Markel Corp.'s Top Holdings: CarMax Inc., Berkshire Hathaway Inc., Weighting Fairfax Financial Holdings Ltd.,DIAGEO plc , Brookfield Asset Management Inc. Ltd.

(GuruFocus, November 8, 2009) Investment Guru Tom Gayner manages the portfolio for Insurance Company Markel Corp. (MKL, Financial). Markel Corporation markets and underwrites specialty insurance products and programs to a variety of niche markets.


There are people compare Markel to Warren Buffett’s Berkshire Hathaway. Like Berkshire Hathaway, Markel thrives on managing the floats it collects as the insurance premiums. And unlike Berkshire Hathaway, it separates the job of CEO and CIO, saving people from speculating the succession plan. Currently, company’s CEO is Alan Kirshner and Tom Gayner is the CIO. GuruFocus tracks the equity portfolio under Tom Gayner.


Currently, Markel Corp. has a market cap of $3.21 billion; its shares were traded at around $327.41 with a P/E ratio of 13.16 and P/S ratio of 1.69. Needless to say, it is much smaller than Buffett’s famous company therefore it is not making as many headlines in the media.


On Nov. 4, Markel Corporation reported diluted net income per share of $6.02 for the quarter ended September 30, 2009 compared to diluted net loss per share of $14.46 for the third quarter of 2008. Diluted net income per share was $11.02 for the nine months ended September 30, 2009 compared to diluted net loss per share of $2.63 for the same period of 2008.. Book value per common share outstanding increased 23% to $274.33 at September 30, 2009 from $222.20 at December 31, 2008, which was driven by improvement in the market value of the Company's investment portfolio.

Insurance company such as Markel, Berkshire, and Prem Watsa’s Fairfax Financial Holdings (FFH, Financial) like to measure their performance in terms of book value appreciation. Thanks to the appreciation of stock market, these company are making historical highs in terms of their book value, yet their stock prices are far from the historical highs.


During the 3Q09 Quarterly Conference Call, Tom Gayner made the following remarks to his asset allocating strategies and policies:

Last quarter I mentioned specifically that it sure was more fun to be bringing you some good news on the investment front after what seemed like a couple of dog years of tough (inaudible). Today I'm happy to report to you the good news continued in the third quarter and at an increasing rate.


We also had some positive developments in our affiliated investment activities, and I will comment briefly on those as well. As to the 2009 year-to-date numbers, through September 30 we were up 11.9% for the portfolio as a whole. Equities were up 20%, matching the year-to-date return of S&P 500.


Fixed income was up 10.4% in local currency terms and foreign exchange effects added 1.5% to our results. The blended average of those factors produced the total return of 11.9%. Those results coupled with the investment leverage inherent in our business, and continued underwriting profitability produced comprehensive income of just over $500 million and the gain on book value per share of 23% since December 31 to its current all-time high level of $274.33.


I would like to add a bit of perspective that comes from a slightly longer time horizon than we have all become accustomed to in our fast paced world. At Markel, we cannot control what the stock market thinks of us, and what value or multiple the market assigns to our balance sheet and the future prospects. All we can control is our effort to do our best in building the book value per share of the Markel Corporation.


When measured over reasonable periods of good time, I think we have done that pretty well. For instance, five years ago on September 30, 2004, our book value per share stood $152.93. Today it is a new all-time high of $274.33, a compounded annual growth rate of 12.4% over that time. In September of 2004, we didn't know that we were in for the most profile financial crisis we faced in generations.


We didn't foresee $4 a gallon gasoline, the sub-prime mortgage debacle, the housing crisis, the Madoff Ponzi scheme, any of the other Ponzi schemes or any of the other hugely important macroeconomic events that subsequently occurred. We also did not know that at Markel we would restructure our insurance operations and face a government backed entity as our largest competitor.


If someone had told us that these bad things were going to happen, and we knew it with 100% certainty that their forecast was correct, we probably would've hunkered down, became very defensive and ultraconservative in our dealings and made very little money during the last five years. As it turns out, without that knowledge we instead methodically kept going to work every day, and trying to make the best of each day’s opportunities.


As a result this company through our daily activities of disciplined underwriting and investing produced $121 of book value per share. This equals comprehensive income for our shareholders of over $1 billion during that time frame. Even with a weaker dollar, that is still a lot of money.


I respectfully submit that given that all of these external factors we face, these results represent excellent stewardship of your capital through one heck of a storm. They also speak to the value of working hard on the past on front of you each day, continuing to put one foot in front of the other and not letting negative forecasts or macroeconomic factors create fearfulness and to paralyze you in inaction or negativity.


Looking forward, I am profoundly optimistic about our prospects. My colleague spoke about the current state of the insurance market and our specific efforts to produce good results despite the conditions. Conditions remain challenging and are likely to do so for the immediately foreseeable future. Conditions change that. We all know what is wrong with the world right now and the challenges we face.


When conditions change for the better, and I believe they will, it will surprise us just as much as it did when they changed for the worse. I'm confident that we at Markel will adjust and adapt as needed to make the best of whatever environment we face. On the investment side, we have something that I would describe in insurance terms as a hard market right now.


And as (inaudible) might say that is a good thing. As a broad generalization, the largest, most historically successful and financially strongest global firms on the planet are selling at their lowest valuation in decades. Our equity portfolio is still with shares of those companies, and I'm optimistic about our future returns from current prices. Compared to a 10-year government bond, on which we would earn slightly less than 3.5%, the earnings yield on these type of companies at 6% or 7% are better.


The current dividend yield often equals or exceeds what we can earn by buying bonds, and I believe that investment in the common shares of these firms offers inflation protected growth as well. Additionally, at some future point in market history these firms will probably sell for premium valuations, and that should create something of a double whammy when it comes time to measure our investment results.


I am also pleased that we are matching the S&P 500 so far this year. 2009’s rally has been lead by rebounds of firms that had near death experiences. The most dramatic stock price increases occurred where companies were thought to be death door earlier in the year. We have tried to stick to higher quality investment in recent years to the best of our ability.


I am pleased that we are keeping pace with the overall market even with what I would characterize as a higher quality and more durable portfolio. To my vantage point, we're getting better company at lower prices than the market as a whole. And we're matching the market returns. If our companies indeed prove to be better than average and higher quality, they will produce better than market returns over time.


Over time that has to be the case for investors at Markel. We continue to invest regularly and methodically in equities. Our current equity allocation is roughly 48% of total shareholders equity, and that leaves us with plenty of ammunition to continue to regularly invest in equity.


We will remain modest and conservative in doing so, while the insurance markets remain hypercompetitive and we will look to increase our flow of funds into equity as insurance premium volumes grow. In the fixed-income arena, we have enjoyed a total return of 9.3% this year and benefited from improvements and the perception of credit quality and lower interest rates.


We will continue to increase the quality of the fixed-income portfolio. The duration of the portfolio remains on the short side at just over four years. We will continue to run a short duration and high credit quality portfolio for the foreseeable future. Also subsequent to quarter-end, we announced the acquisition of Panel Systems Incorporated [ph], of Temple, Texas. We purchased 100% of the equity in the firm.


PSI manufactures panel furniture products. College dorm rooms represent roughly 50% of their revenues and hospital and health care markets are the next biggest sector. PSI was founded 20 years ago and has produced outstanding financial results. They also groomed the next generation of leaders who will remain at the firm and run the business going forward.


PSI operates with the Markel style and has for two decades. In addition to their excellent financial results, one of the ways you can discern this is that the first and second employees ever hired by the company are still with the firm. This transaction continues down the path we first laid out in the 2005 annual report. At that time, we talked about what a dislocation in the financial market might do to the world of private equity in highly leveraged firms.


In 2005, we purchased AMF, which was our first controlling interest in a private company. During 2006 and 2007, we did not purchase any of these type of investments as we faced prices that were simply too high and they did not represent good investment value. During 2008, we started (inaudible) ventures in a de novo transaction and now in 2009 we are riding PSI to our roster of affiliated holdings.


We are very pleased with the results from AMF. Both firms as well as PSI are solidly profitable and the total revenue base of the group should now exceed $100 million. Given the dramatic dislocation in the world of private equity and alternative investment, the opportunity to acquire additional holdings at attractive prices has now presented itself.


We patiently waited for this time with discipline, and now we are seeing the opportunities we were looking for. We view only 80% to 100% of these firms in the same way we considered every other equity investment we have looked at for decades. We look for profitable cash generating businesses, run by management teams with equal measures of talent and integrity with reinvestment opportunities and more capital discipline at fair prices.


Additionally, with these affiliated investments we have the opportunity to make the capital allocation decisions that these firms as well as to set executive compensation levels. These are exactly the two points where a lot of value gets dissipated at public companies. With control over these decisions and the opportunities now available in the marketplace, I'm excited about our ability to add meaningful value to Markel shareholders from these activities in the years to come.

Talk about the high quality issues, here are Tom Gayner’s top holdings as of September 30, 2009:

No. 1: CarMax Inc. (KMX, Financial), Weightings: 8.31% - 5,332,406 Shares

CarMax Group is one of the nation's largest retailers of brand-name consumer electronics and major appliances and a leading retailer of personal computers and music software. Carmax Inc. has a market cap of $4.65 billion; its shares were traded at around $20.94 with a P/E ratio of 32.22 and P/S ratio of 0.67. Carmax Inc. had an annual average earning growth of 21.9% over the past 5 years.

No. 2: Berkshire Hathaway Inc. (BRK-B), Weighting: 7.78% - 31,418 Shares

Gayner is a faithful follower of Warren Buffett. He put 7.78% of his equity investment in Buffett’s company. Berkshire Hathaway Inc. is a holding company owning subsidiaries engaged in a number of diverse business activities. The most important of these is the property and casualty insurance business conducted nationwide on a direct basis and worldwide on a reinsurance basis through a number of subsidiaries collectively referred to as the Berkshire Hathaway Insurance Group. Berkshire Hathaway Inc. Class B shares were traded at around $3425 with and P/S ratio of 0.47. Berkshire Hathaway Inc. had an annual average earning growth of 1.7% over the past 10 years.


Like many of us, Tom Gayner goes to the annual Berkshire Hathaway shareholders’ meeting. When asked about what he saw during 2009 Berkshire meeting, he said:

They didn’t learn anything new per se. But that is a good thing. It shows that the value investing principles are timeless. Don’t need to learn new things when it comes to the discipline required to run businesses. The BRK annual meeting is kind of like going to church. You don’t learn new things each week. You haven’t forgotten the principles. You go to get filled up or re-filled by Buffett and Munger

No. 3: Fairfax Financial Holdings Ltd. (FFH), Weightings: 7.72% - 279,459 Shares

Equally, Gayner has good faith in Prem Watsa. Fairfax Financial Holdings Limited is a financial services holding company which through its subsidiaries is engaged in property casualty and life insurance and reinsurance investment management and insurance claims management. Fairfax Financial Holdings Ltd. has a market cap of $7.03 billion; its shares were traded at around $357 with a P/E ratio of 9.2 and P/S ratio of 0.88. The dividend yield of Fairfax Financial Holdings Ltd. stocks is 2.24%.

No. 4: Berkshire Hathaway Inc. (BRK-A), Weightings: 6.76% - 898 Shares

This is on the top of BRK-B. See my point?

No. 5: DIAGEO plc (DEO, Financial), Weightings: 5.76% - 1,257,358 Shares

Diageo is an multinational branded food and drinks company. Diageo has an outstanding portfolio of world-famous food and drinks brands include SmirnoffJohnnie WalkerJ&BGordon'sMalibuBaileysGuinness and Tanqueray. Diageo Plc has a market cap of $41.61 billion; its shares were traded at around $66.58 with and P/S ratio of 2.77. The dividend yield of Diageo Plc stocks is 3.4%. Diageo Plc had an annual average earning growth of 12.1% over the past 10 years.


Commenting on the investment thesis on DEO earlier this year, Gayner said in the annual shareholders meeting:

Question 20: What is the thesis on Diageo?


Gayner:It fits the 4 criteria they look for: Profitable business with a high return on capital, Return on total capital is their preferred metric; Run by honest, talented people (weigh those traits 50-50); Has positive re-investment dynamics; Earns a high ROC and can re-invest at that rate; If they can’t re-invest at that rate then they pay dividends and buy back shares; Priced fairly. Look for businesses in which 5-10 year shareholder returns mirror the returns provided by the business. All comes down to what you have to pay

No. 6: Brookfield Asset Management Inc. Ltd. (BAM, Financial), Weightings: 5.25% - 3,101,539 Shares

Brookfield Asset Management Inc. is an asset manager. Focused on propertypower and infrastructure assetsthe company has assets under management and is co-listed on the New York and Toronto Stock Exchanges under the symbol BAM. At Brookfield they continually strive to ensure that they have sound corporate governance practices to maintain investor confidence in the way in which they do business. To ensure it communicates with there practices and commitment to strong corporate governancethey are proud to share with its Statement of Corporate GovernanceCorporate Disclosure PolicyCode of Business Conduct and Ethics and other related information on its corporate governance initiatives and practices. Brookfield Asset Management Inc. Ltd. has a market cap of $12.07 billion; its shares were traded at around $21.1 with a P/E ratio of 25.42 and P/S ratio of 0.94. The dividend yield of Brookfield Asset Management Inc. Ltd. stocks is 2.46%. Brookfield Asset Management Inc. Ltd. had an annual average earning growth of 32.6% over the past 5 years.


This is what Gayner said during the annual shareholders meeting back in May 2009:

Question 4: Can you discuss the investment case for Brookfield Asset Mgmt (BAM)?


Gayner:MKL has a long term relationship with BAM. CFO’s mother used to work at MKL. BAM has made some tremendous capital allocation decisions. Natural resources: timber, paper mills, hydroelectric dams. Have realized that the forest is a better investment than the mill. Try to buy minimal capital expenditure requiring assets that will go up in value over time. Thus they own better assets over time. Like and trust the people who run BAM. Believe it is priced attractively and expect to own it for the long run. Will protect against inflation due to the hard asset focus

Comments


Tom Gayner invests with the Gurus; he is heavily investing in companies managed by Buffett and Watsa.


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