Author Topic: Woodlock House blog post about FFH  (Read 2033 times)

StubbleJumper

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Woodlock House blog post about FFH
« on: September 14, 2019, 05:23:37 AM »
I saw this blog-post about FFH linked on the Stingy Investor website.  Nothing profound, but it's nice to see even a modicum of interest in a quiet stock.  Since some forum participants are not from Canada, I thought it was worth adding to this forum:

https://www.woodlockhousefamilycapital.com/post/the-horse-story


SJ


obtuse_investor

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Re: Woodlock House blog post about FFH
« Reply #1 on: September 16, 2019, 05:08:02 PM »
Good article from Mr. Mayer. Thinking a little bit more about the numbers. Looking at the market multiple mentioned in the article: 11% ROE at 1.7xBook. If I plug that into a simple NPV calculator, I see that market is using a 5.3% discount rate.

FFH is selling 0.95xBook as of this writing.

Assuming (and this is a big assumption) this discount rate as a constant, using the same calculator I see that the market is estimating that FFH will have a ROE of 4.8%.

If you think FFH can produce above 4.8% of earnings (or US$21/shr a year) for a couple years in a row, then you should definitely consider buying this stock.

~~~

Why such a low ROE estimate, Mr. Market? I think the narrative says it all. The market has lost faith in FFH's ability to deliver.
However, Mr. Market suffers from periodic case of amnesia. I am sure, this too shall pass.
« Last Edit: September 16, 2019, 07:17:03 PM by obtuse_investor »
Value Investor who manages his personal portfolio with a 25-45 year time horizon | @obtuse_investor

TwoCitiesCapital

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Re: Woodlock House blog post about FFH
« Reply #2 on: September 16, 2019, 05:32:04 PM »
Good article from Mr. Mayer. Thinking a little bit more about the numbers. Looking at the market multiple mentioned in the article: 11% ROE at 1.7xBook. If I plug that into a simple NPV calculator, I see that market is using a 5.3% discount rate.

FFH is selling 0.95xBook as of this writing.

Assuming (and this is a big assumption) this discount as a constant,  using the same calculator I see that the market is estimating that FFH will have a ROE of 4.8%.

If you think FFH can produce above 4.8% of earnings (or US$21/shr a year) for a couple years in a row, then you should definitely consider buying this stock.

~~~

Why such a low ROE estimate, Mr. Market? I think the narrative says it all. The market has lost faith in FFH's ability to deliver.
However, Mr. Market suffers from periodic case of amnesia. I am sure, this too shall pass.

My response to the low ROE estimate is not that markets have lost faith in FFH (been a long time since they've had it), but that the bulk of FFH's portfolio is invested in things that are earning significantly below your 5.3% hurdle (and even lower than the 4.8% that you calculate the market pricing in). With leverage, maybe 4.8% discount is appropriate, but I think we can go lower if interest rates continue to move the wrong direction.

We will see positive bumps along the way, but FFH will not re-rate until interest rates rise to a much higher level - sustainably.

That being said, 0.95x book is probably not a terrible price to pay while we wait for that to happen, but methinks we haven't seen the lows yet.

bsilly

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Re: Woodlock House blog post about FFH
« Reply #3 on: September 18, 2019, 12:12:47 AM »
Insurance needs to be priced to reflect the current interest rate environment. With long term bonds in the sub 2% range, it is not reasonable to count on a 7% or even a 5% return on investments, given that insurance regulators (and general prudence) restrict equity allocation to something in the range of 25% of the portolio.

In my opinion, the target for combined ratio in this environment should be 90 or below. Anything less, and/or hoping for high single digit investment returns, is just not facing reality.

b.

petec

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Re: Woodlock House blog post about FFH
« Reply #4 on: September 18, 2019, 03:27:58 AM »
Insurance needs to be priced to reflect the current interest rate environment. With long term bonds in the sub 2% range, it is not reasonable to count on a 7% or even a 5% return on investments, given that insurance regulators (and general prudence) restrict equity allocation to something in the range of 25% of the portolio.

In my opinion, the target for combined ratio in this environment should be 90 or below. Anything less, and/or hoping for high single digit investment returns, is just not facing reality.

b.

The problem with that is, it's not possible if the market isn't doing the same. There's a trade-off between driving the CR down to compensate for low returns on investments, and shrinking your book to the point where you effectively liquidate your franchise. Up to a point, underwriting discipline drives better ROEs; beyond that point, if the market is happy to accept lower ROEs then FFH has to as well.

Sombunall

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Re: Woodlock House blog post about FFH
« Reply #5 on: September 18, 2019, 07:00:26 AM »
When thinking about the investment return and ROE targets, don't forget the leverage factor... a 3.2% investment return in 2018 turned into 10.3% levered return. See attached table from Raymond James' initiation in June.





TwoCitiesCapital

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Re: Woodlock House blog post about FFH
« Reply #6 on: September 18, 2019, 10:07:26 AM »
Insurance needs to be priced to reflect the current interest rate environment. With long term bonds in the sub 2% range, it is not reasonable to count on a 7% or even a 5% return on investments, given that insurance regulators (and general prudence) restrict equity allocation to something in the range of 25% of the portolio.

In my opinion, the target for combined ratio in this environment should be 90 or below. Anything less, and/or hoping for high single digit investment returns, is just not facing reality.

b.

The problem with that is, it's not possible if the market isn't doing the same. There's a trade-off between driving the CR down to compensate for low returns on investments, and shrinking your book to the point where you effectively liquidate your franchise. Up to a point, underwriting discipline drives better ROEs; beyond that point, if the market is happy to accept lower ROEs then FFH has to as well.

Agreed. We haven't seen a shake-out in the secondary capital being provided for insurance-linked contracts. The demand for these likely has little correlation with interest rates because these investors are simply looking for an uncorrelated return.

If interested rates are zero, alternatives investors don't need CRs to go 80. They simply need a reasonably positive, uncorrelated return (i.e. loss ratios less than premiums received - this could be a CR of 95).

It's hard for me to envision a prolonged hardening of the market until we see a shake-out event in the alternative capital.

The leverage comment is what everyone who is getting on FFH is currently depending on. Can they consistently produce 3-5% returns that are leveraged to a decent overall ROE - but with interest rates at 1.8%...even this will be difficult.

Cigarbutt

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Re: Woodlock House blog post about FFH
« Reply #7 on: September 19, 2019, 07:35:09 AM »
Insurance needs to be priced to reflect the current interest rate environment. With long term bonds in the sub 2% range, it is not reasonable to count on a 7% or even a 5% return on investments, given that insurance regulators (and general prudence) restrict equity allocation to something in the range of 25% of the portolio.

In my opinion, the target for combined ratio in this environment should be 90 or below. Anything less, and/or hoping for high single digit investment returns, is just not facing reality.

b.
The problem with that is, it's not possible if the market isn't doing the same. There's a trade-off between driving the CR down to compensate for low returns on investments, and shrinking your book to the point where you effectively liquidate your franchise. Up to a point, underwriting discipline drives better ROEs; beyond that point, if the market is happy to accept lower ROEs then FFH has to as well.
Agreed. We haven't seen a shake-out in the secondary capital being provided for insurance-linked contracts. The demand for these likely has little correlation with interest rates because these investors are simply looking for an uncorrelated return.

If interested rates are zero, alternatives investors don't need CRs to go 80. They simply need a reasonably positive, uncorrelated return (i.e. loss ratios less than premiums received - this could be a CR of 95).

It's hard for me to envision a prolonged hardening of the market until we see a shake-out event in the alternative capital.

The leverage comment is what everyone who is getting on FFH is currently depending on. Can they consistently produce 3-5% returns that are leveraged to a decent overall ROE - but with interest rates at 1.8%...even this will be difficult.
In a way, managing the underwriting cycle has parallels to managing the extent of % invested when managing money (yours or OPM).
I agree that the CR needs to be 90% or below these days in order to achieve an adequate return on equity but that objective would effectively mean closing down shop in today's environment. So, what to do?

All lines of businesses have different dynamics and the insurer may play the cashflow underwriting game or 'catch-up' when the market hardens but it's an extremely difficult exercise in a commoditized world and this has become harder with the cheap and abundant capital era.
Of all the subs, I admire how Zenith has been able to shrink and grow their business opportunistically. Even if most FFH subs need to continue to write a certain amount of business with an inadequate margin vs reasonable ROE, the holding company should make sure that they can grow the business when the time is right and need to make sure that the asset and liability sides of their books allow them to do so. Right now, the investment leverage is a potential advantage but IMO, given some scenarios, this leverage may actually become a hindrance for growth if, for instance, capital becomes more scarce or more expensive.

The following is interesting (data ends around 2016 but the trends have continued, mostly unabated and even worse for the combined ratios across the industry) as it gives an idea about the CR necessary to obtain adequate returns given what overall yields have become.
https://www.treasury.gov/initiatives/fio/Documents/2_SELECTIVE_FACI_8-15-16.pdf