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Canadian FairFax holder.


alertmeipp
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alert, yes, the rapid increase in the CAN$ from the high 70's to $0.925 today certainly kills FFH in CAN$ terms. For those long term holders of FFH, the currency swings even out somewhat.

 

Regarding calculation today, FFH is trading above stated book = US$265/$254 = 1.04xBV.

- add in gains to Apr 24 (30$), add in additional investment gains ($10) and ICICI Lombard ($10)

- FFH BV today is likely in the US$300 range = US$265/$300 = 0.88xBV

- and yes, markets could crater tomorrow. FFH BV will be MUCH MORE volatile moving forward given their shift to risk assets.

 

I have has a similar effect being an CAN investor and holding ORH. What has helped me is ORH has gone up in US$ terms since I purchased in separate intervals the past few months.

- I am underwater by just under 4% and consider myself lucky.

- ORH continues to trade under stated Q1 BV = US$42/$43.80 = 0.96xBV

- add in gains to Apr 24 ($4), add in additional investment gains ($1.20), ICICI Lombard ($1.00?), currency gains ($2.00) and underwriting profit ($.80)

- ORH BV today is likely in the $52.00 range = US$42/$52 = 0.81xBV

 

Currently I prefer ORH to FFH because:

1.) it appears reinsurance pricing is firming sooner than insurnace pricing which leads me to believe ORH will outperform FFH in underwriting in the near term

2.) ORH interest and dividend income will be greater than FFH in the near term as ORH holds tax exempt municipals, dividend paying US stocks and in Q1 more corporate bonds, whereas FFH is weighed down somewhat by NB holding lower yielding (and taxable) CAN govt bonds

- add 1 & 2 and ORH operating income should outperform FFH

3.) my guess is ORH investments are performing better than FFH (and my assumption is US investments - i.e. WFC and USB - are held primarily in ORH and C&F and CAN investments - i.e. Brick, Mega, Canwest etc are held primarily in NB).

4.) ORH continues to trade at a much lower multiple than FFH to Q1 end stated BV (almost 0.10)

 

What I have been struggling with lately is should I buy more ORH?

- it is cheap at current prices but not crazy cheap.

- the CAN$ continues to move higher

- as the first hurricane starts forming the re-insurance stocks tend to sell off (even though a big hurricance disaster would be a net prositive for ORH by hardening pricing)

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The cad bonds do not look bad considering the recent run up, they've done much better than U.S treasuries in terms of absolute buying power! Both companies are in the enviable position of being able to put excess capital to work buying back shares, all other capital decisions are weighed against the option which results in very shrewd allocation.  The lower the share price, the higher the opportunity cost, which equals improving earning power per share.

 

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http://www.ft.com/cms/s/0/331cd12a-4e22-11de-a0a1-00144feabdc0.html

 

I have never tried this, but the above link was in the FT today.  I hope it allows access.  It adds a little more colour to the already posted FT article about 2009 hurricane season insurance trends. 

 

Like Viking, I think ORH looks more interesting on most metrics than does FFH at present.  Below $40, ORH seems a pretty easy decision to me. 

 

I own ORH prefs. too (mainly series A).  I have hedged the USD exposure with USD margin at 4.25% per annum - enjoying an 8% net interest spread so far.  I have trouble understanding why ORH prefs should trade over 10%.

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Viking,

 

Your BV calculations are great.  I would like to add however, that since April 24th, the US$ has dropped dramatically in value,and the Long US Treasury Yield has spiked up (...also gone down in value).

 

From FFH's annual presentation, although they moved a substantial amount of US treasuries into Tax exempt munis and common stocks, the FFH investment portfolio still had approx 15% in US treasuries.

 

The mark-to-market on these has dropped somewhat, and therefore you should adjust the BV calculation to take this into account.

 

My unqualified guesstimate is a drop in BV (due to mark-to-market US treasury holdings) of $6-$8, and for ORH -- about $2.

 

cheers,

Vinayd

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It is true that reinsurance appears tighter than insurance currently, but I believe it is only temporary. Both follow the same cycle and drivers/issues are generally common. Just have a look at this Globe and Mail article regarding P&C insurance in Canada.

 

http://www.theglobeandmail.com/report-on-business/failures-loom-in-pc-insurance-sector/article1167656/

 

Early last year, I was a big advocate of investing in ORH at $37 vs FFH north of $300 U.S. because of a tangible gap in valuation. This time around, I am more inclined to go with daddy. Although, there is always that possibility of FFH buying the rest of ORH for a decent premium.

 

So yes, I am now back into Fairfax in part because I believe that the Street is significantly mispricing the recent gains in book value. As of April 24, we were told that book value had grown by at least $30 putting it above $285. If you look at various markets, you will see that they have rallied more in percentage between April 24 and now, than they did between March 31 and April 24.

 

On top of that, take a look at some of their big 13F holdings: DELL, JNJ, KFT, PFE, WFC. Only USB has not done much since April 24. I have not done the math for all the holdings disclosed in the 13F, but the result must pretty interesting. Of course, the long term treasuries have hurt the overall result, but adding another $30 to book value since April 24 does not seem that agressive to me. That is over $315.  :P

 

I am also quite confident that Prem has booked obscene profits from this market rally. This will mean more cash to re-invest in other undervalued securities or a fast growing snowball from here in book value and earning power. This will really change the psychology of investors currently seeing Fairfax as described by Viking: "and yes, markets could crater tomorrow. FFH BV will be MUCH MORE volatile moving forward given their shift to risk assets." Booking very large profits two years in a row in what has been a terrible market for most will start to look more like talent vs luck. People pay for recurring.

 

Fairfax is certainly not the cheapest stock that I hold currently, but the certainty of return is mouthwatering. FYI, since 2003 Fairfax stock in USD has never closed below book value on Dec 31. The average for these last 6 years on Dec 31 was 1.145 times book. For the last 3 years it was 1.243, which I would argue represented better years for the company!

 

Cardboard  

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The mark-to-market on these has dropped somewhat, and therefore you should adjust the BV calculation to take this into account.

 

My unqualified guesstimate is a drop in BV (due to mark-to-market US treasury holdings) of $6-$8, and for ORH -- about $2.

 

cheers,

Vinayd

 

To clarify, are you saying $6-8 of losses offsetting the gains, or in total, you are expecting a $6-8 drop in BV at the end of the quarter?

 

There is no way bv is down, barring any unforeseen market crash or cat loss.  Lets make some "worst case" assumptions about that 15% portion of the portfolio.  Lets assume the full 15% is in only 30 year bonds (highly unlikely).  The 30 year rate is up 60 bps since Apr 24.  Lets assume there is $3,000 mm in treasuries, and the 30 year bond has a 20 year duration (probably high).  That means $12 in after tax losses from treasuries, which would be offset by about $40 gains on bonds/stocks.

 

Now lets assume a more likely scenario, that the bonds average duration is around 5. The average duration was 8 when we held the huge long bond portfolio, it has to be much lower now.  That would mean a loss per share around $3.  

 

I think the treasury losses won't be significant.  In fact, I wouldn't be surprised if the duration was much lower than 5 on treasuries.  They could be holding short term treasuries and long term corporates in order to maintain an average duration near the 8-9 that they used to have.

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I like ORH because I think the stock market at these levels and given the environment is risky and ORH has the most downside protection relative to stock market risk.  I'm buying bonds essentially when I buy ORH.  Sweet, secure bond portfolio with only 50% of book in stocks.  I am hoping for the market to drop 30% and a terrible hurricane season.

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Radian, 

 

My BV calculations was to offset BV gains from stocks/bonds.  My calculation was more back-of-the-envelope, and not thta much thought involved.  I simply took $3B bonds and assumed a 3%-5% mark-to-market loss since April 24th and divided by number of shares.  It was in the $6-$8 range.  This is in between your pessimistic and realistic range. 

 

Cardboard made agood point that stock gains occurring from April 24th to now may be significant.  Hopefully FFH will have capitalized on some of it. 

 

I am long ORH in the bulk of my portfolios....and feeling the $CDN short term pain (...hopefully for longer term gain).

 

Vinay

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Regarding ORH and their bond holdings, here are the numbers (in millions from p12 of Q1-10Q):

- Total US Gov't  = 2% of investment portfolio ($163/$7,500)

- I am not including State Muni's in the above calculation because their yields have NOT run up to the same degree that US federal gov't bonds have.

- bottom line is change in US Treasury yields will have no material effect on ORH investment portfolio in Q2.

 

Fixed Income Securities Available for Sale

- US government = $163

- State Muni =    $2,436

- Foreign =            $805

- Corporate =          $433

Total =                $3,846

 

Fixed Income Securities Held as Trading Securities

- Corporate =          $238

- Foreign =                $82

- Mortgage Backed =  $92

Total =                    $412

 

Total Bond =        $4,258

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Cardboard, to provide a little clarity on the investment portfolio, I dropped the 13F numbers into an Excel spreadsheet (attached below). Please note, I did not include the GE calls; we also need to remeber that the 13F does not capture all investments (i.e. Canadian stuff etc) so I use this summary for directional purposes only.

 

March 31 = $2,685 (million)

April 24 = $3,142 or + $456 = 17%

June 3 = $3,390 or + $704 = 26%

 

Also, the $900 million communicated by FFH also included bond gains. Since April 24 stocks have done very well; bonds (muni's) have done OK. Bottom line is I don't think the gains since April 24 have added another $30 to FFH book (100% gain). I used 33% as my conservative guide of the possible additional after tax/minority interest gains after April 24.

 

Regarding FFH versus ORH, I must admit that ORH shares do tend to trade in a sideways market (which can get quite frustrating 6 months or a year later). Check out the three year trend line and the high 30's looks to be the current trend line. FFH does seem to have much more volatility; I would like FFH to get about 10% lower before I get aggressive (given that I hold a chunk in ORH today). 

 

Mungerville, one reason I hold ORH is to play the equity markets/risk assets (via corporate bonds). If equity markets go 30% higher ORH will have even more mark to market gains (and book value will grow $3 to $4 more than I have previously stated). If equity markets go down 30% ORH will still see an increase in BV for Q2. If equity markets stay at current levels ORH will be sitting on large unrealized gains (we will see what Hamblin Watsa has sold when they report Q2).

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Guest kawikaho

Well, considering Berkshire is trading at 1.25x book, I don't see why FFH shouldn't be trading at book.  I guess you have to pay a premium for a company with better credit rating, more mind share, and a legendary jockey. 

 

It is true that reinsurance appears tighter than insurance currently, but I believe it is only temporary. Both follow the same cycle and drivers/issues are generally common. Just have a look at this Globe and Mail article regarding P&C insurance in Canada.

 

http://www.theglobeandmail.com/report-on-business/failures-loom-in-pc-insurance-sector/article1167656/

 

Early last year, I was a big advocate of investing in ORH at $37 vs FFH north of $300 U.S. because of a tangible gap in valuation. This time around, I am more inclined to go with daddy. Although, there is always that possibility of FFH buying the rest of ORH for a decent premium.

 

So yes, I am now back into Fairfax in part because I believe that the Street is significantly mispricing the recent gains in book value. As of April 24, we were told that book value had grown by at least $30 putting it above $285. If you look at various markets, you will see that they have rallied more in percentage between April 24 and now, than they did between March 31 and April 24.

 

On top of that, take a look at some of their big 13F holdings: DELL, JNJ, KFT, PFE, WFC. Only USB has not done much since April 24. I have not done the math for all the holdings disclosed in the 13F, but the result must pretty interesting. Of course, the long term treasuries have hurt the overall result, but adding another $30 to book value since April 24 does not seem that agressive to me. That is over $315.  :P

 

I am also quite confident that Prem has booked obscene profits from this market rally. This will mean more cash to re-invest in other undervalued securities or a fast growing snowball from here in book value and earning power. This will really change the psychology of investors currently seeing Fairfax as described by Viking: "and yes, markets could crater tomorrow. FFH BV will be MUCH MORE volatile moving forward given their shift to risk assets." Booking very large profits two years in a row in what has been a terrible market for most will start to look more like talent vs luck. People pay for recurring.

 

Fairfax is certainly not the cheapest stock that I hold currently, but the certainty of return is mouthwatering. FYI, since 2003 Fairfax stock in USD has never closed below book value on Dec 31. The average for these last 6 years on Dec 31 was 1.145 times book. For the last 3 years it was 1.243, which I would argue represented better years for the company!

 

Cardboard  

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Hi Viking,

 

Thank you very much for the spreadsheet! I will take a deeper look at it tonight.

 

Hi Crip,

 

There are many cheaper stocks than FFH out there. For example, I think that something like Canfor Pulp really is, but you need quite a stomach to hold it since you never know what pulp will do in the short term. Still, that stock could double tomorrow and would still be cheap while if Fairfax doubles tomorrow, I will be out.

 

Cardboard

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Well, considering Berkshire is trading at 1.25x book, I don't see why FFH shouldn't be trading at book.  I guess you have to pay a premium for a company with better credit rating, more mind share, and a legendary jockey.

There are other differences as well. For one, Berkshire's non-insurance subsidiaries are a substantial part of the company and these are worth a lot more than book value. Second, I believe Berkshire's insurance operations are superior to Fairfax's. But offsetting this, I think Fairfax has an advantage on the investment side; sounds strange to say given that Buffett is in charge of Berkshire's investments, but Fairfax does not have to deal with size as an anchor yet. It's hard to compare book multiples for the two companies though.

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Well, considering Berkshire is trading at 1.25x book, I don't see why FFH shouldn't be trading at book.  I guess you have to pay a premium for a company with better credit rating, more mind share, and a legendary jockey. 

 

Its that esoteric concept of intrinsic value again, annoying how it doesn't necessary have anything to do with book value or the share price of other companies?

 

Berkshire simply won't grow as fast as Fairfax in the future, you're paying more because Berkshire has a much stronger moat around its earnings power.  As Fairfax continues to establish and grow its moat, shareholders will eventually start to demand more than book.  

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One thing that I am learnings is when valuing insurance companies is most analysts/large investors look for predictable earnings. That is why most analyst reports simply look at operating earnings (CR plus interest/dividend income). Investment gains and losses ARE NOT VALUED until after the fact (i.e. they are realized).

 

FFH/ORH are anomalies in that they outperform their peers with investment gains but they still do not get any respect for this skill. I know FFH did in the 80's and 90's when it traded for crazy multiples. My guess is should FFH continue to outperform (over years, not quarters) Mr. Market will start to attach a higher multiple to its stock. I hope they continue to improve their underwriting versus their peers... this will be icing on the cake...  The benefit is we continue to get great opportunities to buy stock at a good discount to book value.

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Guest kawikaho

Thanks for the response, guys.  I'm aware of Berkshire's other advantages over FFH.  Just based on mere trading volume alone, Fairfax has a long way to go to match Berkshire's outside interest.  I think FFH is still under the radar.  

 

I also wonder about how much longer Watsa will stay in the business.  I mean, he's 59, I think.  You have to wonder if he's planning on retiring any time soon.  I know he could definitely afford to retire right now.  Does anyone else wonder if he plans on staying in the business as long as Buffett?  

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Guest kawikaho

I just realized, maybe a more apt comparison would be FFH to GLRE.  Both are reinsurers.  Both have outstanding jockeys to invest the float.  Both are well capitalized.  However, GLRE trades around 1.25x book.  It also has 1.5x the trading volume of both FFH.TO and FFH, even though it's only 1/7th the size.  The only difference I see is in the credit rating.  GLRE has a better credit rating than FFH.  Besides getting better rates on loans and bonds, doesn't a better credit rating improve the marketability and profitability of your insurance business?  If so, maybe Fairfax should improve their credit rating.  I believe Fairfax's rating is BBB. 

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Berkshire Hathaway does trade today at 1.36 times book value, but to compare it with Fairfax we should make an adjustment for goodwill. Goodwill at Berkshire is $33.8 billion or 33% of common equity. At Fairfax, it's only $286 million or 6.4% of common equity. Removing the goodwill at Berkshire makes it trade at 2.03 times book value.

 

Book value is simply the liquidation value of a company based on the value of the various assets and liabilities on its balance sheet using GAAP. It has nothing to do with the private or public value of this company or its subsidiaries. However, it is kind of a minimum as to what the company is worth assuming that the books are clean. It also makes some sense for financial companies since so many assets and liabilities are worth what they are stated at.

 

Therefore, I don't think it makes sense anymore for Fairfax to trade below book value at any given time. The company has survived the "test" when some market participants claimed that the liabilities were much higher than recorded. So after so much time, we have to conclude that the books are clean and that book value is solid. On top of that, the company is active (not looking to close shop), making money and growing its book value at a decent rate, so it makes no sense for it to trade lower than this amount.

 

I firmly believe that this time of trading below book value for Fairfax is rapidly coming to an end. This is a remnant of a previous era when doubts, financial issues due to too much debt, legacy under-reserving and poorly timed catastrophes caused the market to question the viability of the firm.

 

Cardboard

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Guest Dazel

 

 

Hello everyone! Have been away for awhile...very very busy as I am sure you all are as well! Sorry for the delay.

We think once again the market is missing the boat here...Great job on the numbers!

While we are seeing incredible value in the market...the fact that Fairfax is once again being forgotten is just

crazy to us!

We made a pile of money in Leucadia...However, at $22 bucks or so how can anyone see upside? A third of their value is pinned to Fortesque who quite frankly are not in the best shape...Leucadia does not have dry powder and were forced to watch the bargains that appeared in March! We also made money in Jefferies but at $21 bucks what is your upside there? Yet Leucadia is trading at an enormous multiple! Thier market cap is a billion in half more than Fairfax and they have the same amount of debt. What is their earning power?  I will not go into detail on their investments but quick math puts them at $5 billion in assets which are not liquid. Revs are basically nothing on an operational point of view...their 10Q states that they cannot cover interest and overhead with operations...

 

Why talk about Leucadia? market perception....They are trading at twice a very generous book value yet Fairfax who was the best performing company in the world last year trades at less than one times book likley about 75% of book. I will go a step further.. book does not have goodwill in it which these companies including Berkshire have incredibly high goodwill numbers!

We believe that Fairfax may be in the best condition of any company we have seen! Their future earnings potential is just massive with $20 billion in liquid assets! It feels like taking candy from babies. We seriously cannot believe that Fairfax has come back to us. I have beat the numbers to death here over the years so I guess it is more of the same...The market obviously has problems with addition!

disclaimer...we are long Fairfax..and ORH

 

Dazel. 

 

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