Long Idea - Fairfax Financial

Fairfax Financial Holdings Ltd (FRFHF.PK)

Basic Company Overview

Fairfax Financial is a financial holding company that, through its subsidiaries, writes commercial property and casualty insurance and reinsurance. The company now operates in 100 countries worldwide through its wholly owned subsidiaires:

Northbridge - Canadian insurance underwriter
Crum & Forster - US P&C Insurance underwriter
Zenith National - US Workers' Compensation Specialist
OdysseyRe - Worldwide underwriter of P&C Reinsurance & Specialty Insurance
Advent - US Property Insurance
Fairfax Asia - Consists of two P&C insurers: First Capital, based in Singapore and Falcon Insurance which is based in Hong Kong.
Fairfax Brasil Seguros Corporativos S.A. - Brazil P&C Insurer, founded in March 2010

And JV Partners:

15% Interest in Alltrust Insurance Company of China (a leading Chinese insurer)
JV in India with ICICI Lombard General Insurance

Fairfax also owns a leading North American animal nutrition business, Ridley.

The float is managed by Hamblin Watsa Investment Council (HWIC). Hamblin has gained significant notoriety for betting against the subprime housing market through CDS positions with an $18.5B notional amount on 25-30 bond insurers and mortgage lenders. The net realized gain since inception has been $2.1B vs. original acquisition costs of $433.B. (Note: CEO and Chairman Prem Watsa is quick to note in his most recent letter to shareholders, "Our adventure with credit default swaps is over (Emphasis Mine)- but we will remember it as of one of the the more significant events in our history!" He also notes, "...it is highly unlikely we will ever repeat [these investment results] in the future!" Have to love this guy.)

HWIC has helped take the company from its original $30M in assets and $7.6M in common equity in 1985 to end 2009 with $28B in assets and $7.4B in common equity - an almost 1,000 fold increase. BVPS has compounded 26% per year, while the common stock has gained 22% per year.

Interest and Dividend Income has Grown Substantially As Well:

1985 - $0.70/share
1990 - $2.35/share
2000 - $40.54/share
2009 - $38.94/share

At the end of 2009, the combined float was $579/share. Combined with $370/share in BV and $115/share in net debt, there is approx $1,064 in investments per share.

Also, importantly, float actually increases as the dollar depreciates at no cost to Fairfax as a result of its foreign subsidiaries. Given the dollar depreciation in September, one would expect earnings from Fairfax on October 28th to show a very positive benefit in this regard.

Watsa is a disciple of Benjamin Graham and has been compared to Warren Buffett (largely because of the compound annual growth rates, the constant references to Security Analysis, his holding company structure, and his colorful letters to shareholders.) As a conservative, long-term oriented value-investor (ditto for HWIC), Watsa in my mind is probably as good an asset manager as any should the market begin to behave, shall we say, erratically.

HWIC has large positions in WFC, J&J, USB, and KFT. Watsa notes that KFT has 1,000 stores in India after its acquisition of Cadbury. This is the type of diversification into growing markets that I for one can be excited about.

HWIC hedges its equity exposure to a great extent through swaps and other derivatives. The net exposure to equities has been higher than in previous years, which actually should provide another tailwind into earnings.

Turning to Insurance

Compound Annual Growth Rates from 2001 - 2009 in its insurance subsidiaries:

Northbridge - 18.6%
Crum & Forster - 19%
OdysseyRe - 22.7%
Fairfax Asia - 24.8% (since 2002)

Brazil has just begun and the India and China joint ventures should also provide robust growth and additional diversification.

The consolidated combined ratio for YE09 was 99.8%. Watsa is focused on underwriting at a profit or not at all, causing net premiums written to shrink on a consolidated basis by 1.1% through YE09. The markets will eventually harden and cost of acquisition of new business will go down. It may take some time, but in the meantime, Fairfax can earn excellent ROEs on its existing float. Also, the underwriting environment especially in the US has been very difficult which may account for why Fairfax appears to be so undervalued at this time. To want to own this company however, you'd have to think like Watsa. If that is the case, the lumpiness in the insurance and investment businesses should not be a deterrent to ownership, but actually should be viewed as an opportunity to buy the company at a VERY reasonable 1.1x BV. Fairfax took sizable hits (6.2 combined ratio points) on insurance exposures to Deepwater Horizon and the Chilean Earthquake, without which, Fairfax's consolidated combined ratio in 1H10 would have been 98.4%. This is the natural result of writing insurance around the globe, but even these events did nothing to keep Watsa from his goal of compounding annual BVPS by 15% per annum over the long term. Additioanlly, Fairfax Asia's combined ratio of 82.6% at YE09 and the newly open for business Brazilian unit should provide not only nice additions in net premium growth but also make correspondingly high contributions to the size of the parent company float.

1H10, the company earned $29.64/share. If the company earns $60/share for 2010, then Fairfax is trading at 9x TTM and 1.11 TTM BV for long term 26% annual compounded growth. This company is one that I intend to own for the long term.

It was recently mentioned by Mohnish Pabrai of Pabrai Investment Fund and Zeke Ashton of Centaur Capital Partners at the Value Investors Conference (VIC) which should draw additional attention to the company in the coming weeks/months.

Disclosures & Disclaimers: This article should not be taken as advice to buy or sell any security. It is intended for informational purposes only. The author owns shares in FRFHF.PK and may choose to buy more or sell the current holding at any time without notice.