April 15, 2019
Last week we attended the Fairfax Financial annual meeting in Toronto. While Fairfax has been a successful long term holding for clients of Boyle Capital (first purchased in 2007), the last few years have left a lot to be desired (shares are down 11.40% over the past year and 4.06% annualized over the past three years). CEO Prem Watsa spent a good portion of his presentation walking attendees through the results of the long term and how the most recent past has been an outlier. We agree with Watsa and feel the company is poised to revert back towards its long-term outperformance. Our reasons for this view are the following:
1. Culture: Peter Drucker, the late management guru, used to say that “culture eats strategy for breakfast.” One of the things that always jumps out at us when we attend the Fairfax meeting is the unique decentralized culture they have created, not too dissimilar from Berkshire Hathaway. It is clear employees are passionate about their jobs and it is not uncommon for employees to have been at the company for 20+ years. This kind of buy-in by employees combined with low turnover allows Fairfax to focus on long-term results versus many competitors that are trying to meet next quarters earnings target. While this kind of culture is a huge benefit, as it allows Fairfax the patience to go into new markets such as India (discussed further below), the downside for investors is that results are likely to be (and have been) much lumpier given the long-term orientation.
2. Reversion to the Mean of Investment Portfolio: Since inception in 1985 through the end of 2018, shares of Fairfax compounded at an annualized rate of 17.1% (book value per share grew at an annual rate of 18.7% over the same timeframe). A large driver of the historical gains in both book value and share price has been the investment results the company has generated from both stocks and bonds. As shown below, the investment portfolio has grown at an annualized rate of 8%. While the historical track record is impressive, the last 10 years have been significantly below the historical rate and frankly have left a lot to be desired.
Given the subpar investment results of the past five and ten years, Mr. Market has taken a “show me” attitude toward the investment skill of Fairfax. We believe the results of the first twenty years are more reflective of the skill of Fairfax’s investment team as opposed to the last ten years for a couple of reasons. First, within the past decade, Fairfax made an awful macro bet that the market and economy were headed lower. They made this bet in the form of deflation hedges and short positions on the market. All told, this bet cost them billions in losses. At the end of 2016, the company threw in the towel on the macro call and today the portfolio is more straightforward in terms of the structure. Anyone that has invested for any significant period of time has made mistakes. We take Watsa at his word that they have learned; given 85% of his net worth is tied up in the stock, we know his interests are aligned with investors. Secondly, as value investors, Fairfax’s portfolio has also been impacted by the historic underperformance of value versus growth during the past decade. As we have seen throughout history, no strategy works in all periods and value is due for a comeback. Fairfax’s investments are likely to benefit from a value resurgence.
3. Exposure to India: One of the more attractive long-term investment opportunities today is the extraordinary potential that sits in India as its more than one billion people seek to improve their quality of living and the country embraces more pro-business policies. Fairfax owns 33.7% of Fairfax India Holdings, which is designed to capitalize on the opportunities in India. Since 2014, Fairfax has made 9 investments that include a majority interest in the Bangalore International Airport (BIAL), the second fastest growing airport in the world. Over the next decade, India is expected to have Real GDP growth in excess of 7% annually, versus only a few percent annually for most developed countries. Given such potential and the need for capital, Fairfax will have opportunities to deploy additional resources in India as well as monetize profits from the investments made to date. As a result, Fairfax offers a unique way for public investors to play the growth potential in India without having to bet all on one horse.
4. Compelling Valuation: Lastly, at a time when U.S. markets are far from cheap, we believe that shares of Fairfax provide a compelling reward with a likely very low probability of loss over the next few years. Shares trade right around book value today (we also believe book value is understated given the appreciation of nonpublic investments still carried at cost) and offer a dividend yield of more than 2%. Since Q4 2018, Fairfax has seen a sizeable upward swing in its publicly traded equity investments (eg. Blackberry was up 42% or $139 million in Q12019) yet the share price of Fairfax is largely changed. By comparison, Fairfax’s peers have largely recovered from portfolio losses during the fourth quarter and trade at roughly a 30% premium to book value (see below chart). As a result, at approximately $460 per share, we believe Fairfax is attractively priced and provides investors with a reasonable margin of safety and the potential for attractive forward returns should the company regain some of its historical investment touch.
The information contained in this missive represents Boyle Capital Management, LLCs (dba Boyle Capital) opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, Boyle Capital has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Boyle Capital within the past twelve-month period is available upon request.
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