Fairfax 2024

[gfp]

CIBC raises FFH target to C$2000 from C$1700 fwiw (not much)

Edited March 13, 2024 by gfp

[MMM20]

13 hours ago, SafetyinNumbers said:

Does anyone have a list of the minority interests in the insurance companies (Brit, Allied World, Odyssey) that Fairfax is able to repurchase along with the relevant timelines?

 

For Allied World (from annual report) -

 

 

Edited March 13, 2024 by MMM20

[SafetyinNumbers]

5 hours ago, MMM20 said:

 

For Allied World (from annual report) -

 

 

thanks!

 

I caught this too 

 

[MMM20]

"The key in investing is finding growth in value. You want to find something that is undervalued that can get overvalued. I’ve found you make the most money by having a 1–3-year variant view on a business and buying the stock before the business turns up, inflects, or accelerates. You must be willing to buy and hold dead money and look wrong before you’re right." https://microcapclub.com/turnarounds/?ref=newsletter

 

Feels like FFH is at the "They had a decent quarter, but I don't trust it" phase:

 

 

 

 

Edited March 14, 2024 by MMM20

[gfp]

look at all those green candles - what a crap short sale

 

[dartmonkey]

1 hour ago, SafetyinNumbers said:

Can anyone explain this in plain English? It sounds like FFH has calls allowing them to buy out the minority interests in 2026, 2027 and 2029, but then the minority interests can dump their stakes back to FFH in a variety of was once those call options have expired. Is that right?

 

And I presume there is some formula that says what price FFH has to pay, do we know anything about that?

[petec]

1 hour ago, dartmonkey said:

Can anyone explain this in plain English? It sounds like FFH has calls allowing them to buy out the minority interests in 2026, 2027 and 2029, but then the minority interests can dump their stakes back to FFH in a variety of was once those call options have expired. Is that right?

 

And I presume there is some formula that says what price FFH has to pay, do we know anything about that?

 If Fairfax doesn't exercise the calls, the other owners can force an IPO or (in some cases) a sale.

 

Prior examples would suggest there is a formula; no, we don't know what it is.

[gfp]

8 minutes ago, petec said:

 If Fairfax doesn't exercise the calls, the other owners can force an IPO or (in some cases) a sale.

 

Prior examples would suggest there is a formula; no, we don't know what it is.

 

The idea is that the pension plan partners won't get stuck with illiquid and unsaleable stock of private businesses.  They aren't ever going to IPO or force a sale of a subsidiary but the language is there to protect them.  It really is just preferred equity pawn-shop behavior with a friendly partner.

[vakilkp]

1 hour ago, gfp said:

It really is just preferred equity pawn-shop behavior with a friendly partner

This is correct and funny.  Gfp thanks for the posts and not just this one. 

[dartmonkey]

1 hour ago, gfp said:

 

The idea is that the pension plan partners won't get stuck with illiquid and unsaleable stock of private businesses.  They aren't ever going to IPO or force a sale of a subsidiary but the language is there to protect them.  It really is just preferred equity pawn-shop behavior with a friendly partner.

A special kind of pawnshop, that gives you money for your mother's jewelry that you really don't want them to sell, because you want to come back and get it in a couple of years when your finances are better. So you pay them an annual 10% fee to keep the jewelry in a special safe. They can also sell to someone else it if you don't come back to repurchase it within a few years.

 

Muddy Waters would add that there is another side benefit of this deal: you can 'sell' this jewelry to the pawn shop for an inflated price, because it allows you to claim that the rest of the jewelry you own is worth the same amount, reassuring other creditors. So it is a disguised loan, with a 10% interest rate, which can double as a book value adjustment, if needed. Of course, I don't believe this...

[SafetyinNumbers]

6 hours ago, dartmonkey said:

Can anyone explain this in plain English? It sounds like FFH has calls allowing them to buy out the minority interests in 2026, 2027 and 2029, but then the minority interests can dump their stakes back to FFH in a variety of was once those call options have expired. Is that right?

 

And I presume there is some formula that says what price FFH has to pay, do we know anything about that?

From the recent Allied World repurchases, it seems like they can buy back the shares at the same P/B multiple they were sold. For Allied World that was 1.3x BV. For Brit, I think it’s 1.55x and for Odyssey I recall 1.9x. If anyone can confirm, please do.

[giulio]

@SafetyinNumbers this is what I understood from last year AR.

The amount is fixed, like debt. If you keep the P/B unchanged and the insurance subs increase BV then FFH would have to pay a higher price.

The call option allows FFH to repay the same amount they received instead. If BV increases they record a gain on the value of the option. 

This is what happened last year with Allied and Eurolife purchases. I am halfway through this year AR and I'll write an update when I am done.

Hope this helps.

G

[SharperDingaan]

On 3/11/2024 at 12:46 PM, dartmonkey said:

Sort of the archetype of weak hands. It looks like a good company, but who knows whether Muddy Waters is right or not? Might as well sell, even after the 10% drop, since I’m still above my September buy price. 

 

 

You might want to rethink this; as we recently exited our swing trade at > CAD 1500, and typically swing trade around the dividend record date. We trade FFH because it's well run; but our trades themselves are just about being opportunistic, and acting on value when we see it. We act like insurance; additional buy side demand when the sh1te hits the fan, that quietly exits later when everybody is positive.

 

SD

[petec]

23 hours ago, gfp said:

 

The idea is that the pension plan partners won't get stuck with illiquid and unsaleable stock of private businesses.  They aren't ever going to IPO or force a sale of a subsidiary but the language is there to protect them.  It really is just preferred equity pawn-shop behavior with a friendly partner.

 

Yes, exactly. 

[petec]

22 hours ago, dartmonkey said:

you can 'sell' this jewelry to the pawn shop for an inflated price

 

Only if they're prepared to pay an inflated price to make you look good (and risk looking bad themselves). I highly doubt that.

[dartmonkey]

2 hours ago, petec said:

 

Only if they're prepared to pay an inflated price to make you look good (and risk looking bad themselves). I highly doubt that.

 Yes, sorry for the sarcasm. I don't really believe that Fairfax is primarily motivated by the need to artificially boost its reported book value.

 

On the other hand, when you sell at a high price with a guarantee that you can buy it back at the same high price, with an annual fee, it's not really a sale, it's a loan. But since it is structured as a sale, you can (or perhaps, must) revalue the book value of the shares you still own, which does boost the book value and maybe has some advantages for Fairfax vis-à-vis regulators. Unfortunately, it also opens you up to criticism that you did the deal JUST to boost your book value.

 

 

 

[SafetyinNumbers]

22 minutes ago, dartmonkey said:

 Yes, sorry for the sarcasm. I don't really believe that Fairfax is primarily motivated by the need to artificially boost its reported book value.

 

On the other hand, when you sell at a high price with a guarantee that you can buy it back at the same high price, with an annual fee, it's not really a sale, it's a loan. But since it is structured as a sale, you can (or perhaps, must) revalue the book value of the shares you still own, which does boost the book value and maybe has some advantages for Fairfax vis-à-vis regulators. Unfortunately, it also opens you up to criticism that you did the deal JUST to boost your book value.

 

 

 

The boost in the book value is only for the portion that is sold. Valuations are also surely done by the counterparty to justify the multiple paid. If the prime motivation is to increase book value, it’s not a very effective technique.

[SafetyinNumbers]

3 hours ago, SharperDingaan said:

 

You might want to rethink this; as we recently exited our swing trade at > CAD 1500, and typically swing trade around the dividend record date. We trade FFH because it's well run; but our trades themselves are just about being opportunistic, and acting on value when we see it. We act like insurance; additional buy side demand when the sh1te hits the fan, that quietly exits later when everybody is positive.

 

SD

Can you let us know when you re-enter? I’m curious about timing. 

[dartmonkey]

4 hours ago, SharperDingaan said:

 

You might want to rethink this; as we recently exited our swing trade at > CAD 1500, and typically swing trade around the dividend record date. We trade FFH because it's well run; but our trades themselves are just about being opportunistic, and acting on value when we see it. We act like insurance; additional buy side demand when the sh1te hits the fan, that quietly exits later when everybody is positive.

 

SD

I'm not saying that anyone who sold FFH was necessarily an example of weak hands. I am saying it sounded like weak hands when one particular instance of a seller said this:

 

With such nice gains in a very short period, and no idea of the impact of the short report, I sold. That could be an error to react quickly, because it looks like it is a good quality company. Anyway, with the proceeds I added to existing ones.

 

I am not an expert on insurance, but it’s clear that the book value is aggressively noted, with some assets benefiting from an epic bubble in Indian equities and overvalued US real estate, as well as temporary high interest rates. It does seem that earnings are above the normal trend.

 

The writer acknowledges that he knew little about the company, and proved this when he said that earnings seem to be above the normal trend.

 

You, on the other hand, if your strategy involves taking up shares when they are not in demand, were probably a buyer, not a seller, when the short report came out. If so, you have done well, and it might make perfect sense to have sold back those shares with a quick gain when the share price recovered.

 

But for me, hoping for 100-200% gains from this investment over the next 5-10 years, I would not sell because of a 10% move up or down. It is a lot easier for an investor to hang on if she knew a bit more about Fairfax, and was thus not scared off by the Muddy Waters allegations or fears about their impact.

[dartmonkey]

1 hour ago, SafetyinNumbers said:

The boost in the book value is only for the portion that is sold. Valuations are also surely done by the counterparty to justify the multiple paid. If the prime motivation is to increase book value, it’s not a very effective technique.

Ok, I see this is true for the book value gains for Odyssey and Allied stakes sold to OMERS in 2021 to raise money for buybacks (what a spectacular trade, by the way!)

 

I'm not sure wh OMERS would really care what price they paid, if they have a side deal that Fairfax is going to repurchase the shares at the same multiple. 

 

I'm not saying this is what motivated Fairfax to do the deal; clearly, it was great to get a billion and a half of cash and repurchase Fairfax shares, at a third of today's price. But if you are Muddy Waters and you set out to see the negative side of every trade, the OMERS sales were not really sales, they were loans (an idea that has been discussed here frequently), the price makes no difference if they are just loans, and the impact of the price on Fairfax's book value is sure to be seen as book value manipulation, even if it is only icing on the cake for Fairfax.

 

And for Gulf Insurance in 2023, the book value gain was because the purchase price for the remaining shares was applied to the existing shares:

 

In December, Fairfax Continues its Gonzo Mode by Buying out the Portion of Gulf Insurance it Did Not Already Own at a Very Rich Multiple of ~2.4x Book Value, Taking a ~$300 Million Gain on Existing Shares

https://www.muddywatersresearch.com/wp-content/uploads/2024/02/Fairfax-Financial_FFH_MW_20240208.pdf

 

 

This seems to be confirmed by Fairfax's 2023 AR:

 

Gain on sale and consolidation of insurance subsidiaries of $549.8 in 2023 principally related to the consolidation of Gulf Insurance, which required the company’s previously held equity accounted investment in Gulf Insurance to be remeasured to fair value resulting in a pre-tax gain of $279.9

https://www.fairfax.ca/wp-content/uploads/FFH_Fairfax-Financial-2023-Annual-Report.pdf

 

 

[SharperDingaan]

"But for me, hoping for 100-200% gains from this investment over the next 5-10 years, I would not sell because of a 10% move up or down. It is a lot easier for an investor to hang on if she knew a bit more about Fairfax, and was thus not scared off by the Muddy Waters allegations or fears about their impact."

 

To each his own, and may it work out for you.

We only point out that there is the buy/hold return on FFH itself, AND the swing trade returns from volatility. Global warming is generating bigger Super-Cat losses, and the FFH insurance business has a seasonality to it, that is just part of doing business; nothing wrong in that, but it will generate opportunities from time to time. If you able to make a success of them, you will get to your 200% a lot quicker 

 

SD

[Viking]

Earnings Estimates – Two Year Summary for 2024 & 2025

 

Below is an update to my two-year earnings estimate for Fairfax. Please note, forecasts are a guess at a point in time. To state the obvious, things are constantly changing. As a result, my earnings forecasts quickly become outdated. These forecasts are intended solely for entertainment purposes – please keep this in mind. 

 

Since my last update, Fairfax has released both Q4 earnings and their 2023 annual report. This allows us to finalize results the 2023 year and update our forecasts for 2024 and 2025. 

 

Summary

 

My current estimate is Fairfax will earn about $160/share in 2024 and about $165/share in 2025. For reasons outlined further below, I think both of these estimates have been constructed using mildly conservative assumptions. 

 

 

2024 & 2025 Forecast

 

A hard piece to forecast with Fairfax is capital allocation. Fairfax is currently generating a significant amount of earnings. But we don’t know today how the future cash flows will be invested:

• Grow insurance (continuation of hard market)
• Buy out minority partners in insurance?
• Equities or fixed income?
• Buy back a meaningful amount of Fairfax stock? 
• Other?

Looking at the last 5 years, the management team 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 – likely providing a tailwind to my forecasts for 2024 and 2025.

 

Using Yahoo Finance as a guide, analysts are collectively estimating that Fairfax will earn about US$148/share (C$200) in 2024 and US$157/share (C$211) in 2025 (using $0.742 US$/C$ exchange rate). Why are analyst estimates below my forecast? From what I can see, most analysts are assigning little benefit to future earnings and Fairfax’s proven capital allocation skills. Most analysts will include these benefits into their earnings estimates after Fairfax has announced something.

 

I am assuming interest rates remain roughly at current levels (at March 10, 2024). Of course, this will likely not be the case. But given the duration of the fixed income portfolio is now closer to the duration of the insurance liabilities, changes in interest rates (up and down) might kind of balance out (in ‘net gains/losses on investments’ and ‘effects of discounting and risk adjustment- IFRS 17’)

 

Below is an 8-year snapshot 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 – it has increased from an average of $39/share over the 5-year period 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 $197/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 level looks sustainable.

 

 

What are the key assumptions?

 

1.) Underwriting profit: Estimated to come in at $1.24 billion in 2024.

• Net written premiums 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 NWP. 
  • The Gulf Insurance Group (GIG) acquisition, which will add $1.7 billion of NWP.
• 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: Estimated to increase to a record $2.2 billion in 2024 and 2025

• Interest and dividend income in Q4 2023 was $536.6 million; this provides a good baseline (starting point).
• GIG adds about $2.4 billion to the total investment portfolio in 2024. A tailwind.
• Eurobank will start paying a dividend in 2H 2024. A tailwind.
• Rate cuts by global central banks would be a headwind in 2H.

3.) Share of profit of associates: Estimated to increase to a record $1.03 billion in 2024.

• Earnings at Eurobank, Poseidon, Stelco and Fairfax India, in aggregate, should continue to grow nicely. EXCO (nat gas prices) could be a headwind.
• GIG will be a small headwind as it is now consolidated.

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. 
• I am modelling for interest rates to remain flat. 
• This bucket is among the most difficult to model – therefore, my confidence level in my estimates is low. 

5.) Life insurance and runoff:

• This combination of businesses lost about $348 million in 2023. 
• I expect earnings in 2024 to be a little better – a lower loss of $250 million - with life insurance being a modest tailwind.

6.) Other (revenue-expenses) - non-insurance subsidiaries: 

• Recipe, Dexterra, AGT, Grivalia Hospitality, Boat Rocker, Farmers Edge etc.  
• This combination of businesses earned $46 million in 2023. 
• I expect earnings to be better in 2024, coming in at $150 million.
• This bucket is poised to grow nicely for Fairfax in the coming years. It could surprise to the upside. Yes, the results will be lumpy.

7.) Interest expense: At $520 million, a modest increase to prior year of $510 million.

8.) Corporate overhead and other: At $435 million, a modest increase to prior year of $430 million.

 

9.) Net gains on investments: Estimated to come in around $1 billion in 2024.

• The big driver will be the FFH-TRS position. $250 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: This is where I put the large asset sales/revaluations. 

• In 2023, it was the sale of Ambridge and the revaluation of GIG for a total of $550 million.
• In 2024, I am modelling a gain of $300 million. Perhaps Fairfax (finally) gets approval from regulators in India to move their ownership in Digit from 49% to 68% and this generates a sizable gain. A Digit IPO might also result in a write up of Fairfax’s position. 

Bottom line, this bucket is a wild card. But Fairfax has a long history of surfacing significant value hidden on its balance sheet. $300 million per year seems like a conservative average estimate. I am including insurance and non-insurance here together (even though the title says insurance).

 

11.) Income taxes: estimated at 19% (historical average rate)

 

12.) Non-controlling interests: I am expecting Fairfax to take out one of its minority partners in 2024. The leading candidate is Brit. My second choice would be increasing their ownership in Allied World to 90% (from 83.4%). 

• 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.

13.) Shares Outstanding: Estimated that effective shares outstanding will be reduced by 300,000 shares per year for 2024 and 2025. This is the same amount as 2023. 

 

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 below 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) calculate ROE using an average number for equity. So, this likely makes my ROE estimates more comparable with industry numbers.

Edited March 16, 2024 by Viking

[gfp]

Thanks for sharing your work Viking.  On Eurobank dividends, if we are already recognizing our entire pro-rata share of Eurobank's earnings, why would we benefit from their dividend?  Cash in FFH's hands is different than cash retained at Eurobank, but it should not be double counted.  

[wisowis]

14 minutes ago, Viking said:

6.) Other (revenue-expenses) - non-insurance subsidiaries: 

• Recipe, Dexterra, AGT, Grivalia Hospitality, Boat Rocker, Farmers Edge etc.  
• This combination of businesses earned $46 million in 2023. 
• I expect earnings to be better in 2024, coming in at $150 million

 

Thanks for the post, Viking. Question: Why will earnings from this bucket more than triple?

[Viking]

1 hour ago, wisowis said:

 

Thanks for the post, Viking. Question: Why will earnings from this bucket more than triple?

 

@wisowis good question. The "Other (revenue - expenses)" bucket has had significant noise the past couple of years. In 2023 Consolidated investments produced pre-tax income of $271 million but the 'reported' number was $46 million. Losses from Grivalia, Boat Rocker and Farmers Edge were $204 million in 2023. There was a significant write down on Farmers Edge of $133.4 million in 2022. I don't think these one-time losses will continue at this level moving forward.

 

Consolidated investments produced revenue of $6.6 billion in 2023, up from $5.6 billion in 2022. This bucket of holdings is growing like a weed.

 

There is likely a little more pain coming from Farmers Edge but once Fairfax takes it private my guess is they will do something to (finally) stop the losses/bleeding. Boat Rocker has a carrying value of $84 million and a market value of $24 million so we could see another modest write down here. The past couple of years, Grivalia Hospitality has been spending heavily to build ultra-luxury resorts with minimal money coming in; I think this may have changed late in 2023 as they now have 5 resorts (I think) open for business = revenue.

 

Thomas Cook India is smoking. Recipe, Sporting Life, AGT Food Ingredients and Dextera all look to be chugging along.

 

Once the significant bleeding stops I think people will be pleasantly surprised by the earnings that this bucket will be able to deliver in the coming years.

 

Regardless of reported earnings in recent years, I think significant value is building in the holdings in this bucket. At some point in will show up in reported earnings. And it will likely 'surprise' people like what happened a couple of years ago with the spike in earnings from the 'share of profits of associates' bucket.

 

Therefore, I think my estimate of $150 million in 2024 and $200 million in 2025 is quite conservative.

----------

FFH 2023AR: "As the table on page 15 shows, the consolidated investments include the following: Recipe, Fairfax India, Grivalia Hospitality, Thomas Cook India, Dexterra Group and Boat Rocker Media. Our consolidated investments are significant, producing total revenue of $6.6 billion and pre-tax income of $271 million in 2023. Fairfax India had pre-tax income of $380 million, Recipe $38 million, Thomas Cook $27 million and Dexterra $29 million. Those were offset by losses at Grivalia of $66 million, Boat Rocker $26 million and Farmers Edge of $112 million which included impairments of $64 million."

 

FFH 2022AR: "As the table on page 13 shows, consolidated investments include the following: Recipe, Fairfax India, Grivalia Hospitality, Thomas Cook India, Boat Rocker Media, Dexterra Group and Farmers Edge. Our consolidated investments are significant, producing total revenue of $5.6 billion, EBITDA of $743 million and pre-tax income of $303 million (excluding a $133 million writedown of Farmers Edge) before minority interest in 2022."

 

FFH 2022AR: "Operating income of the Non-insurance companies reporting segment increased to $184.9 in 2022 from $78.2 in 2021. Excluding the impact of the non-cash goodwill impairment charges on Farmers Edge recorded during 2022 of $133.4, operating income of the Non-insurance companies reporting segment increased significantly by $240.1 to $318.3 in 2022, principally reflecting higher share of profit of associates at Fairfax India, higher business volumes at Thomas Cook India, and improved margins and higher business volumes in the Restaurants and retail operating segment and at AGT. This significant improvement of $240.1 from the Non-insurance companies reporting segment reflected the easing of COVID-19 restrictions that had previously negatively impacted this reporting segment with the increase in operating income in 2022 driven by increases reported in all underlying operating segments."

 

Edited March 16, 2024 by Viking