Prem Watsa’s Fairfax 2011 Shareholder Letter: The Highlights

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Prem Watsa’s 2012 letter to shareholders of Faifax Financial Holdings (TSX:FFH) was released today. According to a table on the opening page of the letter the firm’s value per share has increased 23.5% since foundation and 19.4% since five years ago. The tone of the letter is somewhat concillatory in nature it acknowledges early that there was noe growth in value for share in 2011. It reminds shareholders that a dividend of $10 per share was paid and moves on quickly to explaining the lack of growth analysing the large costs faced by the insurer in a year full of large scale catastrophe. It points to the Japanese earthquake as the principle cost followed by the company’s payouts in Thailand and New Zealand over natural disasters there. Other large catastrophes claimed were for Tornados in the US and Hurricane Irene which affected the southwest. Odyssey Re, the company with the greatest exposure to these catastrophes is defended by portraying its track record since the company purchased it. Hope is brought out on better results following a “fine tuning” of the business and a higher price on catastrophe risk but a warning is aimed at shareholders that if there is a major catastrophe “Fairfax will likely be affected”.

After pointing out the specific mechanisms behind the company’s lack of value growth per share there is a quick overview of something the company has gained, a share in Thai Re which was hit hard by the floods in Thailand. It was this very catastrophe that allowed Fairfax to gain a share of the company. Watsa has hope that the company will return to previous form quickly and credibly. This segues nicely into a discussion of Fairfax’s international insurance business with an overview of how it has grown in the past few years, showing their value to shareholders. The concentration here is on the future of these companies as well as their past results. Much is made of their position in emerging economies which should, if the letter’s logic is followed, provide greater returns in the future as these countries grow. Again when looking at results more is mde of the companies performance over the past ten years than is made over the year the letter is titled with.

Fairfax’s investment portfolio performed moderately in 2011, giving a return of 6.4% which Watsa lists against the average over the last five years of 10.6%. The losses in equity are blamed on exposure to such stocks as Bank of Ireland, Resolute and RIM, which performed poorly. Watsa has recently joined the board of RIM and leaves a cheerful “I am trying to help” in parenthesis next to the company’s name. The admitted underperformance is followed by a declaration of dedication to some of the stocks and personal stories relating to how the company came to be in possession of some of them. This is followed by stories of two new investments the company made with funds of up to $1 billion that had been released for 2011 in the hope of finding suitable investment prospects. Both are local Toronto businesses.

Run-Off business which Fairfax has counted profitable for five consecutive years. Run off is a reinsurance clause that means the reinsurance company retains liability for instances of claim that happen after the expiry date of the policy. These policies are extolled in Watsa’s letter and he suggests planning for the future, allowing the float of this type of business to grow without a cost to the firm. Most of the costs accrued in 2011 were from acquisitions according to the letter.

The companies financial position at the end of 2011 is put forward as a strong one. The company holds cash reserves of $1 billion and the debt of the company is pronounced manageable. The company refinanced some of its debt during 2011, and now has minimal near term bonds reaching maturity. Investment weaknesses were a large problem in the companies holdings in the past year however. The reasons give for this are the collapse of China’s retail market and the flat commodity prices 2011 offered. Optimism is offered to the companies shareholders, noting the better position of the market so far in 2012 and the forecast that growth should continue increasing the companies investment earnings.

All in all the report is a mixed and concillatory one. There is much pointing to growth trends in the past that distract the eye from Fairfax’e disappointing 2011 results. The mood throughout the report is congenial and even conversational at times retaining a friendly optimism even when reporting poor results in certain sectors. The presentation given of Fairfax in Prem Watsa’s letter is one of a company that had a bad but not a disastrous 2011. It paints a picture of a company with solid foundations of a company that has only solidified in the past year and is primed for growth in the future. This picture is a little too rosy and doesn’t address the difficulties the company could be facing with its investment portfolio and with the ongoing legal battle with multiple hedge funds.


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