MKL - Markel Corp

[zippy1]

On page 55 of Q3 10-Q, there is an interest rate sensitivity table. Attached below

[ERICOPOLY]

On page 55 of Q3 10-Q, there is an interest rate sensitivity table. Attached below

 

 

So an 8.27% decline in shareholder equity from a 200 bps rise.  In the meantime, how much book value boost annually does the current level of interest income contribute, after tax? 

 

The harder part is knowing how long these low rates will last -- each year it continues, it leads to less BVPS growth.  I imagine it's worth somewhat of a discount given that it leads to slower BVPS growth, but how do you come up with that discount without knowing how long rates will be low for?  So perhaps the market is making an assumption of 5 more years.  In that case, and if the low rates are retarding growth in book by 3% annualized, that would be worth an additional 15% discount, roughly.  But I pulled that 3% number out of my butt -- does anyone know what the real number is?

 

[cayale]

On page 55 of Q3 10-Q, there is an interest rate sensitivity table. Attached below

 

 

So an 8.27% decline in shareholder equity from a 200 bps rise.  In the meantime, how much book value boost annually does the current level of interest income contribute, after tax? 

 

The harder part is knowing how long these low rates will last -- each year it continues, it leads to less BVPS growth.  I imagine it's worth somewhat of a discount given that it leads to slower BVPS growth, but how do you come up with that discount without knowing how long rates will be low for?  So perhaps the market is making an assumption of 5 more years.  In that case, and if the low rates are retarding growth in book by 3% annualized, that would be worth an additional 15% discount, roughly.  But I pulled that 3% number out of my butt -- does anyone know what the real number is?

 

They'll shorten the bond portfolio.  I am guessing a lot of the lengthening came from Alterra.

 

That said, I think you raise a great point regarding book value growth.  a) Can they get away with allocating more to stocks and private companies to grow book value; b) is that prudent?.  I suppose a potential antidote to that is that the market hardens because carrier shareholders won't ultimately accept shoddy returns on equity.  Also, Alterra is getting into greater syndication of deals where they receive a fee for writing business but allow somebody else to risk the capital.  MKL trades at a discount to some other decent insurance companies but it would seem to me the problem is industrywide.

[zippy1]

Eric,

 

      Their fixed-income maturity table is like this below. I suppose the less than 1-year part will get benefit fairly quickly. Unfortunately, they categorize as >1year and less than 5 year, so I am not sure what to guess.

 

      There is about 900m in less than 1 year category.

 

[zippy1]

They really increased weighting on the fixed-income a lot by the acquition. They really need to lower down the fixed-income and increase stock. On the last conference call, they were saying that they are letting the bond "rolling-off" to buy stock.  I suppose there are not so many cheap stock either.

 

[vinod1]

Once Markel deploys all the fixed income from the acquisition into their target stock/bond ratio, we would be getting an exposure of something like $0.7 in stocks and $1.8 in bonds for every $1 of shareholders equity. A CR of 95% is needed just to cover operating expenses and interest expenses.

 

Even if we can buy at 1x book value, I am not too enthusiastic about being levered 1.8x to the bond market and 0.7x to stock market, given the low interest rates and high overall stock market valuation.

 

Vinod

[obtuse_investor]

Yeah, they were at a <3 year duration last time i've seen it disclosed.  They have a ton of cash from hedge fund redemption and are redeeming more in the near future.

 

See attached chart of bond maturities. It shows Q1 numbers, that are pre-alterra.

 

[ERICOPOLY]

I am not too enthusiastic about being levered 1.8x to the bond market and 0.7x to stock market, given the low interest rates and high overall stock market valuation.

 

Vinod

 

Precisely.

[skanjete]

If intrest rates rise, book value per share will be negatively affected as the table shows. At the same time however, the value of the float will clearly rise, because they will be able to invest their cash and cash flow at better conditions.

 

So BVPS will go lower somewhat (if not compensated by other profits (underwriting, venture)), but the market should value the BVPS at a somewhat higher premium. One effect will partly compensate the other. So that mitigates the risk. On the other hand, if one is looking for a "lollapalooza effect", you aren't going to find it here. 

 

Conclusion : it all boils down to the operating and capital allocations skills of the management to generate value over time, compared to their competition. I think Markel will do just fine over time, in any kind of environment.

 

PS. The longer the low intrest rates continue, the better they will digest the Alterra takeover. It gives them time to restructure the investments in a benign environment. Also the hurricane season this year was a big positive for their Alterra takeover. The low losses allow them to strenghten the loss reserves without too much of a negative effect to their book value.

[jay21]

If you are going to MTM the assets, I think you should MTM the liabilities.  The way I think of it is that MKL earns a spread between their float and fixed income.  If they duration match, this spread shouldn't change.

 

Also, rising rates will take a lot of capital out insurers due to MTM.  This could potentially create a hard market.  Insurers like MKL who are trying to lower their duration will benefit b/c they will take less of a hit than higher duration insurers and they will have the capital to underwrite.

[muscleman]

As at September 30:

 

Net investments per share (including cash & Markel Ventures net assets) = $1,088

Per-share Q3 premiums earned (annualized) = $262

 

Assuming 35% statutory tax rate & 2% underwriting profit, the pre-tax return on net investments required to earn comprehensive earnings of 10% of present market value is approx. 7.2%:

 

Comprehensive earnings per share equal to 10% of present market value = $54

Underwriting: $262 * .02 = $5.24 * .65 = $3.41

Investments: $54 - $3.41 = $50.59 / .65 = $77.83 / $1088 = 7.2%

 

Equities together with Markel Ventures net assets currently at 59% of book value.

 

Could you please tell me how to get the net investment per share figure? From Whitney Tilson's BRK.B presentation, he uses net investment per share + operating subsidiaries' income per share * 8 to get his per share intrinsic value, which makes sense, so I am trying to do a similar exercise here. :)

 

From the 09/30/13 10Q:

 

Add "Investments"

Total investments = $14,461,010

Cash = $2,115,322

Non-insurance operations = $903,795

 

Subtract Debt = $2,250,479

 

Equals Net investments = $15,229,648

 

Divide by Shares outstanding = 14,001

 

Equals Net investments per share = $1,087.75

 

Thank you!

I am reading Buffet's 2010 letter and other letters in order to understand how to value insurance companies.

I think right now MKL's non-insurance operations (Markel venture) hasn't generated enough earnings, so the primary valuation of MKL would be simply based on the net investments per share.

http://www.berkshirehathaway.com/letters/2010ltr.pdf

"When, in 1996, we bought the 50% of GEICO we didn’t already

own, it cost us about $2.3 billion. That price implied a value of $4.6 billion for 100%. GEICO then had tangible

net worth of $1.9 billion."

 

So it does seems like Buffet believed that if the combined ratio is lower than 100%, it is ok to value the company at the insurance float plus book value.

[muscleman]

As at September 30:

 

Net investments per share (including cash & Markel Ventures net assets) = $1,088

Per-share Q3 premiums earned (annualized) = $262

 

Assuming 35% statutory tax rate & 2% underwriting profit, the pre-tax return on net investments required to earn comprehensive earnings of 10% of present market value is approx. 7.2%:

 

Comprehensive earnings per share equal to 10% of present market value = $54

Underwriting: $262 * .02 = $5.24 * .65 = $3.41

Investments: $54 - $3.41 = $50.59 / .65 = $77.83 / $1088 = 7.2%

 

Equities together with Markel Ventures net assets currently at 59% of book value.

 

Could you please tell me how to get the net investment per share figure? From Whitney Tilson's BRK.B presentation, he uses net investment per share + operating subsidiaries' income per share * 8 to get his per share intrinsic value, which makes sense, so I am trying to do a similar exercise here. :)

 

From the 09/30/13 10Q:

 

Add "Investments"

Total investments = $14,461,010

Cash = $2,115,322

Non-insurance operations = $903,795

 

Subtract Debt = $2,250,479

 

Equals Net investments = $15,229,648

 

Divide by Shares outstanding = 14,001

 

Equals Net investments per share = $1,087.75

 

Thank you! I compared these numbers with BRK, and I found that BRK has most of its insurance float invested in equity, but MKL has much more invested in fixed income securities.

Is there any regulation that prevents MKL from doing so?

I think if current low interest rate environment continues, it will be hard for MKL to compound the book at 20% per year from now on.

[jay21]

On page 55 of Q3 10-Q, there is an interest rate sensitivity table. Attached below

 

 

So an 8.27% decline in shareholder equity from a 200 bps rise.  In the meantime, how much book value boost annually does the current level of interest income contribute, after tax? 

 

The harder part is knowing how long these low rates will last -- each year it continues, it leads to less BVPS growth.  I imagine it's worth somewhat of a discount given that it leads to slower BVPS growth, but how do you come up with that discount without knowing how long rates will be low for?  So perhaps the market is making an assumption of 5 more years.  In that case, and if the low rates are retarding growth in book by 3% annualized, that would be worth an additional 15% discount, roughly.  But I pulled that 3% number out of my butt -- does anyone know what the real number is?

 

Eric, let me know if I have any flawed thinking here on the impact of a rate rise.

 

Let's say MKL (or ExampleCo) is currently doing a 10% ROE and priced at 1 P/B at $100 a share.  Then there is a 200 bps rate rise and let's say BV goes down 15% (greater than what's shown above) for a BV of $85 a share.  However, because investments are levered by 2 - 3x the 200bps rate rise results in ~5% increase in ROE.  So now they are at 15% ROE and the market re-rates to 1.5 P/B.  This would be a price of $127.5.

 

So we would want to buy at the bottom of the cycle as long as the price is low and the tradeoff between their decrease in BV vs. increase in ROE is there.

 

Owning at the top of the cycle is the polar opposite.  You have an increase in BV, but a lower multiple due to a decrease in ROE.

[racemize]

Thank you! I compared these numbers with BRK, and I found that BRK has most of its insurance float invested in equity, but MKL has much more invested in fixed income securities.

Is there any regulation that prevents MKL from doing so?

I think if current low interest rate environment continues, it will be hard for MKL to compound the book at 20% per year from now on.

 

Well, some of that has to do with the Alterra acquisition--they've indicated that they will slowly get it back to their normal equity:fixed income percentage, but they will do it over a few years.  They have also been defensively postured, waiting for interest rates to rise.  If you go read a few transcripts from conference calls over the last 4-6 quarters, they talk about this.

 

It seems to me to be the right thing to do in the current environment (as Marks would say, "move forward, but with caution").

 

I also would not expect them to go forward at 20% book value compounding--I imagine in the shorter run it will be ~7% and in the longer term ~15%, unless something bad happens to them.  For a lot of investors here, that is too low.  I like to use these types of companies as my foundation positions (e.g., the first 30-50%) of the portfolio.

[ERICOPOLY]

On page 55 of Q3 10-Q, there is an interest rate sensitivity table. Attached below

 

 

So an 8.27% decline in shareholder equity from a 200 bps rise.  In the meantime, how much book value boost annually does the current level of interest income contribute, after tax? 

 

The harder part is knowing how long these low rates will last -- each year it continues, it leads to less BVPS growth.  I imagine it's worth somewhat of a discount given that it leads to slower BVPS growth, but how do you come up with that discount without knowing how long rates will be low for?  So perhaps the market is making an assumption of 5 more years.  In that case, and if the low rates are retarding growth in book by 3% annualized, that would be worth an additional 15% discount, roughly.  But I pulled that 3% number out of my butt -- does anyone know what the real number is?

 

Eric, let me know if I have any flawed thinking here on the impact of a rate rise.

 

Let's say MKL (or ExampleCo) is currently doing a 10% ROE and priced at 1 P/B at $100 a share.  Then there is a 200 bps rate rise and let's say BV goes down 15% (greater than what's shown above) for a BV of $85 a share.  However, because investments are levered by 2 - 3x the 200bps rate rise results in ~5% increase in ROE.  So now they are at 15% ROE and the market re-rates to 1.5 P/B.  This would be a price of $127.5.

 

So we would want to buy at the bottom of the cycle as long as the price is low and the tradeoff between their decrease in BV vs. increase in ROE is there.

 

Owning at the top of the cycle is the polar opposite.  You have an increase in BV, but a lower multiple due to a decrease in ROE.

 

I see your point that the rising interest rates will help the stock earnings (and thus stock price) more than it will hurt the balance sheet.  The earnings though seem weak until it happens.  It's similar to how I view BAC -- rising rates will help it more than hurt it, but in the meantime that stock trades at a much better earnings yield than MKL -- so you still do great if rates don't rise for a long time.  So that's the weakness I see with MKL -- it is too dependent on rising rates.

 

MKL is competing for a spot in my portfolio, against BAC -- that's why I pit one against the other.

[racemize]

I see your point that the rising interest rates will help the stock earnings (and thus stock price) more than it will hurt the balance sheet.  The earnings though seem weak until it happens.  It's similar to how I view BAC -- rising rates will help it more than hurt it, but in the meantime that stock trades at a much better earnings yield than MKL -- so you still do great if rates don't rise for a long time.  So that's the weakness I see with MKL -- it is too dependent on rising rates.

 

MKL is competing for a spot in my portfolio, against BAC -- that's why I pit one against the other.

 

That makes sense, for the rest of us that have more than one position, it is a bit easier...  ;)

[JPerez]

Hi I'm new to the board and I hope I can contribute to the discussion.

I have the attached management projections from the merger proxy for the separate entities before the merger and I have put them together adjusted for the cash payment in the merger and the new amount of shares outstanding.

Based on those projections management was expecting to compound at a CAGR of 9.5% in the next 4 years.

Alterra had a lower tax rate but you would expect better investment results with the Markel management.

It is interesting how Alterra management was expecting a combined ratio of 90% and increasing slightly over time and Markel was expecting a combined ratio of 95% and trending slightly down.

In respect to earnings in the last quarter they earned 4.67$ per share but to those earnings some items should be added

-Prior year reserve releases for Alterra of  48.1 million that were used to bring the reserves to the very conservative Markel standards

- Acquisition costs of 8.5 million

- Amortization expense as a result of establishing a new amortized cost for Alterra's fixed maturity securities of 22.6 million

- Amortization of intangible assets 16.8 million

In total that would add 96 million pre tax and at a 30% tax rate 73 Million or 5.27$ per share extra so close to 10$ per share in real earnings for the quarter or 40$ anualized which is close to 9% increase in book value per year before other comprehensive income.

 

I don't worry about the stock investments losing value in a market crash due to high valuations because the investment in equities as a percentage of book value are very low at the moment after the Alterra merger. They have a lot of cash that could be deployed if the market would crash and the management has  the patience to wait until the right opportunity comes along.

MARKEL.xls

[zippy1]

Hi I'm new to the board and I hope I can contribute to the discussion.

I have the attached management projections from the merger proxy for the separate entities before the merger and I have put them together adjusted for the cash payment in the merger and the new amount of shares outstanding.

Based on those projections management was expecting to compound at a CAGR of 9.5% in the next 4 years.

Welcome to the board, JPerez! Thanks for putting this projection together.

One quick question, there is a "-1000" in the calculation of book value. Can you explain what it is?

[JPerez]

They paid 1 billion in cash for Alterra plus the stock so the combined book value is the combination of the 2 book values minus the cash consideration.

In reality the combined book value is a bit more because they paid  a bit over book value for alterra and that went into goodwill and intangibles but i ignored that in the calculation.

Because of the exchange of x shares of alterra for every x shares of Markel the higher the shares of Markel where at the closing date the higher above book value they would pay according to GAAP so at the end the premium over book value was a random number based on markel share price the day of the closing.

[zippy1]

They paid 1 billion in cash for Alterra plus the stock so the combined book value is the combination of the 2 book values minus the cash consideration.

In reality the combined book value is a bit more because they paid  a bit over book value for alterra and that went into goodwill and intangibles but i ignored that in the calculation.

Because of the exchange of x shares of alterra for every x shares of Markel the higher the shares of Markel where at the closing date the higher above book value they would pay according to GAAP so at the end the premium over book value was a random number based on markel share price the day of the closing.

JPerez,

Thanks a lot.  Again, welcome to the board!

 

Zippy

[CorpRaider]

W/R/T the rate fluctuation impacts on book value, I think it is probably wise to anticipate that the market will discount that fact.  I humbly submit, however, that so long as they do a good job of matching the duration of fixed income assets with the expected claims and maintain adequate liquidity, it will simply be a non-cash accounting "noise" event.

 

To quote WEB from Berkshire's 1975 annual letter:

 

We have continued to maintain a strong, liquid position in our insurance

companies. In last year’s annual report, we explained how variations of 1/10

of 1% in interest rates result in million dollar swings in the market value of

our bonds. We consider such market fluctuation of minor importance, as our

liquidity and general financial strength make it highly improbable that

bonds will have to be sold at times other than those of our choosing.

[Kiltacular]

Hi I'm new to the board and I hope I can contribute to the discussion.

I have the attached management projections from the merger proxy for the separate entities before the merger and I have put them together adjusted for the cash payment in the merger and the new amount of shares outstanding.

Based on those projections management was expecting to compound at a CAGR of 9.5% in the next 4 years.

Alterra had a lower tax rate but you would expect better investment results with the Markel management.

It is interesting how Alterra management was expecting a combined ratio of 90% and increasing slightly over time and Markel was expecting a combined ratio of 95% and trending slightly down.

In respect to earnings in the last quarter they earned 4.67$ per share but to those earnings some items should be added

-Prior year reserve releases for Alterra of  48.1 million that were used to bring the reserves to the very conservative Markel standards

- Acquisition costs of 8.5 million

- Amortization expense as a result of establishing a new amortized cost for Alterra's fixed maturity securities of 22.6 million

- Amortization of intangible assets 16.8 million

In total that would add 96 million pre tax and at a 30% tax rate 73 Million or 5.27$ per share extra so close to 10$ per share in real earnings for the quarter or 40$ anualized which is close to 9% increase in book value per year before other comprehensive income.

 

I don't worry about the stock investments losing value in a market crash due to high valuations because the investment in equities as a percentage of book value are very low at the moment after the Alterra merger. They have a lot of cash that could be deployed if the market would crash and the management has  the patience to wait until the right opportunity comes along.

 

Good post and important points about how the merger / GAAP is obscuring some of the owner earnings.  This was pointed out in the conf. call and it seems like the market may now understand this.

 

Markel is attractive though it is hard to disagree with 'copoly that BAC is cheaper. 

[james22]

MKL is competing for a spot in my portfolio...

 

As a MKL owner, I find that about as encouraging as anything else I've read.

[muscleman]

 

 

MKL is competing for a spot in my portfolio, against BAC -- that's why I pit one against the other.

 

How about BPOP? It is quite similar to BAC but I think it has a higher upside.

[ERICOPOLY]

 

 

MKL is competing for a spot in my portfolio, against BAC -- that's why I pit one against the other.

 

How about BPOP? It is quite similar to BAC but I think it has a higher upside.

 

I haven't been looking.  I know there must be better opportunities out there, but I'm sitting tight and aside from a couple of good calls I'm a fairly below-average investor in terms of spotting a good company from a bad one.  I don't want to go back into the jungle, too much tiger in the jungle -- I just want to stay with the boat.