Fairfax2019

[petec]

Maybe if you think that India or Greece or Blackberry is suddenly going to go gangbusters, it could be worthwhile, but then why not just Eurobank, Fairfax India, or Blackberry directly.

 

I think the answer to that is you can, but the parent has advantaged access to new investments in some cases. You couldn't for example, have got the SSW deal in the market. Over time that advantage may add up.

 

What drives your confidence in the timeframe of the return in Fairfax India? I don't dispute its potential but I have no idea when it will be realised. Do you?

[Broeb22]

TwoCities,

 

Fairfax's investment leverage appears to be approx. 2.78x if you back out the 4.25 billion of assets and the 4.25 billion of non-controlling interests. I get to 37.4 billion - 4.25 billion divided by 11.78 billion.

 

Is that not the right way to think about their investment leverage? If not, how do you figure the investment leverage?

 

If that is the right number, then an after-tax investment return just north of 5% would achieve a 15% book value growth, assuming investment leverage stayed relatively stable.

 

Is this way off-base?

[petec]

TwoCities,

 

Fairfax's investment leverage appears to be approx. 2.78x if you back out the 4.25 billion of assets and the 4.25 billion of non-controlling interests. I get to 37.4 billion - 4.25 billion divided by 11.78 billion.

 

Is that not the right way to think about their investment leverage? If not, how do you figure the investment leverage?

 

If that is the right number, then an after-tax investment return just north of 5% would achieve a 15% book value growth, assuming investment leverage stayed relatively stable.

 

Is this way off-base?

 

No, it's directionally right, and in-line with their guidance that a 95% combined ratio and a 7% investment return gives 15% book value growth after debt costs, taxes, etc.

 

The issue is that if you assume the investment book is 70/30 debt/equity, and you assume a 4% return on debt, you've got to have a 14% return on the equity investments to get to 7% overall. That's not pie in the sky but nor is it easy. That's why they're trying to be smart about debt+warrant deals, to juice the returns on the debt side.

[StevieV]

Same math implies the flip side as well, correct?

 

That is, because of the tilt towards fixed income, particularly high equity returns are necessary to boost the overall returns substantially.  However, mediocre equity returns shouldn't prevent book value from compounding in the high single digits and worse than mediocre equity returns shouldn't stop book value growth from being positive (assuming underwriting and fixed income performs). 

[petec]

Same math implies the flip side as well, correct?

 

That is, because of the tilt towards fixed income, particularly high equity returns are necessary to boost the overall returns substantially.  However, mediocre equity returns shouldn't prevent book value from compounding in the high single digits and worse than mediocre equity returns shouldn't stop book value growth from being positive (assuming underwriting and fixed income performs).

 

Certainly they ought to be able to do mid single digits. But it's not like there's no downside risk. A 10% equity loss would wipe out a 4% fixed income gain, roughly. And position sizes are big - if Eurobank, Seaspan, and Blackberry all go to the wall, you'll know about it. Thankfully there's little risk of that in my view ;)

[TwoCitiesCapital]

Same math implies the flip side as well, correct?

 

That is, because of the tilt towards fixed income, particularly high equity returns are necessary to boost the overall returns substantially.  However, mediocre equity returns shouldn't prevent book value from compounding in the high single digits and worse than mediocre equity returns shouldn't stop book value growth from being positive (assuming underwriting and fixed income performs).

 

Sure, but the argument for owning something for me has to be a higher bar than single digits. Particularly something that itself has the potential to be super-volatioe in a downturn simply due to market sentiment.

 

My only point wasn't to say FFH will lose money. It's just hitting their 15% ROE target consistently enough to get a rerating in the stock is seemingly a pipedream with interest rates and equity valuations where they're at. There's probably better opportunities out there at this time/price.

 

I don't have any specific forecasts for Fairfax India other than being generally bullish on EM, generally bullish on EM currencies, taking advantage of a significant pullback in Indian assets, and generally liking the investments they've made in that vehicle.

 

I don't like the fees, which is why I haven't owned it previously, but the high water mark should ensure I have plenty of upside in the near-to-midterm without paying much for it.

[racemize]

I don't like the fees, which is why I haven't owned it previously, but the high water mark should ensure I have plenty of upside in the near-to-midterm without paying much for it.

 

It's also a PFIC, which sucks for U.S. investors.

[TwoCitiesCapital]

I don't like the fees, which is why I haven't owned it previously, but the high water mark should ensure I have plenty of upside in the near-to-midterm without paying much for it.

 

It's also a PFIC, which sucks for U.S. investors.

 

Yes, that can be an impediment. 95% of my investable/liquid assets are in tax-free/tax-deferred accounts so I'm less impacted by the PFIC designation.

[Luckyone77]

Well, boys, after 10 years of owning this stock I decided to sell my remaining shares today. I'm out. Greatly disappointed in their ability to judge stocks and, in particular, their ability to judge the management of these companies. I simply can't justify their continued underachievement. A dart board would have had greater success of stock picking. I hope my exit proves to be the turning point for the stock, as it so often seems to be (lol), and that you all are greatly rewarded for having hung in there. Hopefully, India will be the salvation.

 

Nevertheless, I do appreciate the keen insight of many of the posts on this site. Its been informative.

[Zorrofan]

Well, boys, after 10 years of owning this stock I decided to sell my remaining shares today. I'm out. Greatly disappointed in their ability to judge stocks and, in particular, their ability to judge the management of these companies. I simply can't justify their continued underachievement. A dart board would have had greater success of stock picking. I hope my exit proves to be the turning point for the stock, as it so often seems to be (lol), and that you all are greatly rewarded for having hung in there. Hopefully, India will be the salvation.

 

Nevertheless, I do appreciate the keen insight of many of the posts on this site. Its been informative.

 

I have been a FFH shareholder for longer than some of you may have been alive! I suffered the seven lean years and hoped for seven prosperous ones before Prem put on the hedges during one of  the longest bull runs in our lifetimes.

 

But facts are facts. At the close of 1998 the book value of FFH was $112.49, rising to $432.46 by the end of 2018. This represents a growth rate of less than 7% for the past twenty years. You can add on a bit for the dividend but it still represents a rather disappointing performance.  Prem is quick to mention the results since inception but frankly the last 20 years have been lackluster and I am seriously questioning the performance we can expect going forward.

[petec]

Well, boys, after 10 years of owning this stock I decided to sell my remaining shares today. I'm out. Greatly disappointed in their ability to judge stocks and, in particular, their ability to judge the management of these companies. I simply can't justify their continued underachievement. A dart board would have had greater success of stock picking. I hope my exit proves to be the turning point for the stock, as it so often seems to be (lol), and that you all are greatly rewarded for having hung in there. Hopefully, India will be the salvation.

 

Nevertheless, I do appreciate the keen insight of many of the posts on this site. Its been informative.

 

I have been a FFH shareholder for longer than some of you may have been alive! I suffered the seven lean years and hoped for seven prosperous ones before Prem put on the hedges during one of  the longest bull runs in our lifetimes.

 

But facts are facts. At the close of 1998 the book value of FFH was $112.49, rising to $432.46 by the end of 2018. This represents a growth rate of less than 7% for the past twenty years. You can add on a bit for the dividend but it still represents a rather disappointing performance.  Prem is quick to mention the results since inception but frankly the last 20 years have been lackluster and I am seriously questioning the performance we can expect going forward.

 

I’m halfway through my annual deep dive. Full disclosure: I’ve always liked this company so maybe I’m biased. But the more I read the more I like. Most of the major investments look good, some great, to me, with considerable value on the table. The amount going on under the bonnet is quite incredible and Fairfax has the opportunity to build several major businesses from scratch. This is a very different business to 20 years ago: Fairfax have worked themselves into a position where they can put incredible people in charge of operations and drive change. Putting info together from various sources I’m not worried about the stock buybacks for treasury - I think the buyback is real. And they’ve sworn off naked hedging. Lots to like, especially with markets where they are.

[wondering]

1st quarter results out.

 

https://s1.q4cdn.com/579586326/files/doc_news/2019/May/PRFFH-May-2-2019-Q1-Press-Release.pdf

 

I like the results.

 

- Shares continue to be bought back 250K + 118K shares for a total $175m

- net capital gains of $700m (a bounce back for the terrible 4th quarter in 2018)

- combined ratio of 97% (I wish it was a little lower, but I can't have everything)

- interest and dividends $235m (we are tracking towards the $1B for the year)

- book value per share 450/share US, increase of 6.7% from Dec

[petec]

I’m confused by the AGT transaction. Have they lent money to management for an MBO, or bought it themselves, or both?

[gfp]

I’m confused by the AGT transaction. Have they lent money to management for an MBO, or bought it themselves, or both?

 

Both.  They are both a lender and shareholder (controlling shareholder actually, 59.6% currently plus warrants that would bring it to 80%)

[Cigarbutt]

I’m confused by the AGT transaction. Have they lent money to management for an MBO, or bought it themselves, or both?

 

Both.  They are both a lender and shareholder (controlling shareholder actually, 59.6% currently plus warrants that would bring it to 80%)

FFH exchanged their common and preferred shares of the old entity for a controlling equity stake in the new entity, which likely rendered the "management" buyout possible as the transaction may have been too leveraged otherwise.

 

[StubbleJumper]

1st quarter results out.

 

https://s1.q4cdn.com/579586326/files/doc_news/2019/May/PRFFH-May-2-2019-Q1-Press-Release.pdf

 

I like the results.

 

- Shares continue to be bought back 250K + 118K shares for a total $175m

- net capital gains of $700m (a bounce back for the terrible 4th quarter in 2018)

- combined ratio of 97% (I wish it was a little lower, but I can't have everything)

- interest and dividends $235m (we are tracking towards the $1B for the year)

- book value per share 450/share US, increase of 6.7% from Dec

 

 

Spot on.  A few more observations:

 

1) Isn't it just a bit weird that FFH had realized gains on both their equities and their derivatives in the same quarter?  Don't get me wrong, I'll take it!  But, these were supposed to have been set up as a hedge, but they didn't act as a hedge in Q1.  The derivatives are starting to become small potatoes, but I found that was a bit weird anyway.

 

2) As you noted the CR is up, and favourable development is down.  The accident year CRs have been wacked for a number of years and there has been consistent, large favourable development.  In Q1 it was still favourable, but the magnitude was down.  What's the story?  Is it just a few shitty policies at Allied and a bit of bad luck in the other subs, or are we seeing the result of pricing pressure of a year or two ago across the line?  While completely irrational, I don't like seeing adverse development in the "new" sub (but somehow I would feel okay if were in an established sub?).

 

3) The interest rate sensitivity table would suggest that duration has increased a smidgen.  Is this a conscious effort and is this a sign of things to come, or is it just a bit of noise?  It would seem like a funny time to go a shade longer on fixed income, but in all fairness it would have worked out over the last quarter or two. 

 

4) With the exception of Zenith, net written looks good.  It's not that mythical 10% YoY growth, but 5% still shows some real organic growth.  It'll be interesting to get some commentary about the pricing environment during the conference call.

 

Nice boring quarter.  Let's hope that some of the large block equity postions continue to gain traction.

 

 

SJ

[Santayana]

The Zenith net written may not have been what we're looking for, but that 78.3 CR sure looks good!

[shalab]

Since they wont give you the diluted number of shares and book value per diluted share, here is the updated calculation after Q1:

 

Diluted number of shares at the end of 2018 - 28.397 million

Diluted number of shares at the end of Q1 2019 - 28.5107 million (obtained by shareholder earnings/diluted earnings per share - 769.2/26.98 - page 6 of the report).

 

Using the diluted shares, I get a book value of 414 at the end of 2018. Adjusting for dividends paid out - I get a book value growth of 5.39%

 

Increase in diluted shares => 113K shares.

 

Book value per diluted share => 425.76

 

The holding company's debt also increased:

 

The company's total debt to total capital ratio increased from 27.2% at December 31, 2018 to 29.2% at March 31, 2019, primarily reflecting increased borrowings by the holding company and non-insurance operations.

 

 

1st quarter results out.

 

https://s1.q4cdn.com/579586326/files/doc_news/2019/May/PRFFH-May-2-2019-Q1-Press-Release.pdf

 

I like the results.

 

- Shares continue to be bought back 250K + 118K shares for a total $175m

- net capital gains of $700m (a bounce back for the terrible 4th quarter in 2018)

- combined ratio of 97% (I wish it was a little lower, but I can't have everything)

- interest and dividends $235m (we are tracking towards the $1B for the year)

- book value per share 450/share US, increase of 6.7% from Dec

 

 

Spot on.  A few more observations:

 

1) Isn't it just a bit weird that FFH had realized gains on both their equities and their derivatives in the same quarter?  Don't get me wrong, I'll take it!  But, these were supposed to have been set up as a hedge, but they didn't act as a hedge in Q1.  The derivatives are starting to become small potatoes, but I found that was a bit weird anyway.

 

2) As you noted the CR is up, and favourable development is down.  The accident year CRs have been wacked for a number of years and there has been consistent, large favourable development.  In Q1 it was still favourable, but the magnitude was down.  What's the story?  Is it just a few shitty policies at Allied and a bit of bad luck in the other subs, or are we seeing the result of pricing pressure of a year or two ago across the line?  While completely irrational, I don't like seeing adverse development in the "new" sub (but somehow I would feel okay if were in an established sub?).

 

3) The interest rate sensitivity table would suggest that duration has increased a smidgen.  Is this a conscious effort and is this a sign of things to come, or is it just a bit of noise?  It would seem like a funny time to go a shade longer on fixed income, but in all fairness it would have worked out over the last quarter or two. 

 

4) With the exception of Zenith, net written looks good.  It's not that mythical 10% YoY growth, but 5% still shows some real organic growth.  It'll be interesting to get some commentary about the pricing environment during the conference call.

 

Nice boring quarter.  Let's hope that some of the large block equity postions continue to gain traction.

 

 

SJ

[StevieV]

Diluted number of shares at the end of 2018 - 28.397 million

Diluted number of shares at the end of Q1 2019 - 28.5107 million (obtained by shareholder earnings/diluted earnings per share - 769.2/26.98 - page 6 of the report).

 

I have to check these numbers and the buyback numbers above for myself.  However, assuming they are correct, that's a big problem.

 

0.4% dilution isn't too bad considered alone, but it's terrible if Fairfax spent the majority of their highly touted dividend and interest income to keep the share count not even flat.

 

Got to go back and refresh my memory on this issue.

[Cigarbutt]

The Zenith net written may not have been what we're looking for, but that 78.3 CR sure looks good!

I would suggest that the 2010 Zenith acquisition will eventually be recognized as an excellent one.

 

-Value at acquisition (May 2010): 1.3B for the 91.8% FFH did not own, including a 200M share issue "undervalued" at 355.

-Valuation parameters now would suggest a relatively low return since acquisition because the market never really hardened, even if 781M in dividends have been distributed to FFH along the way.

 

Workers comp insurance is very unusual, long-tail and requires an incredible amount of underwriting discipline and IMO Zenith continues to be a significant outlier, the value of which will only become apparent over the full underwriting cycle. Always hard to say ex-ante but many experts suggest that the present status of the net loss and LAE reserves is adequate, a similar situation to the soft market environment of the late 90's when, eventually, it was found, around 2001, that the net loss and LAE reserves deficiency had in fact reached about 33% of the calendar year total premiums (!). It's impossible to know the future but the reserve deficiency cycle suggests that redundancies are likely to reverse. For the 1997-2000 period, retrospective hindsight allowed to (see who was swimming naked) increase each of the ultimate accident year combined ratios by 15 to 23 percentage points (!).

 

The last few years have resulted in an amazingly competitive (soft) environment. Zenith has grown in the early 2010's when there was some hardening but growth (almost doubled NPW) came to some degree from rising premiums per policy and written premiums have been essentially flat to declining in the last 3 to 4 years. ZNT reported very poor combined ratios in 2010 to 2012 due to a very high expense ratio (kept their infrastructure, about extra 10% of the CR) and due to (too) conservative reserves adjustments. Over the long term, Zenith continues to show an enduring capacity to report lower loss ratios than the industry. The reserve release (20.5% CR points) in Q1 2019 is another example of their conservative reserving of prior periods.

 

In 2018, NWP for the year were 789.2M. In 2005, their NWP was 1.2B. They have huge opportunistic capacity to increase market share. Since 2015, many competitors have increased market share with gradually decreasing retention and likely a component of "cashflow" underwriting. In the industry these days, the typical reserves to NPW ratio sits around 3.5 to 4. For Zenith, it is now at 1.8, which means that even in an environment where redundancies become deficiencies, the negative impact will be much less on Zenith.

 

So, the market in this space is incredibly soft and nobody knows when the market will turn but turn, it will. Not long ago, AM Best had this to say about payroll growth and its potential impact on the workers comp insurance market:

"However, the US has not recorded a consistent decline in the unemployment rate longer than nine consecutive years since it began tracking the unemployment rate in 1929. Historically, long declines have typically been followed by sharp spikes in unemployment-which may serve as a forewarning for workers' compensation writers to expect payroll growth, and any resulting premium growth, to cease sooner rather than later, unless wage growth accelerates."

 

Zenith looks positioned to profit in correlation to the underwriting discipline they have shown in the last part of the journey.

 

 

 

 

[A_Hamilton]

Diluted number of shares at the end of 2018 - 28.397 million

Diluted number of shares at the end of Q1 2019 - 28.5107 million (obtained by shareholder earnings/diluted earnings per share - 769.2/26.98 - page 6 of the report).

 

I have to check these numbers and the buyback numbers above for myself.  However, assuming they are correct, that's a big problem.

 

0.4% dilution isn't too bad considered alone, but it's terrible if Fairfax spent the majority of their highly touted dividend and interest income to keep the share count not even flat.

 

Got to go back and refresh my memory on this issue.

 

No no...$769.2 is available to all shareholders of Fairfax. Preferred shareholders received $11.2 million, so available to common is $758/26.98= 28 million. Or page 19 of the interim report in Note 12.

[Santayana]

Thank you for clarifying, A_Hamilton.

[shalab]

Thanks for the note - I was going off the press release:

 

Diluted number of shares at the end of Q4 2018 - 28.397 million

Diluted number of shares at the end of Q1 2019 - 28.093054 million

 

Decrease => 303946 shares

 

Diluted number of shares at the end of 2018 - 28.397 million

Diluted number of shares at the end of Q1 2019 - 28.5107 million (obtained by shareholder earnings/diluted earnings per share - 769.2/26.98 - page 6 of the report).

 

I have to check these numbers and the buyback numbers above for myself.  However, assuming they are correct, that's a big problem.

 

0.4% dilution isn't too bad considered alone, but it's terrible if Fairfax spent the majority of their highly touted dividend and interest income to keep the share count not even flat.

 

Got to go back and refresh my memory on this issue.

 

No no...$769.2 is available to all shareholders of Fairfax. Preferred shareholders received $11.2 million, so available to common is $758/26.98= 28 million. Or page 19 of the interim report in Note 12.

[petec]

Some thoughts on the share issuance discussion.

 

I think the split between shares bought for treasury and for cancellation is a bit of a red herring. If they like the price now, it makes all the sense in the world to stock up on shares for future issuance under stock award schemes. The fact that they are buying them doesn't mean they will reissue them any time soon - on the 1q18 call Prem said the new share award plans vested in 15 years, and presumably the awards are somewhat performance based so they not be reissued at all. In 2018 90k shares were reissued, or about 0.33% of the outstanding.

 

More important is the number of dilutive shares. This number went from 0.69m shares to 0.89m over the course of 2018, up 200k. On the YE18 base, that would imply growth in the share count of 0.7% a year, which I wouldn't have a problem with. But the number of dilutive shares rose another 170k in 1q19 alone. If that pace is maintained then the share count is growing at about 2.4% a year, although as discussed above it may be many years before the dilutive shares are actually issued.

 

I can deal with a relatively high pace of issuance at the moment: a new generation is rising through the ranks, as we saw in the reorganisation at Hamblin Watsa last year, and I want them incentivised. But the 1q19 pace of dilution eats about 2/3rds of the 1m/year buyback they spoke of on the 1q call. That strikes me as too high unless performance improves a lot.

 

As an aside, the fact that the number of dilutive securities is growing at that speed when the share price isn't rising makes me wonder how demanding the performance targets are.

 

Finally, it really annoys me that they calculate BVPS using basic shares.

 

[jfan]

Given that Fairfax and Hamblin Watsa is quite dependent on human capital. Perhaps the perspective of share dilution could be viewed as growth/succession cap ex to allow the company to continue operating into the future.

 

Furthermore, since Prem is the largest shareholder, any share dilution is also dilution of his proportion as well.

 

Certainly, long-dated options can have the possibility of incentive malalignment. What long-term incentive structure could fairfax put in place to help transition to the next generation and align them with the common shareholder?