Nice Upgrade National Bank Financial analyst Jaeme Gloyn sees Fairfax Financial Holdings Ltd. as “a mispriced large-cap financial,” calling its stock the “best value idea” in his coverage universe and raising his target for its shares to a new high on the Street on Tuesday.
In a research report previewing Thursday’s after-market release of its fourth-quarter financial results, he pointed to “two key themes investors commonly overlook.” They are:
1. Fairfax Financial’s ability to deliver “rapid and profitable premiums growth.”
“Given persistent hard market conditions, we expect premiums growth to exceed 20 per cent in 2021 and to remain in the double-digits through 2022,” he said. “Moreover, we anticipate Fairfax will sustain profitable underwriting, in line with the company’s 10-year average combined ratio of 96 per cent.”
2. The expectation for “rapid growth in the investment portfolio and improving returns ease the burden to achieve double-digit ROEs.”
“Invested assets of $52-billion as at Q3-21 are up 26 per cent year-over-year,” he added. “FFH’s 5-year average annual total return on its investment portfolio is almost 5.6 per cent (climbing from 2 per cent in 2017). Assuming a 96-per-cent combined ratio, we estimate FFH only needs to deliver a total return on investments of 4 per cent to reach our 12-per-cent ROE forecast in 2023. Crucially, nearly half of that total return comes from ‘locked-in’ interest & dividend income that stands to benefit from rising short-term interest rates given FFH’s 37-per-cent allocation to cash and short-term investments.”
Maintaining an “outperform” recommendation for Fairfax, Mr. Gloyn raised his target to $1,000 from $825. The average is currently $802.77.
“Still trading below book value at approximately 0.85 times, the market is pricing FFH at an ROE of 6 per cent,” he said. “We believe FFH can deliver sustainable long-run ROE in the doubledigits through a combination of consistently strong underwriting growth/profits and improving total investment return performance. Based on sector trading multiples today, double-digit ROE merits a valuation multiple above book value. In fact, our 2023 ROE forecast of 12 per cent implies a P/B multiple of more than 1.5 times. We apply a 1.1 times P/ B multiple (was 1.0 times) on our Q4 2022 estimate to arrive at our Cdn$1,000 price target ... Moreover, we anticipate FFH will continue to chart a more shareholder friendly course in the coming quarters that firmly started with the value surfacing sale/buyback transaction in late 2021.”