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EQUITY RESEARCH
November 4, 2022 Earnings Update
FAIRFAX FINANCIAL HOLDINGS LIMITED
Solid Earnings Beat In A Challenging Quarter
Our Conclusion
Fairfax reported diluted EPS that came in solidly above our estimate owing to better-than-expected investment and underwriting losses and a higher earnings contribution from equity-accounted associates. CAT losses were elevated in Q3, as expected, but this was offset by lower-than-expected non- CAT-related losses. Notably, the company indicated that it continues to reallocate its investment portfolio back into fixed income. On a year-to-date basis, run-rate dividend and interest income has increased nearly $700 million. We rate Fairfax Financial Outperformer and are increasing our price target to reflect an increasingly optimistic outlook on underwriting margins and investment income.
Key Points
Earnings came in above our estimates and consensus. Headline EPS
came in at a loss of $3.65 versus our estimate for a loss of $28.19 and
consensus at a loss of $17.43. Relative to our forecast, the beat was driven by a variety of sources including: 1) lower-than-expected losses on the investment portfolio; 2) a higher-than-expected earnings contribution from equity accounted associates, and; 3) lower-than-expected underwriting losses. BVPS decreased 3% on a sequential basis. The total debt to total capital ratio increased to 28% compared to 25% in the prior quarter, primarily driven by a $750 million issuance of senior notes in August.
Investment losses were more modest than anticipated. Net losses on
investments amounted to $519 million, which was lower than our estimate of $834 million. Relative to our forecast, the variance appears attributable to lower-than-expected losses on both equity and fixed income exposures. As expected, Fairfax did not crystallize any gains on Digit or the sale of the Pet Insurance Business in Q3. Although the latter is still expected in Q4, the timing of gains on Digit (if it materializes at all) appears increasingly uncertain in the context of an unfavourable ruling from the Insurance Regulator in India.
Reallocating back into fixed income. At the end of the quarter, only 17% of portfolio investments were in cash and short-dated investments, down from 45% in the prior quarter. Fairfax now estimates run-rate dividend and interest income of $1.2 billion versus $530 million at the outset of the year.
Elevated CAT losses offset by lower non-CAT-related losses. The
combined ratio came in at 100% for the quarter including 15 points of CAT losses (mostly related to Hurricane Ian). Despite neutral underwriting
margins, the combined ratio excluding catastrophe losses improved both
sequentially and Y/Y (85% in Q3/22 versus 91% in the prior quarter and 87% one year ago). In general we believe that investors should look through weather-related events like Hurricane Ian and place greater emphasis on the trendline of underwriting margins excluding CAT losses.