Description

If you’re prone to motion sickness, this one might not be for you.  We are about to go on a Tilt-a-Whirl of interrelated holdings.   As you might imagine, I believe there is a heavily discounted security at the end of the ride.  I’ll also go ahead and let you know that unlocking that value is probably a long ways off, but I’m getting ahead of myself.  Let me first introduce you to Economic Investment Trust Ltd (TO:  EVT, EVT, or the Company).  All dollars CAD.  This one doesn’t trade much, so definitely a PA investment. 

EVT is a closed-end fund with ~$1.1Bn assets trading at a 34% discount to NAV.  Since 2004, it’s traded at a between a 16% and 36% discount and averaged a 27% discount.  So, the good news is that it’s trading near its trough discount to NAV, but the bad news is, there isn’t a ton of upside to its average discount from here, and at least going back to 2004, it’s never traded at or above NAV.  Further, management expressly states that they have no intention of causing the fund to open-end and have been reluctant in the past to buy back shares. 

The $1.1Bn of assets under management is roughly evenly divided into what management terms long-term holdings and the global investment portfolio.  The global investment portfolio was up until recently managed by Burgundy Asset Management, but Burgundy was recently replaced with Neuberger Berman Canada.  The global investment portfolio has been invested with a quality, value mindset in the past and is expected to be going forward.  Expense ratio for EVT is 36 bps.     

There long-term holdings are comprised of related party public traded holdings:

•         E-L Financial Corporation (TO:  ELF) – 33% of EVT holdings

•        Algoma Central (TO:  ALC) – 3% of EVT holdings

•        And some other small holdings not worth noting here

EVT, ELF, and ALC are all ultimately controlled by Hal Jackman, a Canadian billionaire and former Lt. Governor of Ontario.  Given the relative size of the ELF and ALC holdings, ELF is the one to focus on in this write-up.  So, what’s E-L Financial?

Glad you asked.  ELF is a collection of…

•        Other closed ends funds that trade at discounts to NAV. 
•        A life insurance company with a wealth management division. 
•        Oh yeah, and they also own some ALC.; and… 
•        They own some EVT!  Ha – getting dizzy yet? 

Don’t worry – I’ll put it in a table for you in a sec.

ELF Holdings Overview:

Here is the run-down of ELF owns:

•        52.7% stake in United Corporations (TO:  UNC). 

o   It’s a diversified closed-end fund managed by Comgest Asset Management International Limited, Harding Loevner LP, and Causeway Capital Management LLC. 

o   Expense ratio is 53 bps. 

o   It trades at a 39% discount to NAV.  Since 2001 it’s traded at a discount between 17% and 47% (briefly during the dotcom bust) and averaged 30%.  So again, trading on the attractive end of its historical discount range, but not much upside to average.

o   ELF consolidates UNC on its books.

•       37.4% holding in ALC.  ALC is a bulk cargo and tanker fleet trading at 6x EBITDA and at a slight premium to book value. 

•       ELF has its own portfolio of stocks and bonds.  We’ll need to deconsolidate UNC to get a true picture of ELF’s investment portfolio. 

•        99.4% stake in Empire Life

o   Empire generated a 16% ROE in the LTM period ending September 30^th, 2021

o   8% ROE in 2020 and 11% in 2021

o   Empire Life shareholders’ equity sits at $1.8Bn (deducting $300mm of Pfd that sits at the Empire Life level) at 9/30/21.

o   I’m valuing at book despite peers trading higher than book with similar (to worse) LTM ROEs

•         Finally, ELF owns $176mm market value of EVT

The chart below outlines ELF’s holdings and provides a market-based valuation and an intrinsic value column that marks UNC and EVT to NAV.  We then deduct non-insurance related borrowings and deferred taxes, which by my estimates should approximate tax liability in a breakup to arrive at market-value and intrinsic value per ELF share. 

Impact on EVT:

OK, another spin around and back to EVT (this will all be over soon, I promise).  In EVT, we have a closed-end investment fund trading at a big discount to NAV who’s largest holding, ELF is significantly undervalued as well.  Plus, ELF appears to own some undervalued assets.  The below chart below outlines how EVT NAV would increase if ELF traded at the market value or the intrinsic value of its holdings, while EVT continued to trade at a discount to NAV.  Note that these are net of the increased tax liability that would result from said increase in value.  

Prospective Returns:

At this point, you’re probably saying – I’ve owned these kinds of things before.  They are called value traps.  They always trade at huge discount to intrinsic value, and they just lie there (or worse!).  These never realize their full potential. 

Well, I’ve certainly done the same.  But typically, that’s because I’ve bought an asset whose value is growing relatively slowly (or…ahem, declining) and the discount didn’t narrow fast enough for me to make my return.  I think this situation is different – NAV has and should continue to grow.  I’ll try to lay out why below by examining the ultimate assets you are purchasing by buying EVT. 

Let’s go back to ELF (oh, boy – here we go again; everyone pop a Dramamine).

•         We’ll start with Empire Life.  I think a 9% - 10% ROE is achievable over the long-term.  As illustrated below, that results in $3.27 per share of look through earnings to EVT.

• Next, let’s look at ELF’s corporate investments.  It’s almost all equities.  Assume a 6% - 10% long-term return on equities?  Note that I’m factoring in the corporate ELF leverage here, but in theory this can be done at any point in the ELF analysis.

  (in millions, except per share values)
  Corporate Investments	CAD 3,981.89
  Investment Returns	8.0%
  Gross Investment Income	CAD 318.55
  Interest Expense	(CAD 8.09)
  Levered Investment Income	CAD 310.46
  ELF Shares Oustanding	3.71
  Inv Income NI / ELF Share	CAD 83.72
  EVT's ELF Shares Owned	0.39
  Look Through Earnings to EVT	CAD 32.33
  EVT Shares Oustanding	5.59
  Look Through Earnings / EVT Share	CAD 5.79

• -        Now, let’s turn to the UNC stake and assume the same long-term investment returns. 

  (in millions, except per share values)
  UNC Value @ NAV	CAD 1,162.26
  Investment Returns	8.0%
  Gross Investment Income	CAD 92.98
  ELF Shares Oustanding	3.71
  UNC NI / ELF Share	CAD 25.07
  EVT's ELF Shares Owned	0.39
  Look Through Earnings to EVT	CAD 9.68
  EVT Shares Oustanding	5.59
  Look Through Earnings / EVT Share	CAD 1.73

• For ALC, it has averaged a 9% ROE since 2000 and currently trades at 1.1x price to book value.

  (in millions, except per share values)
  ALC Market Value Held by ELF	CAD 246.84
  Price to Book	1.08x
  ROE	8.8%
  Income to ELF	CAD 20.19
  ELF Shares Oustanding	3.71
  ALC NI / ELF Share	CAD 5.44
  EVT's ELF Shares Owned	0.39
  Look Through Earnings to EVT	CAD 2.10
  EVT Shares Oustanding	5.59
  Look Through Earnings / EVT Share	CAD 0.38

• -        EVT is circular (weee!), but same concept as above.  You’ll see where I am getting the EVT returns from in a second. 

  (in millions, except per share values)
  EVT Returns	17.0%
  ELF's EVT Investment	CAD 176.35
  Income to ELF	CAD 30.00
  ELF Shares Oustanding	3.71
  EVT NI / ELF Share	CAD 8.09
  EVT's ELF Shares Owned	0.39
  Look Through Earnings to EVT	CAD 3.12
  EVT Shares Oustanding	5.59
  Look Through Earnings / EVT Share	CAD 0.56

  Now, that takes care of look through earnings at the ELF level (whew).  The global investment portfolio at EVT should be able to earn similar equity returns over long periods of time as assumed above for the other equity portfolios. 

   

  NAV Per Share	CAD 196.89
  % Not Attributable to ELF	67%
  % Returns	8.0%
  Earnings / Share on Non-ELF Portion	CAD 10.55

  Taking it all together, results in $22.29 of earnings we’ll receiving each year on a $131 purchase price or a 17.0% annual return at EVT.

  	$ / Share	Portion
  Empire Look Through	$3.27	14.7%
  ELF Corp Investment Look Through	$5.79	26.0%
  UNC Look Through	$1.73	7.8%
  ALC (ELF Holdings Only) Look Through	$0.38	1.7%
  EVT Owned by ELF Look Through	$0.56	2.5%
  Total ELF Look Through	$11.73	52.6%
  Non-ELF Estimated Earnings	$10.55	47.4%
  Total EVT Earnings	$22.29	100.0%

  That means that even if the discount stays the same (historically high discounts), we are still going to have a nice return at EVT because given the discounts at EVT, ELF, and UNC, you are buying a lot of assets that should compound nicely over long-periods of time relative to your purchase price.  Each share of EVT is ultimately benefitting from 2.4x that number of assets compounding given the discounts at each level.  The table below shows expected returns at various Empire Life ROEs and long-term equity returns.

  Inv	Empire ROE
  Rtrns	8%	9%	10%	11%	12%	13%	14%
  5%	16.1%	16.4%	16.6%	16.9%	17.2%	17.4%	17.7%
  6%	16.3%	16.5%	16.8%	17.1%	17.3%	17.6%	17.9%
  7%	16.4%	16.7%	17.0%	17.2%	17.5%	17.8%	18.1%
  8%	16.6%	16.9%	17.1%	17.4%	17.7%	18.0%	18.2%
  9%	16.8%	17.0%	17.3%	17.6%	17.9%	18.1%	18.4%
  10%	16.9%	17.2%	17.5%	17.8%	18.0%	18.3%	18.6%

  Management:

  Hal Jackman’s Dominion and Anglo owns 27% of EVT and 39% of ELF.  There is over $1Bn of incentive to close the gap between market and intrinsic value for the Jackman family. 

  OK Mustang, but have they really done anything to close the gap?  Sometimes these billionaires don’t care about making the next billion.  Short answer is they have taken steps, but probably not as aggressively as all of us would prefer.  In other words, they haven’t been shareholder unfriendly, but not the friendliest either. 

  However, there are some recent, optimistic datapoints. 

  -        EVT and ELF have launched share buybacks starting in 2020.  These buybacks were by my study the first ever at EVT.  But they’ve been admittedly small. 

  -        ELF has significantly increased its dividend in 2H ’20 from $1.25 / quarter to $2.50.

  -        ELF declared a special dividend of $80 in Q3 ‘21 (they’ve done three special dividends since 2012, and two have occurred in the past two years). 

  To me, it feels like Jackman is starting to make a bigger effort to close the gap, but it’s early days and moving slowly.

  Conclusion:

  I think purchasing EVT represents an opportunity to buy a collection of assets at a 34% discount to NAV whose largest asset likely trades at an ~50% discount to intrinsic value.  Modest investment level returns on gross assets would result in mid-to-high teens returns on our purchase price with a controlling shareholder that appears to be signaling a willingness to take action to start closing the intrinsic value gap, albeit at a slower pace than we’d all like. As illustrated above, we’ll get paid decently in the form of rapidly compounded NAV, while we wait for the discount to potentially close some day. 

Catalyst

- See discussion of recent management actions above

- Likely wait a long time and benefit from growth in NAV in the interim