National Bank analyst Jaeme Gloyn once again named Fairfax Financial Holdings Ltd. his top pick for 2024 in his Diversified Financials coverage universe.
The Toronto-based holding company was also selected a year ago and saw its shares jump 52 per cent in 2023 (versus a gain of 9 per cent for the S&P/TSX Capped Financial Index).
“Last year, our Top Picks focused on companies with de-risked growth profiles as macroeconomic risks and uncertainty prevailed,” he said. “While ‘lower interest rates’ and ‘soft landing’ are the bullish buzz words today, we believe uncertainty remains elevated in 2024. We see a Canadian consumer with meaningful signs of strain: retail sales are softening, employment is weakening, credit card balances are rising, and net savings are deteriorating – all of which are leading to rising delinquencies and insolvencies. The U.S. consumer shows similar trends. Moreover, elevated probability of recession (and uncertainty as to its depth and length) could strip away the benefit of lower rates.
“Therefore, our preference to start the year focuses on companies that we expect will deliver solid operating results and valuation upside regardless of whether interest rates move lower or a soft landing materializes. Based on these criteria, Fairfax Financial (FFH) is our Top Pick for 2024.”
In a report released Friday, Mr. Gloyn said he picked Fairfax based on three potential catalysts:
1. Operating Income guidance upgrade.
“In the first three quarters of 2023, Fairfax hit their annual operating income expectation of $3.0-billion,” he said. “We expect management will raise the bar on this outlook to upwards of $5-billion.”
2. Valuation.
“We believe consistent low to mid-teens operating ROE [return on equity] performance will drive a re-rating of the shares,” he said. “At the current trading valuation of 1.05 times, the market is pricing FFH like a 7-per-cent ROE business. We expect interest and dividend income ALONE to drive 7-percentage-points of ROE. FFH peers such as MKL and BRKa also trade at higher valuations of 1.4 times to 1.5 times P/ B.”
3. S&P/TSX 60 Index inclusion:
“FFH is top candidate for inclusion in the S&P/TSX 60 Index, which could drive estimated demand equivalent to 6 days of FFH average daily volume,” he said. “This will turn an under-owned financial into a core holding.”
Mr. Gloyn also sees the property and casualty (P&C) insurance sector remaining “well-positioned for 2024, regardless of a soft landing or changes in interest rates.”
“What if interest rates move lower? Lower rates could be neutral/positive for FH,” he said. “First, Fairfax’s extended duration of fixed income assets protects them from a near-term decline in rates. Second, Fairfax has the ability to purchase higher yield corporate debt. Third, lower rates drive gains in fixed income assets, flowing to net income, ROE and book value growth.
“What if the insurance cycle softens? We don’t see a softer insurance market as a significant concern because; i) Fairfax has proven its ability to deliver mid-90s combined ratios in soft market conditions, ii) Fairfax has the ability to release recently built up excess capital at subsidiaries, iii) underwriting income represents 20 per cent of our operating income forecast in 2024/2025.”
Maintaining an “outperform” rating for Fairfax shares, he hiked his target to a Street-high $2,000 from $1,800. The current average is $1,648.87.