Markel Corporation Conference Call: Tom Gayner Still Finding Value

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Markel Corporation (NYSE:MKL) reported Operating EPS of $8.29 beating  consensus of  $5.47. The beat was mainly driven by a lack of catastrophes, a lower accident year loss ratio, and a higher level of favorable reserve development than  expected. Investment income and income from Markel ventures were ahead of estimate as well.  Premiums increased 14.1%, above forecasts. The specialty admitted and E&S lines both bested estimates, while London matched. Top-line growth will stay in the double digits (pre-Alterra) due to the acquisition of Essentia.Tom Gayner had some interesting remarks on the Markel Corporation (NYSE:MKL) conference call which we have quoted below:

Markel Corporation

Tom Gayner – Markel Corporation (NYSE:MKL) – President, Chief Investment Officer

Item one, the first quarter investment results and our public securities portfolio. Item two, the start of the year for our Markel Ventures operations; and item three, our perspective plans for our newly-expanded investment portfolio we now manage, as a result of the Alterra acquisition. As to item one, the year is off to a fine start. In our equity and fixed income portfolios, we are in total return of 13.1% and a half a percent, respectively.

The total return for the portfolio was 3.5%. I am very happy with those results. While any one quarter is essentially meaningless, the way in which those returns were earned means a great deal. And our equity portfolio, we continue to own a set of high-quality global accessible company. In many cases, the dividend yield comfortably exceed what we can earn on appropriate fixed income alternatives.

Markel Corporation (NYSE:MKL) also continues our long-standing process of step-by-step measured and selective additions to the equity portfolio. In our fixed income operations, which continue to maintain a portfolio of the highest credit quality that we can find, and we continue to let the duration roll in. In a repeat statement from previous quarters (inaudible), we believe that interest rates are too low and the risks of longer-term fixed income commitments outweigh the rewards. As such , we continue to build a portfolio that increasingly resembles cash. Stay tuned for our plan on what we will do with the cash.

On March 31, Markel Corporation (NYSE:MKL)’s equities represented 65% of our shareholders’ equity, up from 62% at year-end. It’s worth pointing out to our new and longstanding shareholders that our approach in managing our equity portfolio remains quite tax efficient, with low turnover and stocks that go up over time, we now sit on and unrealized gain of $1.3 billion. We’ve provided for the taxes in our financial statement, but those taxes remain deferred until such time as we actually sell the securities and realize the gains. It’s worth remembering that at a 35% tax rate, the deferred tax associated with this gain would be, roughly, $450 million.

I know that you all love hearing about accounting just as much as I love talking about it, but I think it’s worth taking a minute to engage in a little thought experiment on this topic. Imagine if our balance sheet was only comprised of the unrealized gains in the equity investment portfolio.

In that case, Markel Corporation (NYSE:MKL) would have and access of $1.3 billion on the left-hand side of the balance sheet, and a liability of $450 million for future taxes, and equity capital of $850 million on the right-hand side. The net effect of this dynamic is that we’ve got the entire $1.3 billion working for us as shareholders on a reported equity capital base of $850 million. This is incredibly tax efficient and helps our reported return on equity over time.

Over the decades, this component of our balance sheet and capital has grown larger and larger. It is a meaningful contributor to total shareholder returns at Markel Corporation (NYSE:MKL) and not a common feature in the insurance world. I’m glad to report that those balances continue to grow during the first quarter, by following the same disciplines we’ve used to build it for decades.

Onto item two. Markel Corporation (NYSE:MKL)’s Ventures Operations also performed very well during the first quarter of 2013. Our Other revenues of $172 million, that you see in the income statement , are largely those of the Ventures Company. Those revenues rose 55%, compared to last year. Other expenses [$552 million] up 52% from a year ago.

Back to Markel Corporation (NYSE:MKL)’s accounting again, those expenses include noncash amortization and purchase accounting entries that are separate and distinct from the ongoing operational performance of the Markel Ventures Company. As such, we use EBITDA and our internal review and management of those operations. As Anne noted earlier, EBITDA more than doubled to $19.4 million in the first quarter, compared to $9.4 million in the previous year. A reconciliation of EBITDA to GAAP net income is available on our website (inaudible).

Item three. The biggest, single challenge, and opportunity, on the access side of Markel Corporation (NYSE:MKL)’s balance sheet at this time is the future investment and capital allocation decisions that we will make with our growing cash balances, which are now augmented by the addition of the investment balances from Alterra. We’ll invest the money in the same way we’ve invested the access of Markel Corporation (NYSE:MKL) over the year. Specifically, on the fixed income side, we will continue to focus on high credit quality and maintaining the duration that is shorter than our natural position of matching the duration of the insurance liabilities to our bond portfolio. We will continue to do this until interest rates are higher than they are today and that we feel we are being paid appropriately to accept the risk of longer-term commitment. While this penalizes current investment income, it doesn’t penalize very much at today’s low rates of interest across the curve.

On the equity side, we have a vibrant and profitable insurance business. We have a strong balance sheet and plenty of cash. Our constraint is finding appropriate ideas and protecting and preserving the balance sheet. For now, we will continue to methodically invest in many of the same securities we already [own]. Prices are still reasonable, in many cases, and we will pick up investment yield from the dividends as we go.

Given our new circumstances, we will have a lot of dry powder and we will look to deploy that more aggressively as opportunities present themselves. I cannot predict when the general environment will produce an opportunity, but I’m confident that it will. As many people say about the weather, wherever they live, “If you don’t like it, wait five minutes and it’ll change.” We’re in a unique and, what I think, is a fantastic position in that we have capital to deploy in what can be a rapidly-changing environment. Rest assured that the same disciplines and thought processes that were used for decades to make those decisions remain in place.

I’m optimistic about our opportunities to make positive capital allocation decisions in the coming years, as well as the ultimate results from our shareholders. As we begin this new era at Markel Corporation (NYSE:MKL), I took a moment this morning to look at our first Annual Report, and to remind myself of what this Team has accomplished for you in the years since we went public in 1986. Immediately following the public offering, we had shareholders’ equity of about $16 million, and a total investment portfolio of, approximately, [$30 million]. We’ve scaled back the process of reinvesting our earnings and making sound capital allocation decisions for a long time, and I think it’s fair to say that the results should speak for themselves.

To add one more note on the sense of perspective , the comprehensive income in the first quarter of 2013 of $257 million exceeded our entire cumulative earnings during our first decade as a public company. I know that analysts’ reports on Markel Corporation (NYSE:MKL) rarely address comprehensive income in their estimates and their discussions about us, but the comprehensive income is what we, as shareholders, ultimately receive as owners of this business. As such, it’s what we focus on as the stewards of this Company. It’s undeniable that we face the challenge as we begin to integrate the Alterra operations into Markel Corporation (NYSE:MKL) and reinvest our new, larger base of capital. The good news is that we have done this sort of thing before, and we are excited and optimistic about doing it again, now and into the future.

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