Fairfax Financial (FFH.TO, FRFHF.PK) reported Q1 2011 interim results on April 28, 2011. The press release can be found here . Below is the high level summary from the press release.
Fairfax Financial Holdings Limited (TSX: FFH)(TSX: FFH.U) announces a net loss of $240.6 million in the first quarter of 2011 ($12.42 per diluted share) compared to net earnings of $418.4 million in the first quarter of 2010 ($20.38 per diluted share). The decrease in earnings arose primarily from the impact of $311.3 million of pre-tax ($217.7 million after tax) Japan earthquake losses net of reinsurance and reinstatement premiums and from net investment losses of $101.5 million. Book value per share decreased to $354.72 at March 31, 2011 from $376.33 at December 31, 2010, a decrease of 3.1% (adjusted for the $10.00 per share common dividend paid in the first quarter of 2011).
For a company that gives absolutely no short term guidance (I wish more companies were like this) you can’t say the results were either better or worse than expected. From my perspective, given that Fairfax is a world wide insurance and re insurance company and given the 3 major natural disasters that occurred in Q1 2011 (Japan quake, NZ quake, Aus floods) the results were better than my expectations.
Lets hit the bad news first. Most of the losses for the quarter were due to catastrophe losses in the insurance portfolio. The table below summarizes the company’s underwriting results.
Most of the catastrophe losses came in their reinsurance portfolio. The catastrophe losses amounted to 32.8 combined ratio points, with 25.8 of those from the Japan quake alone. Prior to the catastrophe losses the combined ratio would have improved to 97.5% in Q1 2011 from 98.4% in Q1 2010. The underwriting performance prior to losses just shows the base underlying trends in the business without the lumpiness of losses. While the losses are a short term big impact, this improving underlying trend is a positive for the company.
The revenue side, premiums for insurance companies, continued to grow for Fairfax in Q1. The company is continuing to take advantage of the soft insurance market and their strong balance sheet to acquire more businesses or increase their stake in existing ones. Gross premiums rose 24% year over year, with 9% coming from organic growth. This is adding to their investment portfolio via growth of the float. The table below shows the premium results.
Next, Fairfax’s investment performance in Q1 2011 was mainly impacted by a few large mark to market losses. The mark to market losses came from their equity hedges, their bet on deflation via CPI derivative contracts, and from the effect of the rise in interest rates in Q1 on the bond portfolio. The detailed results are shown below.
Their equity hedging program seems to be working quite well. The equity portfolio is generating larger gains than the losses on their hedges. This is the ideal situation when you hedge an equity portfolio. It is called generating alpha. In the bond portfolio all the losses were mark to market due to the rise in general interest rates in Q1. When rates rise the value of the bonds fall even if you never intend to sell them. Fairfax has a strong bond portfolio with a yield of 6.5%, not adjusting or the tax free status of the munis in their portfolio. Lastly, their deflation bet has not worked out so far. The recent pickup in inflation has hurt the value of the CPI contracts. The company still believes that the CPI contracts are worthwhile bet in the event of deflation coming back. This is probably the most controversial part of their investment portfolio. I’m ok with it given that it will payoff big in the event of a negative shock to the world economy and it is not costing them that much overall. If as an investor you are long other equities in your portfolio this piece of your Fairfax investment will also act to hedge your overall portfolio.
Lastly on the investment side interest and dividend income from the Fairfax portfolio continues to be strong. On a per share basis and adjusting for the tax free muni portfolio the company is generating about $42 annualized. $42 per share on a current share price of about $400 for the US shares is over a 10% dividend yield on your investment. Or on book value, which due to the losses was down to $355 in Q1 2011 the portfolio is yielding about 12% on a pre-tax basis. So, it is still the best stealth dividend stock in the world. See my previous Fairfax posts here for more info.
In summary, Q1 2011 was a tough quarter for Fairfax mainly due to the catastrophe losses. However, the underlying insurance business remains strong and is improving, the investment portfolio is performing well on a long term basis and is throwing off significant dividend income, and the company’s balance sheet remains rock solid and well positioned for the future.
Disclosure: long FRFHF.PK