Fairfax 2024

[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, 2024 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, 2024 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, 2024 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!

[petec]

8 hours ago, TwoCitiesCapital said:

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. 

 

Sure, but we are analysing the stock today. If it goes to $2000 we will be richer; this is good, not bad.

[Hoodlum]

Fairfax Announces Termination of Total Return Swaps and Acquisition of the Common Shares.

 

 

https://www.fairfax.ca/press-releases/fairfax-announces-termination-of-total-return-swaps-of-ensign-energy-services-inc-and-acquisition-of-common-shares/

 

[Hoodlum]

Could someone help to explain the acquisition cost of these shares?  I presume this would lower the number of outstanding shares significantly, although I don't understand the low cost to Fairfax of only $2.34 per share.  

Edited June 11, 2024 by Hoodlum

[nwoodman]

50 minutes ago, Hoodlum said:

Could someone help to explain the acquisition cost of these shares?  I presume this would lower the number of outstanding shares significantly, although I don't understand the low cost to Fairfax of only $2.34 per share.  

Wasn’t that yesterday’s closing price?  It seems rather than have the swaps counterparty dump the shares onto the market,they have purchased them directly from the counterparty that arranged the swaps.  I haven’t followed this closely but a Perplexity search offered the following:

 

Equity Ownership

• In April 2022, Fairfax converted C$11.05 million of convertible debentures into 6,314,286 common shares of Ensign, increasing its ownership stake to 12.87% of outstanding shares at the time.

• In June 2020, Fairfax entered into cash-settled total return swap contracts for 4,557,600 notional common shares of Ensign, representing 2.79% of outstanding shares.

• On June 10, 2024, Fairfax terminated total return swaps over 7,787,600 Ensign common shares and agreed to purchase those shares at C$2.34 per share, representing 4.24% of outstanding shares.

• After the June 2024 transaction, Fairfax's beneficial ownership and control in Ensign increased to 29,588,486 common shares, or approximately 16.10% of all outstanding shares.

Major Shareholder

• Along with Murray Edwards (approximately 23% ownership), Fairfax is one of the largest shareholders in Ensign Energy Services.

• As major shareholders, Fairfax and Murray Edwards have the ability to provide capital to support Ensign's operations and potential refinancing needs.

Looks like they must have added to the swaps position after the initial setup in 2020.  My quick search doesn’t show this.  
 

What I find interesting is that Fairfax purchased the share position from the swap counterparty.  Might provide some color around how they intend to eventually wind up the FFH TRS position.

Edited June 11, 2024 by nwoodman

[gfp]

45 minutes ago, Hoodlum said:

Could someone help to explain the acquisition cost of these shares?  I presume this would lower the number of outstanding shares significantly, although I don't understand the low cost to Fairfax of only $2.34 per share.  

 

Seems like you are missing that these are TRS on Ensign Energy Services and not FFH.

[Hoodlum]

Just now, gfp said:

 

Seems like you are missing that these are TRS on Ensign Energy Services and not FFH.

Yes, that is what I missed.  

[petec]

2 hours ago, nwoodman said:

Wasn’t that yesterday’s closing price?  It seems rather than have the swaps counterparty dump the shares onto the market,they have purchased them directly from the counterparty that arranged the swaps.  I haven’t followed this closely but a Perplexity search offered the following:

 

Equity Ownership

• In April 2022, Fairfax converted C$11.05 million of convertible debentures into 6,314,286 common shares of Ensign, increasing its ownership stake to 12.87% of outstanding shares at the time.

• In June 2020, Fairfax entered into cash-settled total return swap contracts for 4,557,600 notional common shares of Ensign, representing 2.79% of outstanding shares.

• On June 10, 2024, Fairfax terminated total return swaps over 7,787,600 Ensign common shares and agreed to purchase those shares at C$2.34 per share, representing 4.24% of outstanding shares.

• After the June 2024 transaction, Fairfax's beneficial ownership and control in Ensign increased to 29,588,486 common shares, or approximately 16.10% of all outstanding shares.

Major Shareholder

• Along with Murray Edwards (approximately 23% ownership), Fairfax is one of the largest shareholders in Ensign Energy Services.

• As major shareholders, Fairfax and Murray Edwards have the ability to provide capital to support Ensign's operations and potential refinancing needs.

Looks like they must have added to the swaps position after the initial setup in 2020.  My quick search doesn’t show this.  
 

What I find interesting is that Fairfax purchased the share position from the swap counterparty.  Might provide some color around how they intend to eventually wind up the FFH TRS position.

 

My take is that back in 2020 they bought swaps because they didn't have cash. Now they do, so they're swapping for direct exposure. In effect, they bought these shares at $1.31. Nice move. At the current price ESI trades on a roughly 50% free cash flow yield and is paying off debt every quarter.

[petec]

2 hours ago, nwoodman said:

What I find interesting is that Fairfax purchased the share position from the swap counterparty.  Might provide some color around how they intend to eventually wind up the FFH TRS position.

 

Exactly. In effect the TRS locks in a buyback at the TRS price. Lovely stuff.

 

[nwoodman]

46 minutes ago, petec said:

 

Exactly. In effect the TRS locks in a buyback at the TRS price. Lovely stuff.

 

True albeit with a financing component and +/- cash flow implications.  As long as the price direction is correct then you also get the use of the cash in excess of interest payments on the way through.  It becomes a bit of a virtuous circle when that cash gets used for buybacks below IV.  
 

The Ensign swaps demonstrated that the process can be as simple as Fairfax fronting up with the cash based on the days closing price.  The counterparty doesn’t have to dump shares back into the market etc.  they get surety of price and Fairfax gets a swag of shares.  No epiphany but good to see it can be done this elegantly.

Edited June 11, 2024 by nwoodman

[TwoCitiesCapital]

I know TRS don't have to be disclosed, so it's hard to know what FFH holds. 

 

 But does anyone else know what other TRS may be on the books? I kind of thought they were historically using TRS to short stocks and didn't realize they were using them to go long anything but their own. Now I'm curious what other long positions reside outside of disclosure rules as structured like this? 

[dartmonkey]

On 6/9/2024 at 7:36 PM, Thrifty3000 said:

The three items above [dividend, buybacks, predicted buyouts of minority partners] '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.

 

On 6/9/2024 at 7:36 PM, 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 agree with Thrifty and think that the remaining 55% of earnings will either be reinvested in buybacks or else something even better. So a reasonable approach might be to plug in 75% in buybacks instead of 30%, even if we are not really predicting that level of buybacks. Equivalently, that extra 45% of earnings could be in 'Unknown Investment', with a 15% return; that unknown investment could end up being either more FFH shares or else something better.

 

Implicitly assuming a 0% return on that 45% of earnings is unrealistically low. In my opinion, we don't want to just throw in extra 'conservatism', we want to get our best estimate of value. It would be a shame to sell or reduce the size of a good investment like Fairfax because we've made assumptions on returns that are significantly lower than what we really expect. 

[dartmonkey]

On 6/8/2024 at 3:05 PM, Viking said:

 

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. 

 

 

Brief recap of recent Digit valuation:

 

Fairfax has this at a fair value of $2.265b on its 2023 annual report. Although Fairfax notes that it owns 49%, it also has 'securities' that, when converted, would give it a 68% stake. My understanding (someone please correct if this is not true) is that the $2.265b number is for the whole 68% stake, not just the 49% they own outright, so this would put the total fair value at $3.331b.

 

In February 2024, Muddy Waters contended that "Since 2021, the valuations for "InsureTech" stocks and Indian unicorns have collapsed. Digit's prospects for an IPO in the near future seem minimal."

 

They also said that "it is incontrovertible that Digit is worth far less today than where Fairfax ultimately marked it in 2021, ... we see Digit as generously being valued at ~$1.5 billion presently. We therefore adjust Fairfax's book value downward by -$1.1 billion to align Digit's carrying value with a more reasonable value."

 

 

Four months later, these predictions are not doing well. The IPO, with minimal prospects of happening in the near future, is done. The market capitalization, at today's share price (337.6 INR) is $3.78b, higher than the $3.331 fair value on Fairfax's books, and considerably higher than Muddy Waters 'generous' valuation of $1.5b.

 

I know it takes a while to process this new information, but 3 weeks after the IPO, I am eagerly awaiting Muddy Waters acknowledgement that at least this one adjustment, representing $1.1b out of their "~-$4.5 billion "conservative adjustment to book value," turns out to be unneeded. I don't know the details of the IFRS accounting for majority stakes, so it may well be that there will be no fair value adjustment in Q2, given the controlling stake, but the collapse in valuations sure hasn't played out. 

[petec]

14 hours ago, nwoodman said:

True albeit with a financing component and +/- cash flow implications.  As long as the price direction is correct then you also get the use of the cash in excess of interest payments on the way through.  It becomes a bit of a virtuous circle when that cash gets used for buybacks below IV.  
 

The Ensign swaps demonstrated that the process can be as simple as Fairfax fronting up with the cash based on the days closing price.  The counterparty doesn’t have to dump shares back into the market etc.  they get surety of price and Fairfax gets a swag of shares.  No epiphany but good to see it can be done this elegantly.

 

+1 to both paragraphs.