Description

E-L Financial (ELF.TO) is an investment and insurance holding company trading for ~56% of NAV that consists of a ~$5 billion proprietary investment portfolio (as of Q3 2019) and a 99.4% ownership of a large and profitable Canadian insurance company called Empire Life.  E-L has been a well-managed, family run holding company that has generated excellent per-share book value growth for the past 50 years.  The more recent track record of BVPS growth has been solid and certainly comparable to other total-return style insurers. Below is the company’s 10-year track record ended 2018, as well as the cumulative track record.  Sorry about the poor formatting for this write-up; I did the best I could.

2009-2018 10-year period:     9.7% annualized

1969-2018 Since inception:  12.4% annualized 

The recent history of yearly BVPS change is shown below (note that BVPS growth is adjusted to include the minor impact of dividends):

Annual BV Per Share Growth                            BVPS                           Growth

            2007                                                     $    671.81                       12.7%

            2008                                                     $    551.59                    -17.8%

            2009                                                     $    681.51                       23.6%

            2010                                                     $    747.28                        9.7%

            2011                                                     $    642.98                    -13.9%

            2012                                                     $    740.49                       15.2%

            2013                                                     $    872.45                       28.0%

            2014                                                     $    970.65                       11.3%

            2015                                                     $ 1,089.23                       12.3%

            2016                                                     $ 1,159.26                        6.8%

            2017                                                     $ 1,316.64                       14.0%

            2018                                                     $ 1,295.65                       -1.2%

            Q3 2019                                               $ 1,421.57                       10.0%

The most recent stock price was ~$810, while the Q3 2019 report showed BVPS of $1,421 per share.  I’m projecting that Q4 2019 BVPS will be around $1450, which means that shares of this company are trading at a multiple to Q4 2019 book value of just 0.56X. 

E-L originally began as a holding company for the purpose of acquiring a majority stake in Empire Life, and over the years E-L acquired other insurance companies and assets. For many years E-L has been managed by Hal Jackman, a Canadian billionaire (now retired but still on the board) and his son Duncan Jackman who is currently the CEO.  

For the last ten years E-L has mostly engaged in managing its large equity portfolio (much of which is sourced to outside managers) but has also been opportunistic on both the buy and sell sides of large insurance transactions on occasion.  In 2013, for example, E-L sold one of its large insurance operations called Dominion of Canada to Travelers for $1.125B.  That year E-L paid out a special $75 per share special dividend to investors.  In 2015, E-L paid $200M to increase its ownership of Empire Life from 80% to 99.2%. E-L today has two units, one representing the operations of Empire Life, and the other being E-L Corporate. 

E-L Corporate is mostly an investment portfolio that is invested in publicly traded stocks around the world (~$4.992B as of Q3 2019) plus some long-term strategic holdings that include a ~52% ownership in closed end fund United Corporations Limited (which is consolidated with the portfolio investments shown above), a 37% direct ownership in publicly traded shipper Algoma Central (ALC), and a 24% ownership of another closed end fund, Economic Investment Trust Limited (note: you’ve got to hand it to whatever marketing genius named these funds!) which trades under the ticker EVT. As of Q3 2019, the fair value of E-L’s ownership of EVT was $140M and the fair value of Algoma was $195M, for a total of $335M between them.

As of Q3 2019, E-L’s ~85% of the value of E-L Corporate’s equity portfolio was invested outside of Canada, with 45% in the US, 22% invested in European/UK, and ~20% in the rest of the world, with about half of that in Japan.

The two closed end funds (UCT and EVT) have each been around and publicly traded in Canada since the 1920’s.  UCT is controlled by E-L’s management, with Duncan Jackman serving as the senior corporate officer.  UCT is a global multi-manager fund, and it appears to me that all the managers are solid, reputable firms with a value orientation.  In addition, UCT also owns a nearly 9% ownership stake in Algoma Central.  It’s a big fund, with NAV of over $1.8B in AUM, and E-L’s 52% ownership is consolidated within E-L Corporate.  EVT is a smaller fund with approximately $900M in NAV.  It also appears to be controlled by the Jackman family as ~80% of the shares are owned by an entity owned by the family and the officers of the fund are primarily from E-L Financial.  E-L also acts as EVT’s fund administrator, such that ELF gets a small amount of money per year for administration fees (10 bps or so of AUM).  EVT has three significant investments in the fund, with E-L itself being the largest individual position at roughly 40% of AUM.  Algoma was recently about a 4% position and The Bank of Novia Scotia was a 6% position. The rest of the portfolio is managed by Burgundy Asset Management, a global equity manager based in Toronto.  Average trading volume is only about 300 shares per day, so it’s illiquid and not a particularly practical investment for outside investors.  Both UCT and EVT currently trade at roughly 30% discounts to NAV, and historically both have typically traded at 20-30% discounts to NAV.

Algoma is publicly traded ALC.TO, and at the current stock price of ~$12.60 per share values the business at about $540M.  It appears that E-L owns about half of Algoma either directly or indirectly through its ownership of the two closed end funds noted above.  Algoma Central owns and operates the largest Canadian fleet of dry and liquid bulk shippers operating on the Great Lakes – St. Lawrence Waterway, which is a huge system of locks, canals, and ship channels that extends all the way from the Atlantic Ocean to the head of the US Great Lakes and which is a major trade and cargo artery in North America.  The company also manages shipping “pools” in other areas, and in late 2015 decided to enter the “global short sea shipping” with a strategy to focus on “niche markets requiring specialized equipment or services and lacking an existing dominant player.”  They seem to have had decent success so far.   

Unlike most shipping companies I’ve looked at, Algoma is a decently consistent business from year to year and has a long history of profitability and strong cash flow generation.  Algoma does experience extreme seasonality, as Q1 typically accounts for about 10% of total annual revenue due to harsh winter weather.  The canal system is often closed during the winter months and the dry bulk fleet typically doesn’t operate for much of the first quarter.  Q1 therefore is almost always a significant negative earnings quarter, while Q3 and Q4 are typically the strongest quarters.  The company reported full year revenue of $508M in 2018 with net profits of $51M.  Through the first nine months of 2019, revenue was $399M with net profit of $20.4M with the seasonally strong Q4 earnings not yet reported.  ALC will report year end results at the end of February.  Algoma has been refreshing its fleet and adding new vessels to enter certain adjacent markets in recent years, so the company’s capital spending has been somewhat elevated in the past 3-4 years.  Based on a quick review of the company’s financials, Algoma looks like a solid, consistently profitable company trading at about 70% of tangible book value and roughly 11X earnings or 6X EBITDA.

Empire Life is an insurance and investment management company in Canada.   ELF had previously owned about 80% of Empire Life, and in December 2015 took its ownership up to 99.2% by purchasing 19% of the company from Guardian Assurance Company in Canada for $200M, which would have implied a value for the entire company at about $1.05B.  The current ownership of Empire Life is 99.4%.

Empire has operated in Canada since 1923 and provides individual and group life and health insurance as well as investment and retirement products to the Canadian market. Empire is among the top ten largest life insurance companies in Canada though it has less than 6% market share in each of its three product lines.  Empire is well capitalized and has a strong credit rating from AM Best of A (Excellent).  Empire’s business is focused exclusively in Canada.  The company offers three product lines: individual life insurance accounts for roughly ~35% of revenue, wealth management accounts for ~35%, and an employee benefits unit comprises roughly for 30%. 

I believe that Empire Life is a well-managed insurance business that is far less risky than typical U.S. based life insurance specialists.  This is because Empire’s business is roughly one-third life insurance, one-third wealth management, and one-third Employee benefits (focused on Canadian companies with fewer than 200 employees).  Empire Life reported net income of $137M in 2018, $170M in 2017, $151.5M in 2016, and just over $100M in 2016.  The difference in net income across these years is generally attributable to variances in investment returns on Empire Life’s investment portfolio and the managed assets in the wealth management business line. Empire is a sizable insurance operation, and its investment arm managed ~$18B in AUM as of September 30, 2019, which includes its general insurance funds related to the life insurance business as well as segregated accounts invested on behalf of its clients.  

Empire’s own insurance investment portfolio is more conventionally positioned, with 83% or so in Canadian government and corporate bonds and the rest invested in preferred shares and equities.  This is roughly $9.2B of the $18 billion above.  Given that Empire Life appears to comprise only about 20% of the total asset value of E-L Financial, I won’t spend an excessive amount of time on it.  But I think it is a decent asset that is probably worth at least book value. 

E-L’s consolidated shareholder equity was $5.714B as of Q3 2019, so when you consider the Corporate equity portfolio of $4.99B plus the $335M for EVT and Algoma, this accounts for roughly $5.327B of the consolidated BV of $5.714, or about 93%.  

Here is a brief review of the results for the first three quarters of 2019: BVPS grew to $1,421.57 as of Q3 2019, up 10% for the first nine months, and I’m expecting a least a 2.5% jump in Q4 given the strong rally in global stocks in the quarter – this would put the BVPS at about $1450.  For the first nine months of 2019, EL enjoyed a bountiful $451M in earnings or $111.99 per share.  YTD the global portfolio earned 10% in the first nine months with 13% returns in Canada and the US, 10% in Europe, and 5% elsewhere.  Empire Life reported decent results for Q1 and Q3 but reported an unusually weak quarter in Q2 from which it recovered to a more normal $35M in profits for Q3.  Empire Life reported $97M of net income through the first 9 months of 2019, which was down from $130M in 2018. 

In summary, at the current price of ~$800 per share, one is essentially getting two entities that combine for over $1,400 per share in economic value.  It’s true that a significant chunk of this economic value is in the form of a diversified portfolio of global equities, but it should be noted that this portfolio has been historically very well managed with a bit of a value tilt.  Obviously if you are bearish and don’t want equity exposure and don’t be attracted to a globally diversified portfolio even at a 45% discount, this idea probably isn’t for you.  The roughly 20% of the economic value comprised of Empire Life is comprised of a decently managed insurance business that has been a profitable and steady grower with a strong balance sheet, albeit in an unexciting sector.  I don’t see any assets here that make me think that E-L is going to get hit worse than anybody else if the equity markets have a rough 2-3 year period, and I think that maybe the relatively obscure stock and big discount could even provide some buffer from an environment where equities get aggressively sold for an extended period of time.

I can find no major problems with reported NAV, and I can see no reason why the discount should be this enormous.  For my fair value estimate I don’t assume anything close to NAV.  I value E-L Corporate like a closed end fund, thinking maybe it should probably trade closer to a 20-25% discount to NAV.  Maybe Empire Life is a decent business, but let’s assume it should trade at something closer to 75% of book value as well.  That would imply a stock price of $1087, or 36% appreciation from here.  Even at 70% of BV, the stock price would go to over $1,000. 

E-L has a long history of trading below NAV, but prior to the financial crisis it would occasionally achieve stock prices at or above NAV, but mostly traded in a range from 70-85% of NAV.  E-L was posted as an idea on VIC in 2002, 2003 and 2004.  The price/NAV at the time of the 2004 write-up was 0.97X.  As recently as 2013 and 2014, the stock has touched 85-90% of NAV on occasion.  But since 2015 the stock has mostly traded between 62% and 75% of NAV, averaging roughly 2/3 of NAV.  It isn’t unreasonable for the stock to eventually see at least 70% of NAV at some point.

The management appears to be highly competent and their significant ownership aligns them with shareholders, but they don’t seem to feel the need to take action to address discounted value of the stock.  This is my primary complaint about ELF.TO – it just seems that the management isn’t really that motivated to take any obvious action to take advantage of the huge corporate discount.  That said, the current discount is as wide as it has been in maybe 20 years, so there is a chance that they will do something at some point.  If they do decide to take some positive action, there is obviously a huge gap between value and price for them to exploit, and I don’t doubt that they are smart enough to figure out a way to close that gap in an intelligent manner if they decide to do something. ELF did increase the dividend in early 2016, raising the quarterly dividend by 10X to $1.25 per quarter or $5 per year – but this is still only a dividend yield of just 0.6%.  The company also paid a very large special dividend after divesting Dominion back in 2013. 

Anyway, for anyone who might be interested, here are some links to various information sources:

https://www.e-lfinancial.ca/general-information is E-L Corporate’s web site.

https://www.empire.ca/ is Empire Life’s website.  Empire files financial statements on SEDAR as well.

http://www.ucorp.ca/  is the website for United Corporations

http://www.evt.ca/ is the website for Economic Value Trust

http://www.algonet.com/ is the website for Algoma Central.

Catalyst

• There aren't any obvious catalysts here, but it seems reasonable that a stock price reversion to 70-75% of NAV is likely at some point.
• A significant increase in the dividend would be helpful as a signal that management wants to reward minority shareholders.
• The discount has now reached a historically extreme level, and it may be that management might be motivated to take some action to close it.