Fairfax’s Prem Watsa Releases His Latest Letter to Shareholders

Prem Watsa, CEO of global insurer Fairfax Financial Holdings, has gained a large following due to his performance in the years since he took over the company that now bears the name Fairfax. At year-end 1985, when Watsa began running Fairfax, its stock traded at C$3.25 compared to C$649.00 today. A C$10,000 investment then would be worth C$2 million today.

As with most letters, Watsa reviewed Fairfax’s business performance last year along with general thoughts on the current environment. Among the highlights of the letter:

  • Catastrophe losses swung Fairfax to an underwriting loss in its insurance operations of $642 million. Last year, underwriting profits were $576 million. Despite the insurance losses, Fairfax’s book value per share increased by almost 25% to $450 per share.
  • Watsa revealed the reasons behind selling a large stake in ICICI Lombard and the entirety of First Capital, its Singapore operation. In the case of ICICI Lombard, getting under 10% ownership will give Fairfax the regulatory ability to start a wholly owned insurance business in India. First Capital’s sale came about because of the need for distribution throughout Asia, an attractive price, and a quota-share agreement that allowed Fairfax to retain 20% of First Capital’s book.
  • Watsa hinted that he feels Fairfax’s share price is currently undervalued. It presently trades at 1.15x book value and shares were issued earlier last year for the Allied World acquisition at 1.06x book value. According to Watsa: “over the next ten years we expect to….use our free cash flow to buy back our shares.”
  • A discussion of the removal of Fairfax’s equity hedges and their cost over the previous several years. Pro-growth United States’ policies were the impetus for removing them, but there is little question that Fairfax’s extremely conservative positioning cost money for the company as equity prices rose swiftly. Fairfax retains its swaps that pay out in the event of deflation, but those are likely to expire worthless in the years to come.
  • Assuming a 95% combined ratio in the insurance operations, the insurance investment portfolios will need to deliver 7% returns in order to produce 15% increases in book value. Hamblin Watsa (Fairfax’s asset management arm) elevated Wade Burton, currently Chief Investment Officer, to CEO.
  • The U.S. equity market appears fully valued at 18x earnings, but with economic growth set to accelerate it is possible that elevated valuations will persist for some time. That will create a “stock picker’s market” according to Watsa.
  • Fairfax has been investing in a series of debt and warrant deals that combine an immediate coupon with potential equity upside. Investments include Seaspan, Chorus Aviation, and AGT Foods. A total of $786 million has been invested in these deals at an average coupon of 5.5%. None of the warrants are currently in the money, but they do not expire until 2024 and 2025.
  • Of particular interest is Watsa’s comments on David Sokol, now Chairman of Seaspan, with Watsa saying that Sokol has “one of the most outstanding records I have come across.” Sokol was previously an executive at Berkshire Hathaway, but left after questions arose surrounding his ownership of Lubrizol stock while he recommended the company purchase the company in its entirety.
  • Watsa joined the long list of value investors decrying mania in bitcoin.
  • Among the $6 billion equity portfolio at Fairfax is General Motors, General Electric, and USG.

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