Fairfax’s Q3 2017 operating earnings of $16.42 were slightly below street expectations of $16.74 due to general softness in insurance underwriting and weak investment results. Despite these issues, results were solid with combined ratio of 91.6% (excluding storm losses), improving year over year from 94.5%. Including storm losses of $791m (after taxes), Fairfax still made a profit of $476.9m. Book value grew 15.4% YoY before investment results, mainly due to the acquisition of Allied completed earlier this year.
Current Price: $ 531.4 Price Target: $580 (raised from $505)
Position Size: 1.5% TTM Performance: +5.7%
Thesis Intact. Key takeaways from the quarter:
1. Insurance results
a. Book value grew by 15.4% YoY ex-dividends to $415/share
b. 91.6% combined ratio – All of Fairfax’s major insurance companies had combined ratios <100% – showing good profitability.
c. Net written premiums increased 8.3% from Q3 2016, excluding acquisitions.
2. Investment results
a. Investment assets totaled $37.4b with 42% invested in cash, 29% fixed income, 14% stocks and 14% in other insurance companies. On the quarterly call Chairman Prem Watsa did not specify when cash would be invested, rather he reiterated concerns about valuations in both the fixed income and equity markets.
b. Top two stock holdings are Blackberry and IBM (35% of stock holdings). Equity portfolio is hedged via puts on broad market
c. Firm has a large position ($114b notional value) in CPI-linked derivative, which will protect the company from a Japan-like scenario as well as potential debt solvency concerns. However, this position has recently been a drag on investment returns.
3. Valuation:
a. Fairfax trades at a slight discount to other P&C stocks at 1.2x BV. Resetting price target at 1.4x book value of 415.48.
b. Given that we view Fairfax as a core holding, we would consider adding back to positions closer to book value
c. Net debt to capital is 26.9% which has increased from 18.3% due to the Allied Acquisition.
The Thesis on Fairfax:
• Fairfax is a disciplined insurance underwriter with an excellent investment track record
• Unmatched book value growth – 25%/yr for 25 yrs
• Attractive valuation and well above average management team
• Defensively positioned balanced sheet