Description

All numbers are USD. 

My thesis is twofold. A. Fairfax is about to have an excellent 2021 based on expected book value growth per share driven by a hard market and the pricing of equities on its book. My guess is that we will see book value growth per share in excess of 15%. B. Also Fairfax owns a 74% economic interest in the Lemonade of India, called Digit, at a valuation of $900 million for Digit. If that company did an IPO today it would be valued at billions of dollars in my estimation. Lemonade’s market capitalization $6.7 billion and Lemonade does business in a smaller market, has a worse combined and writes about 50% of Digit’s gross premium.

I made up this rule, when they all love Prem Watsa you sell Fairfax. When he is widely being despised it is time to look at Fairfax. I owned it when he was widely despised early 2000s and was out during the CDS period where Prem Watsa acquired the status of deity. Now I am back. If you want a nice touch of how much he is liked nowadays just listen to the Q&A last conference call or read some of the comments on boards about him. I have always thought he was not as good as people have ascribed to him in the past, but to my understanding he is still a good steward of Fairfax.

Currently Fairfax is trading at a discount to where I believe it should trade, being about 1.2 times book. And I think we will get to see this multiple expansion likely in 2021 due to my expectation of a rapid increase in book value.

A.     Current book value at the end of $478 per share. (Dec 31 2020)

B.     Prem bought 150 million USD in Fairfax stock for himself at $308 per share.

C.      Prem believes that Fairfax stock is cheap indeed and is also buying back his own stock. On top of buying back stock the regular way, recently they did a total return swap on 1.4 million shares of Fairfax stock at $344.45 per share. That gets me $3.31 in additional book value per share.

D.     When I calculate the increase in “economic value” on the equity book, since Jan 1 based on the current investment portfolio, I get an additional value of $56.8 per share in book value. Now I do include the “Equity Accounted Associates” and “Consolidated” stocks in this calculation, hence the term economic value. If I exclude those, I get an additional $20.5 per share in book value to be reported March 31, 2021.

E.      On the fixed income side duration is 1.8 year, leaving little risk to its bond portfolio from rising interest rates. The current interest rate is a little of 3%. I assume 2% for 2021. That gets me $272 million post tax or $10.3 in book value per share.

F.      Fairfax ex covid had a 93% combined ratio for 2020. A hard market has developed, especially in 2020. Most of these increased prices still have to work their way through to earned premium.

I have heard plenty of general stories about the hard market but I think Evan Greenberg has been most direct/detailed about the pricing environment he sees. From the Q3 and Q4 2020 releases by Chubb. “Commercial P&C rate increases in the quarter, which averaged 16.5% in North America Insurance and 18.5% in Overseas General Insurance, exceeded loss cost trends by 11.5 percentage points and 15.5 percentage points, respectively. (Q4 Chubb info)” and “The company continued to experience strong and improving commercial P&C underwriting conditions in most regions of the world, with rate increases averaging 15% in North America and 16% in Overseas General Insurance. (Q3 Chubb info)”. Evan Greenberg talks in more detail about the price improvements he sees in the earnings calls, but this already shows that margins are improving markedly. I especially appreciated the Q4 2020 comment where he compares the increased pricing to loss cost trends.

Back to Fairfax now. I assume $15 billion in net premiums for 2021 at a 93% combined, similar as achieved in 2020. That gets me $33.81 post tax in additional book value per share for 2021. I feel I was conservative in my assessment using the 2020 93% combined. If prices are truly evolving as positive as Evan Greenberg commented, then Fairfax should be able to do better than 2020.

G.     This gets me a total of just above $104.22 per share if I use the economic value of the equity book. More conservative is to use the increase book value per share of $20.5 per share in equity related book value what gets me to $67.92 per share, which is solid and will likely attract a rerating of Fairfax during 2021. Using $67.92 per share in book value growth I get to $545.92 at the end of 2021. Using the more optimistic “economic value” of $104.22 I get to $582.22 per share. Putting a multiple on $478 of 1.2 times book I get $573.6 per share. Using $545.92 times 1.2 I get $655.1 per share. Using $582.22 times 1.2 I get $698.6 per share.

H.     And now I get to Digit. Fairfax has an economic interest of 74% in the Lemonade of India. Digit has twice the gross premiums of Lemonade already at $400 million and closed 2020 at a combined ratio of 114%. This 74% economic interest is currently on the books of Fairfax a 100% valuation of Digit of $900 million. Recently Digit raised money at a valuation of $1.9 billion. If Digit had an IPO tomorrow it should trade at a significant premium to Lemonade. After all Lemonade is subsidizing policies at an insane rate, not so with Digit. And Digit is in a market with a population 4 times the size of the US and with an economy that is expected to outgrow the US by multiple percent a year for a long time. If I use the current market cap for Lemonade of $6.7 billion per share for Digit, one would see book value per share of Fairfax increase by $187 per share. I would not count on a listing soon, but I do believe Fairfax has a winner on its hands with Digit. Some catalyst will develop over the next few years is my guess. There must be a lot of paper millionaires that work at Digit.

Concluding, I think it is reasonable to expect significant book value growth per share from Fairfax for 2021. Fast growth in book value per share should renew interest in Fairfax. And then there is Digit, which I think is of significant value to Fairfax. Value that will realize itself over the next few years. Few investors know even that Fairfax owns Digit.

One last point, I would not be surprised if the entire insurance space gets a rerating over the next year. This hard market is bound to do wonders to the bottom line of these firms and due to the delayed effect from price increases to net earned premium I do not think the broader market has started paying attention yet to this.

Catalyst

Digit

BV growth