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Markel Corp (MKL) - Conservative Value

March 07, 2011 | About:
Toddius

Toddius

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Value investors have always had a love affair with insurance companies, dating all the way back to Ben Graham and Geico. Warren Buffett, the world’s best known, best liked and most often quoted investor is well known for his numerous insurance industry investments and his amazing ability to allocate the float provided by Berkshire’s insurance subsidiaries. Buffett has gone on the record for saying (obviously I’m paraphrasing) that Berkshire was one of his biggest investing mistakes, and that if he had it to do over again he would buy a small insurance company and go from there.

The people at Markel (MKL), a holding company not dissimilar to Buffett’s Berkshire Hathaway (BRK.A, BRK.B), have taken that information to heart. In fact, MKL might be the company most like Berkshire (they even have a $230 million equity investment in BRK). The heart of their business, perhaps to an even greater extent than Berkshire, is insurance.

Business

Insurance companies are actually much more complex than they sound. The complexity comes from the complexity of the instruments they provide and the complexity of the underlying, difficult to understand risks involved (ask AIG!). That being said, the basic premise behind the business is very simple. Insurance companies make money in two basic ways: (1) from underwriting premiums, and (2) gains from investing those premiums (otherwise known as “float”).

One thing that stands out about MKL is their stated commitment to conservatism. It isn’t the kind of company that’s going to be caught holding less by way of reserves than they should. Their commitment to conservatism is further illustrated by their approach to underwriting. Insurance is a competitive business. Many insurance companies underwrite policies at a loss in exchange for use of the float in investments. Companies utilizing this strategy need excellent returns to make up for the loss they’re starting with right out of the gate. That is not MKL’s style. They underwrite at a profit. In fact, in the last 9 years, up to and including 2010, MKL has had an underwriting profit every year except two (2002 and 2005).

A large portion of MKL’s business is focused on insurance. Outside of insurance, they invest in publicly traded companies doing just about anything. Most often these companies are large, stable companies. As stated above, Markel maintains a large position in Berkshire Hathaway. You can find the stock picks of Tom Gayner, MKL’s Chief Investment Officer, right here at Gurufocus. Gayner casts a large net. He focuses on large, blue chip companies, and lots of them. I’m not even sure I’d call what he does value investing (can you know the details of that many companies?), but he’s a good investor.

Markel Ventures is MKL’s investment arm that focuses on non-insurance businesses. Markel Ventures is comprised of 6 operating companies with a 2010 EBITDA of around $20 million. Management has an excellent discussion of why they used EBITDA in the 2010 shareholders letter. They aren’t crazy about it as a metric in general and provide a brief rationale under the section titled, “A Digression on Accounting.”

So Much Like Berkshire

This has very little to do with the value of the company, other than to make investors and prospective investors hopeful, but I was truly struck by how similar the company is to Berkshire. The company actually seems to be an attempt to copy the best attributes of Berkshire. I’m aware that I’m not the first person to point this out. This line particularly struck me in the annual letter:

“We also offer tremendous advantages to potential sellers of these businesses. We offer a long-term home for great businesses. If sellers want to make sure that their business is permanently placed in patient hands that will help current and future managers to build wonderful businesses, we are a unique buyer. We will not use excessive leverage or look to sell to subsequent buyers. That one sentence differentiates us from 90% of the other buyers in the world.

P.S. If you or someone you know owns a business that meets these criteria and would like to find a permanent home let us know.”

Sound like anyone else you know? I feel like I’ve read almost that exact paragraph in a Berkshire letter a couple years ago.

The main difference between this company and Berkshire is size. Berkshire, by market cap is a +$200 billion company. MKL, by market cap, is a $4 billion company. Obviously there are no guarantees, but which company has more growth potential? Which company has a better chance of doubling in the next 7-8 years?

Risk Factors

Obviously, the insurance business is all about risk. The risk of particular events happening is the first thing I think of when I think about insurance. The gulf oil spill hurt MKL. Any major catastrophe – a hurricane, earthquake or a fire, would cost a company like MKL money. They’re also heavily involved in the specialty insurance market, insuring hard to quantify risks (like Berkshire).

Beyond insured risk, the company is exposed to a significant amount of market risk. Rising interest rates pose a negative threat for the company’s fixed income portfolio. This poses a threat to the company, but would also be hard on competitors that aren’t as well equipped to handle tougher market conditions. It’s a double-edged sword. Rising interest rates would certainly negatively affect the value of MKL’s fixed income portfolio.

Just as anyone else with an equity portfolio does, the company also has significant exposure to general stock market risk. The company projects that a 35% general decline in the stock market would correlate to a 12.5% reduction in the company’s tangible book value. Obviously, the other side of that coin would be improved opportunities for Tom Gayner to put capital to work at discount prices. Since he mostly focuses on large blue chips (and lots of them), he’s likely to do his best work in a down market.

What’s in it for the potential shareholder?

MKL doesn’t pay a dividend. Like Berkshire, they retain all of their earnings and use those earnings to invest in additional opportunities. They’ve done pretty well doing this so far, and as long as they continue to grow the tangible book value of the company….more power to them.

MKL has authorization to repurchase up to $200 million in stock on the open market. They’ve previously shown a commitment to buying their stock back. We all know that this only works if you buy at the right time.

Since MKL went public in 2005, they’ve never split their share price. This, too, is Buffett-esque. The high share price discourages day traders from messing with the stock too much and encourages long-term investors. It’s a pretty low volume stock. The volume isn’t so low as to make an investor’s position illiquid, but it’s low enough that every eye on Wall Street isn’t watching the company’s every move.

Valuation

MKL’s stock price, as of the close on 3/4/11, stands at a lofty $410 per share. Holding companies are typically valued in terms of their book value. This usually gives us a better picture of a holding company than earnings or cash flow, in part because much of what would be the company’s earnings and cash flow are tied up in unrealized investment gains.* In their annual report, MKL reported book value of $326 per share. At today’s price, the stock trades at approximately a 1.25 multiple to book value.

*This is definitely the case for MKL, which had net income of $266 million versus a “comprehensive income” of $430 million. Comprehensive income includes the company’s unrealized investment gains. The comprehensive income figure comes from page 113 of the 2010 annual report.

Ideal market conditions could yield a book value multiple closer to 1.5, which would put the stock at around $490, just under 20% above today’s price. Holding companies in general aren’t trading at 1.5 multiples right now, but it certainly isn’t unheard of. That being said, MKL’s value lies in its ability to grow its earnings and book value in the future. Earnings and cash flow are going to become more important metrics as Markel Ventures continues to grow.

If you don’t like book value for some reason, we could also try to use the comprehensive income number provided by MKL. We can apply whatever multiple we want on that $430 million number – at 8 the company is worth about $3.4 billion, at 10 - $4.3 billion, at 12 - $5.1 and at 15 – $6.5. Obviously, using this approach creates a very wide range – which is exactly why using book value usually works better for holding companies. Using net income simply doesn’t make sense, because so much of the value of the company is tied up in unrealized investments. Likewise, it’s tough to count those unrealized gains as income, because anything could happen in the market.

For all of the Berkshire comparisons, MKL isn’t simply a more youthful Berkshire Hathaway. The model is the same. The idea is the same. What’s missing is Buffett. Buffett’s talent. Buffett’s brilliance when it comes to capital allocation. Timing matters as well. Buffett brought Berkshire to where it is through the greatest bull market in history. Buffett has grown Berkshire at an average of about 20% a year. MKL has grown its book value at about 12% a year over the past 10 years. Despite a 16% gain this year, I think it’s unlikely that it will grow considerably faster than that in the future, especially as the company continues to grow. Of course, you don’t have to be Berkshire to constitute a solid investment opportunity. MKL takes a smart, conservative approach to investment and management, and if it stays true to those roots, there’s considerable value in the stock now and going forward. At $410, the stock is trading close to its 52-week highs. There may be a better entry point sometime in the future – I would expect there to be. Still, to me, the stock looks attractive where it sits.

Conclusion

Overall, this is a very well managed company that takes a conservative approach to investing. I believe the company’s conservative investment approach to underwriting and access to investment float offers an excellent longer term opportunity for patient investors. Good luck and thanks for reading.

Disclosure: Long BRK-B, no other positions – though MKL is on my watch list.

About the author: I’m a licensed Missouri attorney. I live in St. Louis with my brilliant and beautiful wife, Rachel. I like volleyball, golf, the St. Louis Rams and the St. Louis Cardinals. I blog over at The Personal Finance Playbook (please stop by!). Feel free to email me at personalfinanceplaybook (AT) gmail (DOT) com with any comments, questions, or criticisms you might have. Thanks! - Todd Metheny


Rating: 4.0/5 (24 votes)

Comments

the Spark
The Spark - 3 years ago


One small correction. Markel went public in 1986, not 2005.
luishernadez
Luishernadez premium member - 3 years ago
One detail about their Book Value per share growth (in order to compare it to Berkshire´s) is that over the last 10 years it has grown at a 12% rate (as mentioned on the article), but over the last 20 years it has grown at a 19% rate... which is very close the 20% long term growth of Berkshire.
Toddius
Toddius - 3 years ago
Spark: 1986 - thanks for the correction.

Luis: That's an excellent point. Looking at the growth rate over the longer period is probably a better apples to apples comparison to Berkshire. There was a chart in the 10-K specific to the growth over the last 10 years - that's why I went with that number.

rnagarajan
Rnagarajan - 3 years ago
Nice article. Markel used to trade at a much higher price/book ratio. One observation I made when reading the 10K recently is that, unlike Berkshire, Markel invests policyholder float entirely in fixed income and buys equities and subsidiaries with shareholders equity. Berkshire has historically invested a portion of float in equities. This could make a big difference going forward. Also noted that Markel employs significant debt (not dangerous levels but significant) and the coupons aren't that low. Berkshire, on the other hand, has ready availability of dirt cheap financing.

MKL is on my watch list as well, thanks for the article.
Toddius
Toddius - 3 years ago
Rnagarajan: thanks for the comment. I follow you on twitter and read your blog when I get the chance! Appreciate the added insights. I noticed that you're going back through older filings. I think that's a very worthwhile practice (one that I need to practice more!). Thanks again.

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