Fairfax enters choppy waters but making safe investments
An article written by James Daw for The Toronto Star summarizes the investment performance of Fairfax Financial and details the current investments Fairfax is pursuing. Fairfax, in case one is not familiar, is the insurance company run by Prem Watsa. I don't follow Prem Watsa or Fairfax closely and hence am not a follower of them. He is thought to be one of Canada's top investors, and certainly one of the top value investors in Canada. Fairfax has done exceptionally well in the last few years, betting against the financial bust through CDS (credit default swaps). The future is very uncertain and Fairfax is entering a tough stage.
Let me summarize some points mentioned by the author of the article.
One of the things one should keep in mind is that Prem Watsa, similar to Warren Buffett, runs an insurance company so it's never clear how much of it is driven by need for liquidity and safety. One should also keep in mind that only a portion of the assets are deployed into common stocks, whereas an average investor off the street, like me, would invest 100% into stocks.
Prem Watsa seems to be riding Warren Buffett's picks. I don't like any of the stocks suggested (Johnson & Johnson, Kraft, Wells Fargo) since returns are likely to be low. J&J and Kraft are "safe" but the upside seems low. J&J is a megacap and Kraft is a big large-cap and both share prices will likely be driven more by the market action than anything. Wells Fargo seems risky but will do really well if losses on mortgage and other lending remains manageable. Verdict on Wells Fargo is quite murky, with some bears claiming it may be under-reserving for losses. Bulls, in contrast, tend to argue that Wells Fargo has a good culture and wouldn't have taken on a lot of risk (and would have properly priced the Wachovia assets.)
In any case, Prem Watsa equates, to some degree, the current environment to the credit bust in the 1930's and the Japanese credit bust. I think that is a fair comparison. The question is whether it will be "really bad" or simply "bad". So far, it isn't so bad, mainly because governments are acting to cushion the blows. I don't think the residential mortgage losses are anything to worry about, since most them have been accounted for and likely priced in--although do note that I thought Ambac's losses were also priced in an year ago :(. My concern is with commercial real estate loans, commercial loans, credit card loans, auto loans, and the like. If these liabilities blow up, we will face the "really bad" scenario. So far there is no reason to believe this dire scenario will materialize.
The author also points out how Fairfax seems to sidestep some losing investments:
I have been tracking some of these and all have been hit really hard. These are Canadian companies and may not be familiar to most readers. Torstar is a left-leaning newspaper company that publishes Canada's most popular newspaper (it's sort of like New York Times of Canada but not as recognized internationally.) Canwest is a right-leaning media company that owns major television stations and newspapers. Canwest is on the verge of bankruptcy and will go under if it can't cut deals with its creditors. AbitibiBowater is the a forestry company that happens to be the largest newsprint paper producer in North America. Needless to say, the decline in the newspaper industry has seriously hurt them.
Prem Watsa also owns bonds of some of these companies so it is possible for him to break even in a re-organization if he can seize control of these companies. But amateur investors only investing in shares will likely suffer massive losses.
I remember looking at these deep value stocks a few years ago but have moved away from them. Back then I was following them more closely because they were some of the few contrarian stocks that seemed cheap. Many of these companies are in industries that are facing secular declines (newspapers, forestry, paper, media, cable companies, etc) and my strategy was to buy the survivor of last resort. From my limited readings, such a strategy has historically worked. Right now, however, there is little reason to look at these distressed companies given how leading blue-chips and potentially high-growth stocks seem cheap.
Another reason I have lost my interest in some of these stocks is because I started putting more emphasis on one of Warren Buffett's strategies. Warren Buffett has suggested at times that companies with high capital expenditures and low returns are not very good investments*. Needless to say, some of these companies require heavy capex and have low returns.
It remains to be seen how Prem Watsa does on these investments. A weak economic environment, on top of being in a secularly declining industry, will be very painful.
Fairfax has some positive thoughts about muni bonds:
The bond insurers, including their shareholders like me, are really hoping that muni/state bonds don't blow up. Fairfax seems confident with many of them. Warren Buffett actually warned about potential problems with them but, as quoted above, muni bonds have rarely ever defaulted. Yes, the credit bubble is much bigger now but most of the excesses lie with consumers and financial corporations. The government, believe it or not, is less leveraged now than it was during the 30's or 40's**. Some municipalities, states, and public-private partnerships will face serious problems but I'm thinking they will be isolated cases.
SIDENOTES:
(* Yes, I realize that Warren Buffett invests in Burlington Northern Santa Fe which has pre-2005 ROE less than 15%--long-term American corporate average is an ROE of around 15% and leading companies should beat that--but I believe he purchased it for its massive moat, rather than for its efficiency. BNI has posted ROE above 15% in the last 5 years but, since I'm bearish on commodities and also somewhat bearish on world trade, I think those are peak earnings. I don't know anything about BNI but when I looked at Canadian National, a major Canadian railroad, a few years ago, its profit boost seemed to have come from intermodal (likely due to imports from China) and commodities (like coal, wheat, and forestry products). Rails will be less competitive against trucks if oil prices stay low.)
(** Many people don't even know this but the US government, if you exclude the GSEs, is less leveraged than in the distant past. Check out the following chart from Morgan Stanley (from a Michael Panzer article on FinancialSense.com).
Eyeballing the chart, US govt debt is around 50% of GDP right now, with GSEs being an additional 60%; while govt debt was around 80% of GDP in 1933. I know a lot of people are bearish on anything to do with the GSEs, but if you think about how the GSE debt is backed by real estate (admittedly declining) it's not as bad as it seems.)
Let me summarize some points mentioned by the author of the article.
But what have the smarty pants at Fairfax Financial Holdings Ltd. been doing lately? A freshly printed annual report reveals they:
Dumped contracts that insured their stock holdings from losses, partly in October and entirely by mid-November.
Jumped back in to buy $2.3 billion (U.S.) in stocks late in 2008.
Sold almost all their U.S. federal government bonds, and switched to state and municipal bonds, most of them insured by billionaire Warren Buffett's company Berkshire Hathaway.
Watsa tells shareholders he still expects a long, deep recession, with a contraction in debt comparable only to the 1930s in the U.S. and in Japan from 1989 to the present. He expects this will be offset only partly by multi-trillion-dollar government bailouts and spending plans....
The only stocks he discusses buying are Johnson & Johnson, Kraft Foods (maker of the dinners we once ate with pork butt in our first apartment) and Wells Fargo Bank for a total of $822.8 million.
One of the things one should keep in mind is that Prem Watsa, similar to Warren Buffett, runs an insurance company so it's never clear how much of it is driven by need for liquidity and safety. One should also keep in mind that only a portion of the assets are deployed into common stocks, whereas an average investor off the street, like me, would invest 100% into stocks.
Prem Watsa seems to be riding Warren Buffett's picks. I don't like any of the stocks suggested (Johnson & Johnson, Kraft, Wells Fargo) since returns are likely to be low. J&J and Kraft are "safe" but the upside seems low. J&J is a megacap and Kraft is a big large-cap and both share prices will likely be driven more by the market action than anything. Wells Fargo seems risky but will do really well if losses on mortgage and other lending remains manageable. Verdict on Wells Fargo is quite murky, with some bears claiming it may be under-reserving for losses. Bulls, in contrast, tend to argue that Wells Fargo has a good culture and wouldn't have taken on a lot of risk (and would have properly priced the Wachovia assets.)
In any case, Prem Watsa equates, to some degree, the current environment to the credit bust in the 1930's and the Japanese credit bust. I think that is a fair comparison. The question is whether it will be "really bad" or simply "bad". So far, it isn't so bad, mainly because governments are acting to cushion the blows. I don't think the residential mortgage losses are anything to worry about, since most them have been accounted for and likely priced in--although do note that I thought Ambac's losses were also priced in an year ago :(. My concern is with commercial real estate loans, commercial loans, credit card loans, auto loans, and the like. If these liabilities blow up, we will face the "really bad" scenario. So far there is no reason to believe this dire scenario will materialize.
The author also points out how Fairfax seems to sidestep some losing investments:
Watsa does not mention the large holdings in such hard-hit stocks as Torstar Corp. (owner of this paper), Canwest Global Communications Corp. (owner of television networks and newspapers) and AbitibiBowater Inc. (a maker of newsprint). Fairfax's own stock is down about $80 (Canadian) or 20 per cent in Toronto from $400, a bigger loss than stock markets in general since the start of 2009.
I have been tracking some of these and all have been hit really hard. These are Canadian companies and may not be familiar to most readers. Torstar is a left-leaning newspaper company that publishes Canada's most popular newspaper (it's sort of like New York Times of Canada but not as recognized internationally.) Canwest is a right-leaning media company that owns major television stations and newspapers. Canwest is on the verge of bankruptcy and will go under if it can't cut deals with its creditors. AbitibiBowater is the a forestry company that happens to be the largest newsprint paper producer in North America. Needless to say, the decline in the newspaper industry has seriously hurt them.
Prem Watsa also owns bonds of some of these companies so it is possible for him to break even in a re-organization if he can seize control of these companies. But amateur investors only investing in shares will likely suffer massive losses.
I remember looking at these deep value stocks a few years ago but have moved away from them. Back then I was following them more closely because they were some of the few contrarian stocks that seemed cheap. Many of these companies are in industries that are facing secular declines (newspapers, forestry, paper, media, cable companies, etc) and my strategy was to buy the survivor of last resort. From my limited readings, such a strategy has historically worked. Right now, however, there is little reason to look at these distressed companies given how leading blue-chips and potentially high-growth stocks seem cheap.
Another reason I have lost my interest in some of these stocks is because I started putting more emphasis on one of Warren Buffett's strategies. Warren Buffett has suggested at times that companies with high capital expenditures and low returns are not very good investments*. Needless to say, some of these companies require heavy capex and have low returns.
It remains to be seen how Prem Watsa does on these investments. A weak economic environment, on top of being in a secularly declining industry, will be very painful.
Fairfax has some positive thoughts about muni bonds:
"If you look back, even into the Depression, very few municipalities defaulted; and you can pick your spots and see that Berkshire (another holder of insurance companies) is guaranteeing them," said Rivett [ chief legal officer and spokesperson].
The bond insurers, including their shareholders like me, are really hoping that muni/state bonds don't blow up. Fairfax seems confident with many of them. Warren Buffett actually warned about potential problems with them but, as quoted above, muni bonds have rarely ever defaulted. Yes, the credit bubble is much bigger now but most of the excesses lie with consumers and financial corporations. The government, believe it or not, is less leveraged now than it was during the 30's or 40's**. Some municipalities, states, and public-private partnerships will face serious problems but I'm thinking they will be isolated cases.
SIDENOTES:
(* Yes, I realize that Warren Buffett invests in Burlington Northern Santa Fe which has pre-2005 ROE less than 15%--long-term American corporate average is an ROE of around 15% and leading companies should beat that--but I believe he purchased it for its massive moat, rather than for its efficiency. BNI has posted ROE above 15% in the last 5 years but, since I'm bearish on commodities and also somewhat bearish on world trade, I think those are peak earnings. I don't know anything about BNI but when I looked at Canadian National, a major Canadian railroad, a few years ago, its profit boost seemed to have come from intermodal (likely due to imports from China) and commodities (like coal, wheat, and forestry products). Rails will be less competitive against trucks if oil prices stay low.)
(** Many people don't even know this but the US government, if you exclude the GSEs, is less leveraged than in the distant past. Check out the following chart from Morgan Stanley (from a Michael Panzer article on FinancialSense.com).
Eyeballing the chart, US govt debt is around 50% of GDP right now, with GSEs being an additional 60%; while govt debt was around 80% of GDP in 1933. I know a lot of people are bearish on anything to do with the GSEs, but if you think about how the GSE debt is backed by real estate (admittedly declining) it's not as bad as it seems.)
Comments
Post a Comment