Author Topic: Is it time to buy Fairfax?  (Read 7493 times)

Viking

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Is it time to buy Fairfax?
« on: October 21, 2019, 12:41:02 PM »
Is Fairfax a $20 bill laying on the street that everyone is walking by? Lots of former investors in Fairfax have such a long history with this company it is easy to let emotions cloud the decision making process. It is sometimes difficult to separate past experiences and what you do not like about a company from where it is today and more importantly where it is going tomorrow. The calculus shifted for me over the weekend. There are lots of great threads regarding Fairfax (thanks to Petec, Stubblejumper and others) to help get up to speed on the company.

Bought a big chunk of FFH today. The summary provided by Woodlock House pretty much sums up my thoughts on the company (i copied a chunk of it below). In addition, ex workers comp, we look to be in a hard market and Fairfax is growing its business nicely (it is after all an insurance company). Shares are trading today at US $420 P/BV ($465) = 0.9 look cheap to me.

- Positives: Shares are trading at a 5 year low (absolute price and P/BV, sentiment might be at all time low, we are in a hard market, bond portfolio is positioned very conservatively.
- The jury is still out: on equity investment decision process; saying better things, amd brought in some new blood but time will tell.
- Negative: i am not sure the company is run in the best interests of shareholders. That alone might make this purchase a trade for me.
- Impending: i am expecting news on taking out minority partners in the coming months (Brit and Eurolife). Down the road they need to do the same with Allied World.
- stock buybacks: one big catalyst for the shares would be if managment decided buying back stock trading at 0.9X BV was a top priority. Right now it is clear that they would rather use excess cash to grow the business and taking out their minority partners. My hope is they get creative here and find a way to do a meaningful buyback. 

From Woodlock House letter: http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/woodlock-house-blog-post-about-ffh/
“Most of the investors I’ve talked to about FFH will bring up Watsa almost immediately as, basically, someone they no longer trust to make good decisions or deliver good returns. I can understand why. (The baffling macro bets of some years ago cost FFH shareholders billions of dollars. Watsa said he not would make such bets again. But the damage was done.)

The insurance side of the operation has been strong for FFH in recent years. But even there, operations are below Watsa’s target of a 95% combined ratio. FFH’s Q2 number was 96.8%. Profitable – anything below 100% is profitable – but below target.

So, as you can see, the valuation is not such a cut-and-dried matter. FFH has had some issues. Nonetheless, we own the stock at a price below book value.

The most important reason is that the downside seems low. The valuation protects you, the company appears well-financed and management seems honest and well-intentioned. These are not small things.

Moreover, I think the assets collectively could generate a ~10%-type ROE. Watsa has made a public goal of hitting 15%. (FFH’s ROE was 15% in the second quarter, thanks to investment gains). He says a 95% combined ratio and a 7% return on FFH’s investments gets to a 15% ROE.

But in a low-interest rate environment, and given a large bond portfolio, a 7% return seems unlikely. But possible. Sustaining a double-digit ROE is key. (FFH can reach 10% by following a number of roads. For example, one road requires a ~95% combined ratio and ~5% return on its portfolio. That seems do-able.)

Anyway, a consistent 10% would grow book value at a decent clip and then you’d likely get an additional lift from the valuation even if the stock moved just to 1.2x book. As RayJay reports, a comparable set of North American insurers with an 11% ROE trades for 1.7x book value per share.

I admit, FFH is not exciting. It’s not fake meat or pot or sending billionaires into space. But it shouldn’t hurt you and has potential to deliver a very nice return.”

https://www.woodlockhousefamilycapital.com/post/the-horse-story
« Last Edit: October 21, 2019, 12:44:50 PM by Viking »


Parsad

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Re: Is it time to buy Fairfax?
« Reply #1 on: October 21, 2019, 01:38:06 PM »
Every time it falls below book value, I see Brian Bradstreet buying some shares.  We shall know shortly! 

I think for long-term investors, who don't want to fiddle with their portfolio and just sleep at night...it's a buy!  Cheers!
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petec

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Re: Is it time to buy Fairfax?
« Reply #2 on: October 22, 2019, 12:55:34 AM »
A couple of thoughts.

1) The 95% combined ratio target is almost certainly a long term/through the cycle target (like the ROE target). You therefore need to work out where we are in the cycle to know whether Fairfax is hitting its target or not.

2) You say management are honest but the company is not run in the interest of shareholders. Leaving aside whether either statement is true, could you explain why they don't contradict each other? I'm interested.

Thanks

Pete

vinod1

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Re: Is it time to buy Fairfax?
« Reply #3 on: October 22, 2019, 07:46:36 AM »
I bought it too. To me it is good for a 15%-20% puff and nothing more. Buy at close to 0.9x BV and sell out closer to 1.05x BV.

But I am under no illusion regarding a number of things

1. Its insurance business have gone from terrible to "do not suck" anymore. Does not mean they are good businesses.

2. A P&C company to me always comes with a ton of tail risks. I am not particularly imaginative but I can imagine enough scary scenarios that can impair value. FFH does not have a lot of offsetting exposures to positive tail events on its investment side like it did during 2008-2009 period.

3. Its investment portfolio is particularly exposed to economic tail risks.

4. Many think they have a great bond management team. Perhaps the best in the world. I disagree. No out-performance. Fooled by randomness at its best.

5. FFH investment team did not become dumb. They are smart. To take a fishing analogy (dangerous since I know nothing about fishing). Imagine there are several ponds and some ponds yield a lot of fish. Now imagine if some environmental factor depletes fish in some of the ponds. I think that is what happened to FFH. Replace pond with "value stocks" and environmental factor to "Internet". So investment returns are going to be tough going forward not only because of this but a number of other factors.

6. What happens if interest rates remain low or even turn slightly negative for an extended period of time? What returns would the investment portfolio generate in this case?

I did make an investment very recently. But if it goes up 20%, to me there is no MOS.

Vinod
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BPCAP

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Re: Is it time to buy Fairfax?
« Reply #4 on: October 22, 2019, 08:11:49 AM »
The idea that “value stocks” are underperforming is a myth.  If you buy five low quality, high debt companies that all fall apart on you, you didn’t buy “value.”  You were buying turn around specs that didn’t work out.  What is underperforming is low quality, capital intensity, over-leverage, etc.

I’m a fan of fairfax.  I root for them.  But their investment ills aren’t about value.  If anything their stocks are susceptible to a world of too much cheap capital, which feeds increasing competition, which erodes pricing power, which means moats collapse, etc.

Too many managers blame “value” being out of favor instead of realizing they mis-measured value.

For now, I wait for a meaningful discount to BV before I buy.
« Last Edit: October 22, 2019, 08:17:23 AM by BPCAP »

Cevian

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Re: Is it time to buy Fairfax?
« Reply #5 on: October 22, 2019, 08:18:24 AM »
Bought some more yesterday. Waiting for Q3 results which may include losses from Hurricane Dorian. Will double down if there is a significant drop.

petec

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Re: Is it time to buy Fairfax?
« Reply #6 on: October 22, 2019, 08:40:49 AM »
This is all rather disappointing. My main reason for holding on was excessive pessimism. I may have to sell  ;)

Viking

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Re: Is it time to buy Fairfax?
« Reply #7 on: October 22, 2019, 10:39:50 AM »
A couple of thoughts.

1) The 95% combined ratio target is almost certainly a long term/through the cycle target (like the ROE target). You therefore need to work out where we are in the cycle to know whether Fairfax is hitting its target or not.

2) You say management are honest but the company is not run in the interest of shareholders. Leaving aside whether either statement is true, could you explain why they don't contradict each other? I'm interested.

Thanks

Pete

Pete, my guess is bond yields and combined ratio are connected. If bond yields in the US stay at current low levels or drop more then this will force all insurance companies to achieve a lower CR moving forward. Perhaps this is the key driver of the current hard market (not sure). This will take years to play out. So based on current yields and the outlook for the future i would expect FFH to get to a 95 or better CR in the coming years (similar to all companies they compete with).

I read both the Q1 and Q2 conference call transcripts and was happy with the presentations and the answers to questions (and minimal promotion). I do have a certain level of trust in management and that is why i bought shares.

I have found that over the years Fairfax has made decisions that appear to be focussed on making the company bigger (empire building) with the long term impact on shareholders a secondary concern. There has also been lots of discussion around corporate governance (family control and bringing the kids into the fold) that feed the ‘not shareholder friendly’ narrative. Is Prem’s number 1 focus to drive shareholder value? No, i don’t think so. Is it important to him? Yes.
« Last Edit: October 22, 2019, 10:42:04 AM by Viking »

Viking

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Re: Is it time to buy Fairfax?
« Reply #8 on: October 22, 2019, 11:07:12 AM »
I bought it too. To me it is good for a 15%-20% puff and nothing more. Buy at close to 0.9x BV and sell out closer to 1.05x BV.

But I am under no illusion regarding a number of things

1. Its insurance business have gone from terrible to "do not suck" anymore. Does not mean they are good businesses.

2. A P&C company to me always comes with a ton of tail risks. I am not particularly imaginative but I can imagine enough scary scenarios that can impair value. FFH does not have a lot of offsetting exposures to positive tail events on its investment side like it did during 2008-2009 period.

3. Its investment portfolio is particularly exposed to economic tail risks.

4. Many think they have a great bond management team. Perhaps the best in the world. I disagree. No out-performance. Fooled by randomness at its best.

5. FFH investment team did not become dumb. They are smart. To take a fishing analogy (dangerous since I know nothing about fishing). Imagine there are several ponds and some ponds yield a lot of fish. Now imagine if some environmental factor depletes fish in some of the ponds. I think that is what happened to FFH. Replace pond with "value stocks" and environmental factor to "Internet". So investment returns are going to be tough going forward not only because of this but a number of other factors.

6. What happens if interest rates remain low or even turn slightly negative for an extended period of time? What returns would the investment portfolio generate in this case?

I did make an investment very recently. But if it goes up 20%, to me there is no MOS.

Vinod

Vinod, FFH for me is also a trade at this point in time.

1.) regarding insurance, Brit and Allied are the watchouts for me. Past experience shows it can be a bumpy ride for a few years post aquisition.

4.) my understanding is their long term bond results are among the best in the industry. Have they perfectly timed the changes in rates the past 2 years? No.

5.) FFH investment team is a big watch out. I do like the exposure to India and i do think this is a good fit. I have started reading up on Seaspan and the company is executing its plan well (and FFH has done well on its investment). Eurobank looks well positioned; if the Greek economy does ok this investment could perform very well. Blackberry trading at $6.50 does not look expensive to me and it is in the right spaces (QNX and cybersecurity). Many of the issues have already hit BV. Moving forward, yes, if the economy falls off a cliff their investments will take a hit. Or perhaps we bump along for a few years at 1.5% GDP growth... in this scenario their invesments should perform ok to very good.

6.) if bond yields stay low this will affect everyone in the industry. I think we can assume CR come down (perhaps this is what is driving the current hard market).
« Last Edit: October 22, 2019, 11:09:16 AM by Viking »

petec

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Re: Is it time to buy Fairfax?
« Reply #9 on: October 23, 2019, 01:24:08 AM »

Pete, my guess is bond yields and combined ratio are connected. If bond yields in the US stay at current low levels or drop more then this will force all insurance companies to achieve a lower CR moving forward. Perhaps this is the key driver of the current hard market (not sure). This will take years to play out. So based on current yields and the outlook for the future i would expect FFH to get to a 95 or better CR in the coming years (similar to all companies they compete with).


That's rational, but only if low ROEs cause capital to leave the industry. Unfortunately that hasn't been happening as far as I can tell. If anything low rates and innovative financial instruments have brought more capital into the industry, depressing CRs, such that bond yields and CRs may actually be positively correlated.

Regardless, my broader point is that if the through-the-cycle CR is 95% then at times it will be above and at times below, so you need to know where you are in the cycle to know whether they are on target. My guess is they are: they are not much above 95% after years of soft-ish markets. Suggests to me they will do better than 95% in a hard market.

I read both the Q1 and Q2 conference call transcripts and was happy with the presentations and the answers to questions (and minimal promotion). I do have a certain level of trust in management and that is why i bought shares.

I have found that over the years Fairfax has made decisions that appear to be focussed on making the company bigger (empire building) with the long term impact on shareholders a secondary concern. There has also been lots of discussion around corporate governance (family control and bringing the kids into the fold) that feed the ‘not shareholder friendly’ narrative. Is Prem’s number 1 focus to drive shareholder value? No, i don’t think so. Is it important to him? Yes.

Understood, thanks. I perhaps make less of a distinction between whether I trust management and whether they are shareholder friendly - I think it's largely the same thing - but I'm an active proponent of family control so I worry less about that part.