Jeffrey Stacey of Stacey Muirhead Capital Management presented his investment thesis on Fairfax Financial Holdings (Canada: FFH) at Best Ideas 2021.

Thesis summary:

Fairfax Financial Holdings is a property and casualty insurance and reinsurance company. Its stated corporate objective is to achieve a high return on invested capital and build long-term shareholder value. The company has been under present management since 1985 and is led by V. Prem Watsa, Chairman and CEO. He is also the controlling shareholder with an effective stake of 1.54 million shares, recently valued at $515 million (all figures in USD). This is down from over $1 billion a few years ago.

Fairfax has an amazing long-term track record of business and share price performance, but the share price has lagged recently. Over the 34 years since its beginning in 1985 to the end of 2019, Fairfax achieved a compounded annual growth rate of 19.3% in book value per share (including dividends), while the share price grew at 17.8%. In 2020, the book value per share declined by 6.9% while the share price declined by 29.7% The share price recently reflected a 24.5% discount to book value.

Jeff believes that the discount is not justified, and that Fairfax represents an attractive investment opportunity at recent prices. Insurance pricing is growing at double-digit rates, and the value of Fairfax’s equity investment portfolio has improved considerably. As well, Fairfax continues to strategically monetize some of its non-insurance businesses. Recent dispositions include Davos Brands and the pending sales of the Riverstone Europe runoff business and the Easton baseball equipment business.

Fairfax has been an active buyer of its shares in recent years, having repurchased 2.02 million shares since Q4 2017. In June 2020, Prem Watsa purchased an additional 0.48 million shares personally for just under $150 million.

With a favorable pricing environment for insurance, improved returns from the equity portfolio, strategic monetization of some of its non-insurance businesses, and share purchases by both Fairfax and Prem Watsa, Jeff believes that Fairfax Financial represents a compelling investment opportunity.

Listen to this session:

slide presentation audio recording

We share an insightful follow-up exchange between a fellow member and Jeff:

Q: I have been thinking deeply about changes in insurance as they pertain to the use of AI and algorithmically-driven enhancements. I would love to hear your general thoughts on Ki and your assessments of the business in the context of Fairfax’s broader insurance operations.

A: I am not sure that I have anything particularly insightful to say about AI and fintech platforms disrupting the insurance business. It is a real phenomenon and the good insurance companies will adapt or die. The one observation I would make is that it will be harder to disrupt the marketplace for the most complex coverages but not impossible. While not exactly the sane thing, that is why personal insurance coverages have become so automated… think Progressive, Geico and Admiral. Even Digit (Fairfax is the largest shareholder) is a good example of that trend.

The other part of this is the distinction between the distribution process and the capital required to take on the risk. I could envision a future where the traditional sale or underwriting process is decoupled from the risk taking (i.e. capital) function. You already see this developing in the insurance linked securities (ILS) business. So all these trends are real.

Regarding Fairfax specifically, I believe that they recognize this and are working hard to be one of the disrupters. That is why they have invested in Ki with Blackstone. I know this was not your question but I find it interesting that Fairfax has made a number of “venture capital” investments in areas that might be transferable to insurance. Two examples are electronic payments technology and drones. On the latter, they believe that drone technology could helpful drive efficiency in the underwriting or claims process. Examples would be (1) sending up a drone to inspect HVAC systems on the roof of tall office buildings as part of underwriting process or (2) sending a drone to inspect a pipeline for leaks.

About the instructor:

Jeffrey Stacey is the founder of Stacey Muirhead Capital Management Ltd. and he has over 35 years of investment industry experience. Jeff has an Honours Bachelor of Business Administration degree from Wilfrid Laurier University and is a Chartered Financial Analyst. He is married and has two children. Personal interests include hiking, fitness, reading, travelling, and playing the drums.

Jeff is an advisory board member of the student managed Ivey Value Fund at the University of Western Ontario and an advisory board member of the student managed School of Accounting and Finance Investment Fund at the University of Waterloo. He is also a member of the Board of Trustees at Parkminster United Church in Waterloo.

Prior experience includes being a member of the Finance and Investment Committee at the University of Waterloo and a member of the Dean’s Advisory Council at the Wilfrid Laurier University Lazaridis School of Business and Economics. Jeff is a former director of Rainmaker Entertainment Inc. and previously served on the Board of Trustees and the Investment Management Committee at the University of Guelph.

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