Fairfax Financial Holdings Ltd. has made big, long-term investment bets in the name of value. After the dismal performance of some of those high-profile Canadian names in the third quarter, the company had some explaining to do.
BlackBerry Ltd., Stelco Holdings Inc. and Ensign Energy Services Inc. are all among Fairfax’s 10 biggest equity positions, and all fell 25 per cent or more in the third quarter. Resolute Forest Products Inc., another huge holding, fell 35 per cent in the quarter and has declined another 22 per cent in the month of October.
All told, Fairfax posted a loss of US$160-million in the quarter on the portion of its stock portfolio that it held through the whole quarter. That unrealized loss was offset by some profitable stock sales, but all told, the company posted a loss of nearly US$100-million on its investment portfolio in the third quarter.
That’s the main reason reason why Fairfax shares are in the doldrums, trading at multiples not seen since the depths of the financial crisis. Prem Watsa, who founded Fairfax in 1986 and whose musings at the company’s annual meetings are gobbled up by value investors, emphasizes that the company is investing with a decades-long horizon, not a quarterly one.
And Fairfax is not just a stock-investing vehicle, by any means. Its bond portfolio, at US$16-billion, is roughly three times the size of Fairfax’s equity investments. And the visible failures in the quarter obscured a solid performance at the company’s insurance operations, Fairfax’s primary cash generator. The company said that even with two natural disasters in the quarter – a hurricane in North America and a typhoon in Japan – it took in more insurance premiums than it paid out in claims, and premium growth hit 14 per cent.
Yet, Fairfax’s recent stock woes are an indication that investors are focused on the near-term investment performance. Analysts say the company’s shares can rebound if Fairfax can persuade investors it can get back on track for big annual gains in the company’s value, led by its investing.
Cormark Securities Inc. analyst Jeffrey Fenwick said on a conference call Friday that he’s getting “pushback” from concerned investors because “Fairfax isn’t afraid to take some bigger swings at stocks and have some larger positions like the BlackBerry and Stelco in there.” He asked Paul Rivett, Fairfax’s president, if the company is considering selling some of the names to “reorient the portfolio,” reduce volatility and improve performance
“We've heard that from our shareholders,” Mr. Rivett replied. “But for us, we're always going to be value-focused and there may be larger positions from time to time. Generally speaking, we don't want to go any bigger than the current position sizing that we have. But we continue to be focused on the names we have, and we will always be value investors. And there may, from time to time, be larger positions as value investors.”
Even a US$1-billion position “is relatively small in the portfolio,” Mr. Rivett said, as Fairfax’s insurance operation has US$40-billion in money to invest.
Fairfax’s nearly 47 million shares in BlackBerry, worth about US$350-million at June 30, decreased in value by more than US$100-million, as the company’s shares dropped by 30 per cent in three months.
A US$151-million position in steelmaker Stelco fell by nearly 40 per cent, or about US$60-million in the quarter. And Calgary’s Ensign fell by more than 25 per cent, trimming about US$15-million from Fairfax’s portfolio.
Fairfax doesn’t record quarterly gains or losses in its 30 million shares of Resolute Forest Products. It owns more than 20 per cent of the company, so accounting rules dictate that it be considered an “associated investments.” But its position lost more than US$75-million in the third quarter as the stock fell 35 per cent, plus another 23 per cent, or US$33-million, in October.
Fairfax recorded a realized investment gain of nearly US$171-million in the quarter, in part from exiting a hugely profitable position in Indian insurer ICICI Lombard General Insurance Co., which Fairfax established in 2001 with co-investor ICICI Bank Ltd. Mr. Rivett told investors Thursday that Fairfax recorded a US$150-million gain in the quarter from the sale of its final 9.9 per cent of the company. All told, Mr. Rivett said, Fairfax invested US$347-million in the company and sold its stakes for US$1.64-billion.
Fairfax shares rose 3 per cent Friday to $575, a bit higher than the 52-week low of $542.70 reached Oct. 18. Its share price was around 0.9 times the book value of the company’s balance sheet, a standard metric for evaluating financial companies. The last time Fairfax’s price-to-book value averaged 0.9 for a quarter, it was the depth of the financial crisis in 2009, according to S&P Global Market Intelligence.
CIBC World Markets Inc. analyst Paul Holden sees double-digit premium increases continuing in the insurance business and believes that with sales of some profitable positions, Fairfax could achieve a 10-per-cent investment return in 2020. He sees Fairfax meeting or slightly exceeding insurance-industry profitability in next year – and with a 1.1 multiple. He’s set his 12-to-18-month target price at $750.
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