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Investing Specialists

Alleghany and Markel Offer Up Some Buy Ideas

Recent 13-F filings yielded a few ideas our analysts believe are worth a look.

By Jim Ryan | Senior Stock Analyst

Once again,  Alleghany Corporation  and  Markel (MKL), two of the insurance companies in our Ultimate Stock-Pickers' Investment Roster, managed to beat the market, even through the individual strategies employed by each firm to accomplish this feat during the first quarter were quite different. On the one hand, Alleghany was active, selling a large portion of a major holding and allocating the proceeds to another sector, whereas Markel seemed content to mostly stand pat with the positions it held at the end of 2008. While both companies showed a loss in the value of their stock portfolios--with Alleghany and Markel down 7.2% and 9.7%, respectively--it was still a better showing that the 11.7% loss recorded by the S&P 500 Index (SPX). A closer look at each company's actions during the quarter not only sheds a little light on how these two managers continue to outpace the rest of the market on a regular basis, but also generates a few stock ideas that our analysts believe are worth buying right now.

Different Strategies from Alleghany and Markel
For Alleghany, the big surprise was another substantial sale of  Burlington Northern . As our colleague Brad Meeks pointed out in a recent article, Alleghany has a long history of ownership in Burlington Northern, dating back to the founding of the company in 1929. So we were a bit taken aback to see Alleghany's investment in the railroad firm is now down to 2 million shares from 5 million at the end of 2007. Back then, Burlington Northern was 31% of Alleghany's investment portfolio and it rose to 36% at the end of 2008. After the first-quarter sale it has now dropped to 21%. Interestingly enough,  Berkshire Hathaway (BRK.A) (BRK.B) has been going in the other direction, buying the stock aggressively during the period and making Burlington Northern its second-largest equity holding at the end of the first quarter. While Morningstar analyst Keith Schoonmaker lowered his fair value estimate for Burlington Northern during the first quarter in response to the general slowdown in rail traffic, he continues to believe that the long-term story for the firm remains intact. Our take on this has been that Alleghany's sales were quite likely driven more by portfolio rebalancing than any sort of weakness in Burlington Northern's long-term prospects, and that Berkshire's moves were those of a shrewd investor, but only time will tell at this point which management team made the better move.

 Alleghany's Major First-Quarter Purchases
CompanyStar RatingFair Value
Uncertainty
Size of MoatCurrent Price
( $ )

Price/
Fair Value

ConocoPhillips (COP) MediumNarrow44.400.53
Chevron Corporation (CVX) MediumNarrow64.540.71
Apache Corporation (APA) HighNarrow77.930.64
ExxonMobil Corporation (XOM) LowWide68.930.79
BHP Billiton Limited (BHP) MediumNarrow52.630.81
Freeport-McMoRan Copper & Gold (FCX) Very HighNarrow48.341.46
Cincinnati Financial Corporation (CINF) HighNarrow22.210.72
J.P. Morgan Chase & Co. (JPM) ExtremeNarrow34.710.85

Data through 5-21-09.

So, what did Alleghany do with the proceeds from Burlington Northern? For one, it continued buying more energy stocks like  ConocoPhillips (COP),  Chevron (CVX),  Apache (APA), and  ExxonMobil (XOM)--all undervalued stocks, in our view--raising its energy sector allocation to 50% of the entire portfolio. Alleghany also purchased 1 million shares of mining conglomerate  BHP Billiton (BHP) and 500,000 shares of gold and copper miner  Freeport McMoRan (FCX), which we view as an obvious play on commodities. This helped raise Alleghany's industrial materials sector allocation to 13%, almost 5 times what it was the previous quarter. Finally, Alleghany began to dip its toes into financial services with buys of  Cincinnati Financial (CINF) and  J.P. Morgan (JPM), having briefly trimmed their exposure to this sector over the past year.

Markel's stock portfolio, on the other hand, looks about the same as it did at the end of 2008. The one notable new addition was a $25 million investment in a convertible senior note in  Level 3 Communications , which converts into common stock four years out. On a sector basis, financial services occupied the top spot at the end of the first quarter, accounting for about 45% of the portfolio followed by consumer services (at 19%) and industrials (9%). By far, Markel's biggest winner of the quarter was its 5 million-plus share investment in  CarMax (KMX), a position it continues to hold on to even after recording a 58% unrealized gain during the quarter. Losers were abundant in Markel's portfolio as well, with major positions in  General Electric (GE),  Diageo (DEO), and  Fairfax Financial (FFH) all taking large hits.

Sifting through the Sector Bets for Buy Ideas
Given that there weren't too many buy ideas to consider from the top purchases made by these two insurance firms during the first quarter, and because each company has about one half of its portfolio allocated to one sector--energy for Alleghany and financial services for Markel--we believe it would be useful, as well as timely, to mention our analysts' best stock picks in each of these sectors.

 Morningstar's Top Stock Picks in Energy
CompanyStar RatingFair Value
Uncertainty
Size of MoatCurrent Price
( $ )

Price/
Fair Value

ConocoPhillips (COP) MediumNarrow44.400.53
XTO Energy, Inc.  HighNarrow40.160.69
Spectra Energy Corporation  MediumWide15.090.60

Data through 5-21-09.

ConocoPhillips, which was recently featured in an Ultimate Stock-Pickers article by Morningstar analyst Alan Rambaldini, is one of Alleghany's largest energy holdings (and one that it continued to add to during the first quarter) and remains a favorite of ours as well. Alleghany also has a smaller position in  XTO Energy , which, according to Morningstar analyst Eric Chenoweth, possesses one of the best portfolios of natural gas producing properties in the United States.

While Alleghany did not own this security at the end of the first quarter, Eric thinks that  Spectra Energy , one of the largest natural gas midstream companies in North America, is worth taking a look at right now as well. Because Spectra mainly operates pipelines, storage, and distribution centers, it is largely insulated from commodity price and volume fluctuations inherent in the natural gas market. We'd consider any of these 5-star companies worthy of further investigation and invite you to check out our most recent Analyst Reports on each of these firms.

 Morningstar's Top Stock Picks in Financial Services
CompanyStar RatingFair Value
Uncertainty
Size of MoatCurrent Price
( $ )

Price/
Fair Value

Berkshire Hathaway Inc. (BRK.B) MediumWide2,915.000.63
American Express Company (AXP) HighWide23.500.44
Marsh & McLennan Companies (MMC) MediumWide18.930.53

Data through 5-21-09.

Two of the financial services firms owned by Markel at the end of the first quarter are rated 5-stars by our stock analysts. Holdings of both Class A and Class B shares of Berkshire Hathaway make up around 40% of Markel's financial services holdings. Berkshire is a long-time 5-star, wide-moat favorite of ours, which analyst Bill Bergman believes has, through its melding of insurance with a wide range of nonfinancial enterprises, developed a unique organizational enterprise, one that retains significant potential for taking a growing share in the overall economy.

 American Express (AXP), another 5-star wide-moat stock, is also part of Markel's equity holdings, though nowhere near as large a position as the firm has in Berkshire. Morningstar analyst Michael Kon thinks the company is well positioned to weather the current storm and to benefit from the secular growth in credit card usage around the world. Finally, while not a Markel holding at this time, our analyst (again Bill Bergman) believes that  Marsh & McLennan (MMC) continues on the road to recovery that began in the fourth quarter of last year; MMC is one of his top picks in the sector.

Diverging Paths Can Sometimes Reach the Same Goal
The divergence in equity portfolio strategy between Alleghany and Markel illustrates the point that there is more than one path to a goal. Both companies have achieved a good measure of success in the past, consistently beating the market averages. While part of the success is due to wise sector allocations, that alone wouldn't be worth much without strong stock-picking ability. We think investors can learn from the actions of these two consistently successful stock-pickers, and we encourage you to check out the 5-star stocks we've highlighted, as well as the other 2,000-plus companies we cover on Morningstar.com.

Disclosure: Jim Ryan doesn't own shares in any of the companies mentioned above.

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