Post by
retiredcf on Dec 03, 2021 8:30am
CIBC Initiate Coverage
EQUITY RESEARCH
December 2, 2021 Initiating Coverage
FAIRFAX FINANCIAL HOLDINGS LIMITED
Encouraging Growth Outlook + Free Call Option On Multiple Expansion = Initiating Coverage With Outperformer Rating
Our Conclusion
We believe that the impact of historical investment decisions has cast a long shadow for Fairfax (FFH) shareholders. However, the company’s net long equity exposure is at the highest level in over a decade, and the investment portfolio is positioned to benefit from rising interest rates. Consensus estimates imply that FFH will deliver a 2021 ROE at the very high end of the peer group range, despite trading at the very low end of the range on any conventional measure of value. As of December 2, we initiate coverage on shares of FFH with an Outperformer rating and a C$825 price target, reflecting a 1.0x P/B multiple on our one-year forward BVPS estimate.
Key Points
Key considerations for an investment thesis on FFH: Fairfax Financial is a holding company that owns a diverse portfolio of operating subsidiaries, participating primarily in the property & casualty (P&C) insurance and reinsurance space. The company is arguably best known for its investing activities, which have been a significant area of emphasis and the largest driver of earnings and book value growth in both the short- and long-run. Fairfax follows a value-oriented philosophy, but has also demonstrated an appetite for large, directional macro trades, which have played a significant role in the performance of the stock over the past 15 years.
Constructive outlook on book value growth: Over the past decade,
Fairfax’s share price and BVPS have compounded in the low single-digit range. This anemic growth can be largely attributed to the company’s decision to fully hedge its equity exposure in the earlier part of the decade,as well as its investment in CPI-linked derivative contracts (albeit to a lesser degree). The company has since removed these hedges and committed to never shorting equities again. The fixed income portfolio has also been positioned to benefit from a rising interest rate environment, which appears increasingly likely given the persistence of inflation trends. The fair market value of non-insurance associates and consolidated subsidiaries exceeds carrying value, and the underwriting operations appear to be performing well, supported by favourable market conditions. For these reasons we believe that Fairfax is poised to deliver a much more normalized level of ROE and
BVPS growth, despite the significant valuation gap to peers.
Free call option on multiple expansion: Fairfax trades at 0.8x P/B and 7.9x P/E (2022 consensus), significantly below P&C peers at 2.2x and 15.7x, respectively. Given the size of the discount, we feel that there is significant headroom for multiple expansion in a scenario where investor sentiment begins to improve. With no further drag from equity hedges, fewer concerns surrounding capital adequacy and leverage, and the company delivering on a normalized ROE, we feel that there is greater upside potential than downside risk over the next 12 to 18 months from a re-rating perspective.