Fairfax Financial: Raising our Valuation to CAD 970

We are increasing our fair value estimate for no-moat Fairfax Financial FFH to CAD 970 per share from CAD 790, after reassessing the company’s prospects on the investment side given recent changes in capital market conditions. The company is navigating the current environment well, but we would note that Fairfax’s investment performance has been spotty over time and includes some substantial losses along with impressive gains. Our fair value estimate equates to 0.9 times the book value at the end of the second quarter and 1.2 times the tangible book value. While we have raised our fair value estimate, we still see shares as a bit overvalued at the moment.

We expect premiums to grow at a 6% CAGR over our five-year projection period, with Fairfax’s foreign operations providing a boost and higher growth in the near term based on the current direction in pricing. This growth is front-loaded in our projections, given the increased aggressiveness we’ve seen from the company recently in response to a harder market. We expect the company’s combined ratio to level out in line with recent levels in the first half of our projection period as the company benefits from the hard market. However, we expect the combined ratio to creep up as market conditions normalize and improving investment yields relax the pressure on underwriting profits. We have explicitly modeled one large catastrophe year in order to realistically capture the volatility of the company’s reinsurance operations. The average projected combined ratio over our five-year forecast period is 98%, in line with Fairfax’s average of 98% over the past five years. We use a cost of equity of 9% in our valuation.