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Prem Watsa and Fairfax Financial Holding Limited; Top Holdings: JNJ, ABH, DELL, FTR, ICO

February 18, 2011 | About:
Henry Tan

Henry Tan

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Fairfax Financial Holding Limited (FFH) is a financial services company specializing in insurance and reinsurance. Their area of operations spans Asia, the United States, and Canada through several of their subsidiaries. Their stated corporate objective is to “build long term shareholder value by achieving a high rate of compound growth in book value per share over the long term”. Fairfax Financials is led by CEO and Chairman Prem Watsa, widely dubbed as the “Canadian Warren Buffett”. His educational background is that of a chemical engineer from the Indian Institute of Technology, a MBA holder from The University of Western Ontario, and holder of the coveted, Chartered Financial Analyst designation.

Fairfax Financials, as mentioned earlier, is in the business of insurance. The insurance industry is typically modeled upon a simple practice, collects premiums upon plans, and pay out when claims are filed. Theoretically, short of a massive and widespread epidemic, the money collected should always exceed the money paid out. The money collected is then usually invested in acquisitions, high grade investments, and securities for the long term. This can be seen in Fairfax’s acquisitions of Zenith National Insurance, General Fidelity Insurance, Pacific Insurance, and First Mercury Financials for approximately $2.116 billion. With that in mind, the stability and cash flow of the insurance model is quite stable and consistent.

As such, their conflicted history with short sellers is nothing less then dramatic, as in 2003, a Morgan Keegan analyst initiated coverage of Fairfax Financials with a scathing review. While all companies in their operating lifespan receive negative coverage, the analyst covering this company gave this information to several hedge fund analysts before the report was released. As such, with such privy information, these hedge funds initiated short positions in Fairfax in order to capitalize upon the frenzy that would follow. Fairfax was dubbed “dishonest and under-reserved”, and numerous claims from various sources alleged the raiding of his office by government officials. Prem Watsa also stated that his personal character was attacked by numerous people, when a letter was sent to the pastor of a church his firm managed, paralleling him to insurance convicts. Fairfax filed a lawsuit in 2006 that is still pending to this day, alleging misconduct by several hedge funds in order to profit from their short positions. While the matter is still not settled yet, during I he years of battle with the short sellers, his firm’s price per share hovered between $48, and $150. With his shares currently trading at $380 for FFH at the moment, it can be safe to say the fundamental Prem Watsa came out ahead.

Fairfax Financials equity portfolio returned 18.3% over a 15 year period from 1994-2009 vs. the S&P 500 of 8%. In addition, their bond portfolio returned 10.6% over the same period vs. the S&P 500’S 6.8%. Their general strategy is to “to purchase additional positions in outstanding companies with excellent long term track records which we contemplate holding for the long term.” Their most recent portfolio composition broken into sectors can be seen in the following table and charts. Two notable changes to Fairfax's overall portfolio is the 10.3% increase in health care and 5.6% increase in oil and gas holdings.

Overall Portfolio Composition 2010 Q4 2010 Q3 % Change
Technology 16.90% 17.50% -.60%
Financials 11.30% 10.50% .80%
Telecommunications 12.90% 12.90% No change
Consumer Services 4% 4.10% -.10%
Health Care 29.30% 19% 10.30%
Consumer Goods 7.50% 8.80% -1.30%
Industrials 4.50% 4% .5%
Basic Materials 6.90% 10.60% -3.70%
Oil and Gas 6.60% 1% 5.60%



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Prem Watsa has stated that he fears a deflationary environment, and as such has hedged appropriately against this risk with derivatives upon his portfolio and investment in high quality stable companies. Fairfax maintains a derivative portfolio of $597.4 million that hedges approximately 88.8% of their equity holdings. Furthermore, in 2010, Fairfax Financials initiated positions in credit derivatives, spending $174 million to protect their entire investment portfolio of $22 billion. This contact dictates that Fairfax only profits if deflation occurs at a rate of 2% over the next 10 years with a pay out potential of $9 billion should this occur. Any deviation from this scenario would cause the contracts to become worthless and the $174 million, a sunk cost.

Fairfax manages a $2.54 billion portfolio with 55.27% of their holdings in the following five stocks. A comparison of Q4 and Q3 can be seen in the following tables. One key change to note in the change of the overall composition would be the large purchase of Abititbiowater valued at $313 million.

Top Five Holdings for Q4 Symbol Composition% Shares
Johnson & Johnson JNJ 16.78% 6,884,300
Abitibibowater ABH 12.35% 13,234,217
Dell Inc. DELL 12.11% 22,702,389
Frontier Communications FTR 7.14% 18,620,000
International Coal Group ICO 6.89% 22,577,788
Total Value of Portfolio $2,536,000,000



Top Five Holdings for Q3 Symbol Composition% Shares
Johnson & Johnson JNJ 18.78% 6,884,300
Dell Inc. Dell 13.02% 22,817,389
International Coal Group ICO 10.56% 45,155,588
Kraft KFT 7.30% 5,365,751
Frontier Communications FTR 6.70% 18,620,000
Total Value of Portfolio $2,269,536,000



Johnson & Johnson (JNJ)

Johnson & Johnson is an international manufacturer of pharmaceutical, biotechnological and personal hygiene products. They have a market capitalization of $167.03 billion, and their shares trade around $60.79. Johnson & Johnson is the largest holding of Fairfax Financials, comprising 16.78% of their portfolio.

Johnson & Johnson has a P/E ratio of 12.9, P/B ratio of 2.9, and a P/S ratio of 2.7. From their most recent annual earnings ending in 1/11, they posted revenues at $61.587 billion, with a net income of $13.334 billion, a profit margin of 21.65%. Their EPS was $4.78, with a dividend yield of 3.55%. They currently estimate 2011 earnings to fall between $4.80 and $4.90 per share. Historically, over a 10 year period, they have grown their revenues by 10%, and their earnings by 12.2%.

In terms of recent news, Johnson & Johnson recently recalled 700,000 liquid wound sealants and hernia-treatment device. In addition, they have recalled 70,000 invega syringes. Currently, Johnson & Johnson is attempting to appeal a rejection from the FDA of a medical device that sedates patients.

In Fairfax’s 2008 annual letter to the shareholders, Prem Watsa felt that, “Johnson & Johnson has perhaps the best long term track record we have come across. They have compounded sales and earnings for the last 100 years in excess of 10%per year. The growth prospects for their products on a worldwide basis are unlimited.”

Gurufocus rated Johnson & Johnson with a business predictability rank of 4.5 stars.

Abitibibowater (ABH)

Abitibibowater operates in the forest products industry, producing a range of products from newsprints, commercial printing papers to wood products. They are the third largest pulp and paper company in North America, and the eighth in the world. They have a market capitalization of $2.95 Billion and their shares trade around $29.49. Abitibibowater is the second largest holding, comprising 12.35% of Fairfax’s holdings.

In terms of operating results, Abitibibowater increased its revenue from 2006 to 2009 by 23.6% with revenues at $4.366 billion. Their most recent quarter yielded revenues at 1.192 billion, an increase of 9% when compared to their quarter year to date.

Abitibibowater announced that it is closing an operating segment of their Alabama factory in order to reduce costs, and capitalize upon cost savings down the road. In addition, Abitibibowater sold their stake in an Ontario hydroelectric project for $303.6 million.

Gurufocus rated Abitibibowater with a business predictability rank of 1 star.

Dell Inc. (Dell)

Dell is a conglomerate holding company that operates through its core subsidiaries. It offers a slew of technological solutions and products, from personal computer, IT consulting, to networking and storage. They have a market capitalization of $29.61 billion and their shares trade around $15.40. Dell is the third largest holding, comprising 12.11% of Fairfax’s holdings.

Dell has a P/E ratio of 11.3,P/B ratio of 4.3, and a P/S ratio of .6. For the fiscal year ending in 1/11, Dell reported revenues at $61 billion, with a net income at $2.635 billion, yielding a profit margin of 4.3%. Their EPS for this fiscal year was $1.35. Historically, over the last 10 years, Dell grew its revenue by 12% , along with a 5.3% growth in earnings.

In terms of current news, there are rumors afloat that Dell wishes to purchase AMD. Their recent 4th quarter results, was extremely positive, as they provided raised guidance of revenue growth between 5% to 9%, and operating profit growth between 6% and 12%. This was credited due to a shift in focus of operations, and lowered costs of operations.

Gurufocus rated Dell Inc with a business predictability rank of 1 star.

Frontier Communications Corporation (FTR)

Frontier Communications is a telecommunications company providing services to rural area. They offer a general array of services to their clients, both residential and business, that vary from internet data packages to phone plans. Their market capitalization is $9.37 Billion, and their shares trade around $9.43. Frontier Communications comprises 7.14% of Fairfax’s holdings.

Frontier Communications has a P/E ratio of 32.82, a P/B ratio of 1.8, and a P/S ratio of 4.5. For their fiscal year ending in 12/2009, they reported revenues at $2.117 billion, with a net income at $120.78 million, yielding a profit margin of 5.7%. Their EPS was $.38 per share, with the EPS earnings of $.03 for their most recent quarter. Their dividend yield is 7.99%.

In terms of recent developments, Frontier Communications has invested 8.8 million in the second half of 2010 in order to reach a provide access to a broader audience in West Virginia. A recent interview with the CEO, Maggie Wilderotter, presented a positive image of the company, as she simply stated, “Things are going really well.”

Gurufocus rated Frontier Communications Corporation with a business predictability rank of 1 star.

International Coal Group (ICO)

International Coal Group is a coal company headquartered in West Virginia. They mine metallurgical and steam coal from their mines in North Appalachia and in the Illinois Basin. They market to domestic, steel and electrical utility companies. Their market capitalization is $2.00 billion, and their shares trade around $9.80. International Coal Group comprises 6.89% of Fairfax’s holdings.

International Coal Group has a P/E ratio of 70.71, P/B ratio of 2.6, and a P/S ratio of 1.7. For the fiscal year ending on 12/10, International Coal Group reported revenues at $1.113 billion, and a net income at $30.11 million, yielding a profit margin of 2.7%. In the last 4 fiscal years, International Coal Group has grown its revenue at an average rate of 9.7%. Their last quarter yielded a earning of $.05 cents per share, and an annual fiscal earning of $.15 per share.

In terms of recent news, International Coal Group has earned the Mountaineer Guardian Award for four of their operations for outstanding safety performance in 2010. However, for one of their West Virginia’s mine, they were issued with 10 citations from the Mine Safety and Health Administration for compliance issues.

For a more detailed look at Prem Watsa’s and Fairfax Financial Holdings Limited current stock picks and overall portfolio, please go to: http://www.gurufocus.com/ListGuru.php?GuruName=Prem+Watsa


Rating: 3.7/5 (23 votes)

Comments

grandpagates
Grandpagates - 3 years ago


Page 20 of the ABH corporate brochure shows that Fairfax Financial has had a board member (Paul Rivett)at ABH for 3 years:

http://www.abitibibowater.com/uploadedFiles/Media/Publications/AbitibiBowater-2010_Corporate_Brochure.pdf

Full Disclosure: I own many acres of Southern pine forest.

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