cheap),

 

If you're looking at me, you misunderstand. I am not suggesting they ignore these. But the list I responded to had nothing about value, so it does not in any way guarantee good returns (and 10% is a good return). Plus FFH are value investors - why hope they will become something they are not? If you're looking for that, look elsewhere, would be my advice.

[petec]

10 hours ago, This2ShallPass said:

Unless, they just did a token investment in 2009 and 80-90% of the $978M was invested 5 years ago. In this case, commentary while factually correct is misleading, they shouldn't say we're investing with them for 15 years.

 

Also, in that best case scenario, BDT would have only got Fairfax 15% cagr over the last 5 years. I cannot square with Prem's comments about fantastic long term returns - 15% is good not fantastic, 5 years is not long term and 70% total return is so-so. 

 

My guess is it is quite likely the money is invested for anywhere from 2-7 years depending on the investment, and is then returned. So the IRR could be *well* above the gross return, if that makes sense.

 

And on returns: how do you know what's a good return if you don't know the underlying risk? 15% is an *excellent* unlevered equity return, well ahead of any long term index return. It's much weaker if it is levered; it's brilliant if the investment is structured with downside protections. We just don't know enough to judge, do we?

[glider3834]

@SafetyinNumbers I am just looking at this Allied World acquisition of 0.5% in Jun-23

 

Looks like Fairfax paid $30.6M 

 

It appears (see below) the Non-controlling interests carrying value was $27.6M - so the difference was $3M - so my take is that is P/BV of ~ 1.1x (is that right or am I missing something?)

 

[This2ShallPass]

2 hours ago, petec said:

I am not suggesting they ignore these. But the list I responded to had nothing about value, so it does not in any way guarantee good returns (and 10% is a good return). Plus FFH are value investors - why hope they will become something they are not?

I was only commenting to the question on what are characteristics of a high quality company and hence didn't mention about price / value. Hopefully value investors and quality are not mutually exclusive. With ~$4B coming in next few years, I would be ok with them paying a fair price for better companies (even if it means 10% return vs. their 15% target).

 

2 hours ago, petec said:

My guess is it is quite likely the money is invested for anywhere from 2-7 years depending on the investment, and is then returned. So the IRR could be *well* above the gross return, if that makes sense.

 

And on returns: how do you know what's a good return if you don't know the underlying risk? 15% is an *excellent* unlevered equity return, well ahead of any long term index return. It's much weaker if it is levered; it's brilliant if the investment is structured with downside protections. We just don't know enough to judge, do we?

"Since 2009, we have invested $978 million, have received $979 million in distributions and still have investments with a year-end market value of $683 million." - Sure IRR could be higher. But, practically I don't see how given these numbers..

 

Maybe we're splitting hairs here, the word fantastic is what I was referring to and 15% in 5 years is not that (for me). I just assumed they're a investment company and the terms were nothing fancy. If they were able to get downside protections, then 15% is fantastic. Do you think it's realistic for Fairfax to have got special terms from BDT and Shawkwei?

 

Edited April 8 by This2ShallPass
Edited earlier comment since the returns are already posted

[Thrifty3000]

From Jamie Dimon's annual letter...

 

"we are prepared for a very broad range of interest rates, from 2% to 8% or even more"

 

Notice he didn't say from 0% to 8% or even more.

 

I believe recency bias accounts for much of Fairfax's discount to intrinsic value. Lot's of people heavily weight a return to zirp scenario in their longer term Fairfax model. Dimon lays out why he thinks 0% is off the table and why a higher rate environment is the more likely scenario.

 

If Dimon is on the right track about rates then it seems baseline EPS estimates for FFH will be shifting closer to $200 as more investors/analysts' take zirp off the table and increase their expected portfolio yield by a couple hundred basis points.

[Hoodlum]

14 minutes ago, Thrifty3000 said:

From Jamie Dimon's annual letter...

 

"we are prepared for a very broad range of interest rates, from 2% to 8% or even more"

 

Notice he didn't say from 0% to 8% or even more.

 

I believe recency bias accounts for much of Fairfax's discount to intrinsic value. Lot's of people heavily weight a return to zirp scenario in their longer term Fairfax model. Dimon lays out why he thinks 0% is off the table and why a higher rate environment is the more likely scenario.

 

If Dimon is on the right track about rates then it seems baseline EPS estimates for FFH will be shifting closer to $200 as more investors/analysts' take zirp off the table and increase their expected portfolio yield by a couple hundred basis points.

 

I am also in alignment with Jamie's comments here as it related to inflation and interest rates.   It will take time for the market to completely grasp this and what it will mean for investments.   Long term we will see the Fed revisit the 2% inflation target but that will take more than 5 years and by then it won't be a surprise.   I could see them go back to an inflation target range.

Edited April 8 by Hoodlum

[Hektor]

https://www.thehindu.com/news/national/karnataka/air-india-and-bial-sign-agreement-to-make-bengaluru-premier-aviation-hub-of-south-india/article68042257.ece

 

Air India and BIAL sign agreement to make Bengaluru premier aviation hub of south India. 
 

This includes strengthening the group’s presence at Kempegowda International Airport (KIA) through an enhanced network and establishing a dedicated domestic lounge for premium and frequent travellers of Tata Group airlines Air India and Vistara.

[SharperDingaan]

There are many different methodologies by which to value a company; no 'one way' is right. Most often one would use a weighted average, adjusting weights to each methodology according to whatever one expects the business climate to be over the next year. Most weighted averages would point to north of 1,600/share.

 

Some (MW); will focus on only the lowest number, but if the arguments just aren't credible .... it's no different to the whining kid in the back of the mini-van. If the squeaky wheel gets the grease, simply buy in their shares at adjusted book value and cancel. Thank you for making it possible in a single transaction! and an adjusted book value towards 1,600.

 

Our own view is that the US, India, and Euro-bank are obvious concentrations. One business growing into 3 new ones over time, that ultimately get spun off into majority holdings under a holding company paying a very high dividend. 

 

Good luck to all.

 

SD 

 

 

 

[MMM20]

1 hour ago, SharperDingaan said:

that ultimately get spun off into majority holdings under a holding company paying a very high dividend

 

?

[Xerxes]

44 minutes ago, MMM20 said:

 

?

same here ?

 

comeone @SharperDingaan

more context pls on that last paragraph 

 

i got the “good luck to all” bit, but the paragraph just before lost me 

[SharperDingaan]

2 hours ago, Xerxes said:

same here ?

 

comeone @SharperDingaan

more context pls on that last paragraph 

 

i got the “good luck to all” bit, but the paragraph just before lost me 

 

Over time each becomes its own very strong stand-alone regional business. Each does a small IPO (10-15% of the entire business) to establish a public market, a current share value, raise its own capital, and create the ability to issue its own stock options etc. The other 85% of the shares remain held by FFH, with dividends flowing up to FFH as already occurs.

 

Puts an easy daily minimum sum of the parts value on FFH, and is standard operating procedure in most corporate finance shops. Nothing magical.    

 

SD

Edited April 9 by SharperDingaan

[Xerxes]

Eurobank and Fairfax India are already public. 
 

why create another holding company layer on top of each one ?

[value_hunter]

Seems Fairfax bought back $200m CAD shares in Mar.

https://ceo.ca/api/sedi/?symbol=ffh&amount=&transaction=&insider=