Fairfax Q1 2013 Results

[Grenville]

http://www.fairfax.ca/news/press-releases/press-release-details/2013/Fairfax-Financial-Holdings-Limited-First-Quarter-Financial-Results/default.aspx

 

Combined ratio 94%

 

Book Value 373

[LowIQinvestor]

If only we didn't have this :(

 

Equity hedges - (592.8)

 

[Nnejad]

$25 billion investment portfolio:      $100 mm interest and dividend income

$3 billion in debt:                              -$50 mm interest expense

 

Le sigh...

[nwoodman]

If only we didn't have this :(

 

Equity hedges - (592.8)

 

It will be interesting to see if we feel the same way in 12 months time.  Right now the hedging as well as the low P/B is what I find so appealing about FFH.

[giofranchi]

If only we didn't have this :(

 

Equity hedges - (592.8)

 

It will be interesting to see if we feel the same way in 12 months time.  Right now the hedging as well as the low P/B is what I find so appealing about FFH.

 

nwoodman,

I agree 100%! :)

 

giofranchi

[Uccmal]

These hedges are killing Fairfax's results.  The equity hedges are particularly problematic.

 

In this kind of climate, once the US employment situation stabilizes and starts to improve, it creates a virtuous circle.  This has always been the case.  Check the statistics, if you dont believe me.  The US is not going to enter a deep recession for a long time.

 

FFh has been flat out wrong on all counts.  Unlike 2008, when things were clearly unravelling, things are nowhere like that now. 

 

Did you know, if you bought FFH in 1997 you paid 385 CDN.  Adding in 50 or 60 dollars in dividends takes you to 475.  With inflation you would have lost around 150 dollars per share.  Granted there has been book value compression during that period. 

 

The S&P hedges are set around 1060.  For these to make money, the S&P needs to drop by 600 points or nearly 40%.  We have moved from a secular bear into a secular bull, and these can last for 20 years. 

 

Prem has always had trouble admitting his mistakes. 

 

Shareholder for 15 years.  The only money I have ever made on FFH of significance was the options. 

 

I do walk the talk.  I have reduced my position over the last two or three months and left it in cash.  I can always buy the shares back if/when the market crashes. 

[Parsad]

These hedges are killing Fairfax's results.  The equity hedges are particularly problematic.

 

In this kind of climate, once the US employment situation stabilizes and starts to improve, it creates a virtuous circle.  This has always been the case.  Check the statistics, if you dont believe me.  The US is not going to enter a deep recession for a long time.

 

FFh has been flat out wrong on all counts.  Unlike 2008, when things were clearly unravelling, things are nowhere like that now. 

 

Did you know, if you bought FFH in 1997 you paid 385 CDN.  Adding in 50 or 60 dollars in dividends takes you to 475.  With inflation you would have lost around 150 dollars per share.  Granted there has been book value compression during that period. 

 

The S&P hedges are set around 1060.  For these to make money, the S&P needs to drop by 600 points or nearly 40%.  We have moved from a secular bear into a secular bull, and these can last for 20 years. 

 

Prem has always had trouble admitting his mistakes. 

 

Shareholder for 15 years.  The only money I have ever made on FFH of significance was the options. 

 

I do walk the talk.  I have reduced my position over the last two or three months and left it in cash.  I can always buy the shares back if/when the market crashes.

 

Hi Al,

 

The hedges and investment results aren't exclusive.  They've made alot of money on the equity positions they had, and they've taken profits there.  If and when things turn, and I'm in the camp that thinks things are going to turn pretty soon, those hedges will regain some of their lost value. 

 

I agree, I think they made a mistake in underestimating the interference in asset prices through monetary stimulus, especially since many investments were quite cheap for a long period of time as earnings grew.  But being wrong for the last three years doesn't mean they'll be wrong for the next three years. 

 

I believe we are right on the cusp of things turning decidedly sour again.  I cannot believe the low risk premium investors are willing to accept now considering the upheaval Europe is going through.  Yes, if I find something cheap I will buy it, but this rising tide is lifting alot of ships right now and it is getting very uncomfortable.  Cheers!

 

 

[giofranchi]

These hedges are killing Fairfax's results.  The equity hedges are particularly problematic.

 

In this kind of climate, once the US employment situation stabilizes and starts to improve, it creates a virtuous circle.  This has always been the case.  Check the statistics, if you dont believe me.  The US is not going to enter a deep recession for a long time.

 

FFh has been flat out wrong on all counts.  Unlike 2008, when things were clearly unravelling, things are nowhere like that now. 

 

Did you know, if you bought FFH in 1997 you paid 385 CDN.  Adding in 50 or 60 dollars in dividends takes you to 475.  With inflation you would have lost around 150 dollars per share.  Granted there has been book value compression during that period. 

 

The S&P hedges are set around 1060.  For these to make money, the S&P needs to drop by 600 points or nearly 40%.  We have moved from a secular bear into a secular bull, and these can last for 20 years. 

 

Prem has always had trouble admitting his mistakes. 

 

Shareholder for 15 years.  The only money I have ever made on FFH of significance was the options. 

 

I do walk the talk.  I have reduced my position over the last two or three months and left it in cash.  I can always buy the shares back if/when the market crashes.

 

Uccmal,

I think you are very optimistic about the market, and very pessimistic about FFH.

If it is true that we have entered a new secular bull market, we must have done so in 2009. That would compress the last secular bear market in just 9 years, from 2000 to 2008, the shortest in history. That would be even more peculiar because of the fact the last secular bull market, from 1982 to 1999, stretched market valuations to levels never seen before.

Anyway, I guess in no more than two years we will surely know if your view is right, or if Mr. Watsa’s is the one to be correct. Being invested in FFH now, I will do well either way:

- If Mr. Watsa is right, I will protect my capital egregiously,

- If you are right, and we have entered a 20 years secular bull market back in 2009, two years from now I will still have more or less 15 years to make a lot of money!  ;)

 

giofranchi

 

[jay21]

These hedges are killing Fairfax's results.  The equity hedges are particularly problematic.

 

In this kind of climate, once the US employment situation stabilizes and starts to improve, it creates a virtuous circle.  This has always been the case.  Check the statistics, if you dont believe me.  The US is not going to enter a deep recession for a long time.

 

FFh has been flat out wrong on all counts.  Unlike 2008, when things were clearly unravelling, things are nowhere like that now. 

 

Did you know, if you bought FFH in 1997 you paid 385 CDN.  Adding in 50 or 60 dollars in dividends takes you to 475.  With inflation you would have lost around 150 dollars per share.  Granted there has been book value compression during that period. 

 

The S&P hedges are set around 1060.  For these to make money, the S&P needs to drop by 600 points or nearly 40%.  We have moved from a secular bear into a secular bull, and these can last for 20 years. 

 

Prem has always had trouble admitting his mistakes. 

 

Shareholder for 15 years.  The only money I have ever made on FFH of significance was the options. 

 

I do walk the talk.  I have reduced my position over the last two or three months and left it in cash.  I can always buy the shares back if/when the market crashes.

 

Good thoughts.

 

The problem I have with the "hedges" is their speculative nature and a strike set when prices were depressed.  Also, they seemed to be long duration on their bond portfolio as well when they were putting the hedges on.  That clearly is a deflation position to me and not a "hedge". 

 

I don't follow FFH as closely as others so please let me know if my assessment is off.

[LowIQinvestor]

I just don't understand the macro obsession.

Buffett always says they spend zero time trying to predict macro economics or where the stock market is going.

 

It's just unfortunate that now that the insurance business is humming along that we can't get decent investment results. It seems like the two are never in sync...

 

Full Disclosure: I have been long Fairfax since 2008 but have much more capital in Berkshire

 

 

 

[jay21]

I just don't understand the macro obsession.

Buffett always says they spend zero time trying to predict macro economics or where the stock market is going.

 

It's just unfortunate that now that the insurance business is humming along that we can't get decent investment results. It seems like the two are never in sync...

 

Full Disclosure: I have been long Fairfax since 2008 but have much more capital in Berkshire

 

Agreed.  The one advantage Buffet has is that he has companies spitting out tons of reliable cash flows.  The market is there to serve him because he can start reinvesting those cash flows into the stock market if it offers a higher return than the businesses' retained earnings.  Most other insurance cos don't have this luxury and MTM losses are more real to them.  A very real scenario that equity heavy insurers like MKL and FFH have to worry about is a huge drop in the stock market, rising interest rates, and a hardening insurance market.  A lot of capital can be washed away and they won't be able to write insurance or invest unless they have adequate hedges or risk control.  I prefer MKL's strategy of shortening duration and keeping more cash and cash equivalents around as opposed to using derivatives. 

 

Question to FFH holders, how badly would an inflationary and rising interest rate environment hurt FFH?

[giofranchi]

Question to FFH holders, how badly would an inflationary and rising interest rate environment hurt FFH?

 

Inflation: FFH’s deflation hedges have already lost most of their value.

 

Rising interest environment: the price of all assets will fall, a lot of room to be opportunistic for FFH.

 

Rising market environment: I don’t see FFH to be much more out of sync with the market than it was in 2012, so 2012 probably is the worst case scenario.

 

Again, as I have already said, 2 more years like 2012…? I can live with that! :)

 

giofranchi

 

[stahleyp]

Don't secular bulls have to start with really low valuations? Anyone know when a secular bull started when valuations weren't cheap? I'm not saying that we're expensive now, but things don't seem to be cheap either.

[obtuse_investor]

Don't secular bulls have to start with really low valuations? Anyone know when a secular bull started when valuations weren't cheap? I'm not saying that we're expensive now, but things don't seem to be cheap either.

 

You are right stahleyp-- we don't know of an instance like that. But, if for a minute, I wear my scientist/engineering hat on, we must always keep in mind that 100 or even 200 years of market valuation data isn't statistically significant enough to perform reasonable predictions.

 

I am squarely in "market is moderately overvalued" camp right now, but I also know that this can go on for another 1-4 years!

[giofranchi]

Shareholder for 15 years.  The only money I have ever made on FFH of significance was the options. 

 

If an employee earning Cdn$40,000 had participated fully in this program since its inception, he or she would have accumulated 3,068 shares of Fairfax worth Cdn$1.1 million at the end of 2012.

--AL 2012

 

Uccmal,

let’s assume a 10% saving rate for the last 25 years, and to understand how optimistic this assumption is, let’s just say that we must go back to 1985, to find the last time the U.S. Personal Saving Rate was around 10%… Cdn$4,000 saved each year for 25 years equates to $100,000. So, the “clueless employee” (by clueless I mean that he didn’t care to study investment opportunities and just dollar cost averaged in FFH), now has 11 times his/her original savings… and that imo surely means making some "money of significance"!

It seems very strange that such an extremely accomplished investor like yourself hasn’t succeeded in making money out of FFH… ???

 

giofranchi

 

[giofranchi]

FFH Q1 2013 Conference Call Transcript

 

giofranchi

FFH-Q1-2013-Conference-Call-Transcript.pdf

[Uccmal]

Hey Gio, I have made money in FFH: by moving in and out, and using the Leaps, Not by buying and holding!  That said, I really dont touch the FFh in my tax sheltered accounts including my kids education account. 

 

FFh is going to move in fits and starts.  During the March 2009 meltdown FFh lost $100/share in a matter of days.  My guess is it had nothing to do with FFH, and more to do with margin lending where raising cash became a priority.  If, what Prem believes, comes to pass, then FFh stock may well be down $100 from here and sitting on a mountain of gains, simultaneously.  Call it "the madness of crowds".

 

My two cents.  ;)

[giofranchi]

If, what Prem believes, comes to pass, then FFh stock may well be down $100 from here and sitting on a mountain of gains, simultaneously.  Call it "the madness of crowds".

 

Yes! I know… but that doesn’t really bother me. For me it is always the process… As long as the process is right, I let “the madness of crowds” do whatever it pleases!  :)

 

Cheers!

 

giofranchi

[mcliu]

Did you know, if you bought FFH in 1997 you paid 385 CDN.  Adding in 50 or 60 dollars in dividends takes you to 475.  With inflation you would have lost around 150 dollars per share.  Granted there has been book value compression during that period. 

 

That's not a fair comparison since the management team cannot control the price that investors pay for the business. If you bought it in 1997 at an overvalued 5x book, when you should have only paid 1.5x book, and you lost money, that would be the investor's own fault. That has nothing to do with the performance of the business. The underlying intrinsic value of the business has increased 4.3x since then.

[Guest valueInv]

When do the hedges expire?

[giofranchi]

I just don't understand the macro obsession.

 

I really wouldn’t call it “macro obsession”… To me, what Mr. Watsa is doing and has always done, is just the number 1 duty of every investor: to understand when it is the right time to be greedy, and to understand when it is the right time to be fearful.

 

Panic of 1837 (really, it has always been the same!!):

Vanderbilt slithered unsinged through the financial fire. He had no speculative embarrassments, no debts pledged against consignments of cotton. True, the stocks he owned may have lost some of their market value; their dividends may have been suspended; the promissory notes he held may have gone unpaid. But he had demanded premium real estate as collateral; his property consisted largely of state-of-the-art steamboats; and his was a business that remained in demand. Indeed, he had an abundance of that most valuable item in a deflationary panic: cold, hard cash – piles of silver shillings and gold dollars paid for fares.

Even weakened by illness, Vanderbilt remained an instinctive predator, and, like every predator, he was drawn to the scent of the sick and the vulnerable. To him, the great Panic of 1837 was a time for the hunt.

 

Imo, someone who is reaching for yield today, will always reach for yield… Remember that we can always find some sort of “logical explanation” for most choices of ours… “well, maybe I don’t understand that business so well, and therefore I cannot be sure its stock is really cheap… but, compared to any other available investment, it must surely be a bargain!”… something of the sort, right?

 

So, how to be like Mr. Vanderbilt? How to have “an abundance of that most valuable item in a deflationary panic”? Well, to possess “a business that always remains in demand” might be useful. Not to reach for yield at the wrong time might also be useful. But I guess the truth is we do not really know… there is no sure formula… Someone succeeds, many others simply don’t… That’s why it is so difficult to understand what Mr. Watsa is doing! ;)

 

giofranchi

[giofranchi]

As always, discussion has centered on the equity hedges, but I would like to shift the attention to the $119 million of losses in bonds (basically all unrealized). It doesn’t bother me at all, because, out of a $10.4 billion bonds portfolio, it is just a (1.14)% move, so it should be considered only noise.

Yet, I think it shows something important: without that loss, FFH for Q1 2013 would have almost doubled, from $162 million to $281 million. And, adjusted for the $10 per common share dividend paid in Q1 2013, BVPS would have increased 2.25%, instead of 1.3%. Which equates to a 9% increase in BVPS on a yearly basis. If you think that most of the times FFH makes money out of its bonds portfolio, I think something very interesting can be inferred from Q1 2013 Results:

 

If FFH’s insurance and reinsurance operations go on posting combined ratios around 95%, FFH has the possibility to compound BVPS at circa 10% annual, even while keeping in place its deflation and equity hedges, and even while sitting upon $7.5 billion of cash on the sidelines!

 

I know you now will tell me that I am always too optimistic on FFH’s future prospects, but what’s so wrong with my reasoning? :)

 

giofranchi

 

[tombgrt]

As always, discussion has centered on the equity hedges, but I would like to shift the attention to the $119 million of losses in bonds (basically all unrealized). It doesn’t bother me at all, because, out of a $10.4 billion bonds portfolio, it is just a (1.14)% move, so it should be considered only noise.

Yet, I think it shows something important: without that loss, FFH for Q1 2013 would have almost doubled, from $162 million to $281 million. And, adjusted for the $10 per common share dividend paid in Q1 2013, BVPS would have increased 2.25%, instead of 1.3%. Which equates to a 9% increase in BVPS on a yearly basis. If you think that most of the times FFH makes money out of its bonds portfolio, I think something very interesting can be inferred from Q1 2013 Results:

 

If FFH’s insurance and reinsurance operations go on posting combined ratios around 95%, FFH has the possibility to compound BVPS at circa 10% annual, even while keeping in place its deflation and equity hedges, and even while sitting upon $7.5 billion of cash on the sidelines!

 

I know you now will tell me that I am always too optimistic on FFH’s future prospects, but what’s so wrong with my reasoning? :)

 

giofranchi

 

 

recap = If the results weren't what they were, they would be better?

 

Also, one quarter doesn't make a trend. Especially without any big losses. It has been quiet for now.

 

Giofranchi, you are clearly an entrepreneur pur sang, ever the optimist! ;)

 

 

I sold my FFH for a 15% gain in a few months. If we get any correction that gives FFH those big gains, it's likely that FFH will drop some as well. If I had more capital I would hold onto a certain number of shares forever; but I haven't.

[giofranchi]

recap = If the results weren't what they were, they would be better?

 

Also, one quarter doesn't make a trend. Especially without any big losses. It has been quiet for now.

 

Hi tombgrt,

Yeah…! I thought that would be the most likely objection… But I think it misses the true potential of FFH today... And that’s what we should try to understand, investing in any business: its true potential. Both optimism and pessimism won’t do it, realism is all that matters.

And what’s unrealistic in saying that it is HIGHLY UNUSUAL for FFH to post a loss on its bonds portfolio? And that it therefore could be just noise?

If I had said: without the losses in equity hedges, net earnings would have been… then, I would agree with you! Because we know equity hedges are here to stay, until a big correction in the market comes. Bonds losses instead are an “anomaly” that in Q1 2013 masked the true potential of FFH, provided it keeps doing such a good job with its insurance and reinsurance operations.

 

On the other hand, I agree with you that one quarter doesn’t make a trend… and that it has been quiet for now… Anyway, I cannot help but liking very much the effort FFH, under the leadership of Mr. Barnard, is putting in the betterment of its insurance and reinsurance operations: not only CRs are coming down, but Net Premiums Written are rising too… so far so good! And it bodes well for the future! :)

 

giofranchi

 

[Uccmal]

Did you know, if you bought FFH in 1997 you paid 385 CDN.  Adding in 50 or 60 dollars in dividends takes you to 475.  With inflation you would have lost around 150 dollars per share.  Granted there has been book value compression during that period. 

 

That's not a fair comparison since the management team cannot control the price that investors pay for the business. If you bought it in 1997 at an overvalued 5x book, when you should have only paid 1.5x book, and you lost money, that would be the investor's own fault. That has nothing to do with the performance of the business. The underlying intrinsic value of the business has increased 4.3x since then.

 

Yes.  I have learned how to value invest since then.  I think it was around 3x book most of the time back then.  It was being priced for infinite fast growth when boom, TIG and C&f came to roost.

 

When do the hedges expire?

 

Without looking it up, I believe they are perpetual until one party buys them out.  FFH would have written in a stipulation that they could not be cashed in by the counterparty under certain conditions, such as now. 

 

Gio, there is nothing wrong with your position or philosphy.  There is nothing wrong with mine.  Different ways of looking at the same thing.  I still hold a sizable position but have trimmed it by 40% or so the past year and a half.  I would be very surprised if FFh does not get taken down in a market rout, by virtue of others having margin calls.  It wont be me.  I may well be a buyer knowing the safety in their "process".