Description

At a price of $10.54 FIH trades at 56% of book value (book value per share $18.50), which I believe to be a reasonably attractive entry point for a well-managed company that has good and growing assets and going forward will likely have access to assets in one of the largest growing economies in the world, namely India.

Before I get going, FIH is a Prem Watsa company. I know he somehow is quite polarizing. I have followed Prem for two decades now, and yes, his record is not spotless when it comes to corporate performance, as can be seen for the 2010-2020 period with FFH’s book value per share. But I do believe he is an honest person that wants to allocate resources long-term for the benefit of all shareholders. The way I have described it in the past, is that I don’t buy Watsa companies when they trade at or above book value, but when they trade at a significant discount to book value, I get interested again. Done it a few times over the years and it has always worked out well for me. Yeah, I know many held FFH since 2010 while the stock did little, on the other hand the stock traded during that period above book value, thus I never held it. The key to holding Watsa companies is to buy them when they trade at a discount and sell them when you get a reasonable valuation. Or to look at it differently, when people love Prem, I do not want to own one of his companies, when they hate him and I tend to like owning Prem’s companies. Today regarding FIH people don’t seem to like Prem a lot.

Also, FFH gets a management fee from FIH of 20% of the increase in book value per share in excess of a 5% hurdle rate. To me that clearly detracts from the ultimate value. Still the stock has traded at times over 1 times book. I will be gone if/when it trades back to 0.8/0.9 times book.

Why is FIH trading at this discount?

-        Emerging markets have been out of favor for a while now.

-        These high energy prices will impact emerging markets more. There is clearly a fear for a global recession going forward.

-        The Indian Rupee has lost value versus USD, but looks competitive to me here.

I wonder a little why FIH trades at this discount as it is not as if FIH has done a horrible job building value. At the end of 2015, FIH book value per share was $9.5 per share, as of Q2 2022 it is $18.5 per share. The book value per share at the end of Q1 2022 was $19.77 per share. The decline was caused by a worsening of the value of the Indian Rupee versus the USD. It doesn’t feel as if they knocked it out of the park, but one also can’t say they didn’t do stuff right. Given this track record I find that the current valuation assumes too much negative expectations for FIH.

Buyback

Over the last four years through Q4 of 2021, FIH has bought back 14.4 million shares for $13.26 a share.

During 2021 FIH bought back 7.046 million shares for $14.90 per share with a substantial issuer bid. Under the normal issuer bid FIH also bought 1.734 million shares in 2021 for $12.61.

During the first six months of 2022, FIH bought back 2.100 million shares for $12.51 per share.

Given that the current book value is $18.5 I would say that these buybacks are money well spent. FIH has monetized assets in the past in order to raise cash that allows it to buy back shares. I believe they will do so again as long as the stock trades at such a discount. Sadly, they did not wait till now at $10.50 to spend the money on buying back shares.

At the end of Q2 2022, 139.134 million shares are outstanding. 12 months ago, 149.323 million shares were still outstanding.

Lastly, post June 30 2022 through July 29, 2022, FIH bought an additional 300K shares back. So, it looks like FIH keeps nibling away. FIH is limited in the number of shares is it legally allowed to buy on a daily basis on TSX. Last time I looked, they are limited to buying a maximum of 12.2K shares daily.

FFH buying

FFH bought an additional 5.4 million FIH shares in Q1 for $12 a share.

FIH management is making efforts to bring out the true valuation of FIH.

For example, FIH has created Anchorage, a new entity that will hold FIH’s infrastructure assets. The plan is to list Anchorage soon at a value that puts the value of BIAL at $2.9 billion.

Also, they just listed Sanmar Chemicals.

They also monetized with Privi Specialty, Fairchem Organics and IIFL.

So, is the book value real?

I feel comfortable with the book value of FIH as FIH is using conservative inputs for the NPV for its Level 3 valuations. Here are the Q2 2022 inputs.

To start with the growth rates that are used, they seem conservative overall. India has had significantly higher GDP growth rates. I know I am comparing GDP growth rates with corporate profit growth rates here, but it seems like a reasonable proxy.

Regarding discount rates used, I know that for India a higher risk premium should be used than for example the US, but these discount rates seem pretty conservative to me. For example, I have seen much lower discount rates being used in the past for infrastructure assets like BIAL.

Also, for CSB they take a 15.7% discount to the bid price due to illiquidity.

Then for the rest of the Level 3 assets, representing small amounts, on that balance sheet I assume they are using similarly conservative inputs.

Lastly, looking at the Level 1 assets, I am making an assumption that the Level 1 assets are valued reasonably but just to be conservative I give them a 20% haircut. The level 1 assets are worth at the end of Q2 2022 about $1 billion. Let’s take a 20% discount to that billion which assuming 139 million shares outstanding hits book value per share by $1.43, which gives me a net $17.07 in adjusted book value per share. At a price of $10.5 that gives me an adjusted price to book of 61.5%, which is still quite attractive.

Not saying that the stock can’t trade lower, especially with all the current uncertainty in the world. But I do believe we have a decent margin of safety.

Catalyst

- The valuation discount.

- BIAL second terminal is opening soon.

- More buybacks and monetizations for buybacks.