Seche Environmental, brief unedited and unfinished writeup
EPA: SCHP
All figures in Euros
Market Cap 11/30:240M
Business: Seche collects and disposes of waste. They operate in two segments, non-hazardous waste and the much more dangerous hazardous waste. Disposal runs the spectrum of simple collection to energy generation (biogas/incineration) to highly engineered decomissioning (PCB transformer).
Investment Belief:
With the Euro-zone in the news everyday there is tremendous pessimism. While it may be warranted towards the government and certain debt laden entities dependent on short term financing (banks, insurance etc) I believe that longer term a company like Seche can and will prosper. A steady, essential (nobody screws with trash unless political suicide is in order), profitable business that is being priced extremely low. Throwing the baby out with the bathwater so to speak.
Financials: In 2010 the company generated 406M revenue, operating cash flow of 93M and CapEx of 30.3M. They carry 382M in total liabilities, this has been trending down the past several years. Debt has decreased from 237M to 177M. FCF, defined as operating cash flow less CapEx, was 63M in 2010, 42 in 2009, 22M in 2008, and -100M in 2007(explained later). Right now Seche is being priced around 10x depressed 2008 earnings.
Management and their use of capital: Joel Seche is CEO of the aptly named company. He owns 40% of shares outstanding according to lemonde.fr economy section. He's been there since 1981 and is currently salaried at 412K Eur. He serves on Altamir Amboise Sca's Board. I loathe multiple boards but can live with one.
He has proven to be a prudent allocator of capital. The negative FCF in 2007 was partially attributable to a large capital expenditure. The financing was secured through common stock issuance. About 85M of stock was issued at share prices roughly 5x those of today. This example (although only one) showcases a textbook example of taking advantage of overpriced stock in a bubble. I applaud management for that.
Business Notes:
Hazardous waste represents a majority of their business. Goldman published reports on Veoila and Suez declaring that industrial waste declines will be a drag on the bottom line. This obviously could effect Seche but...
Non-hazardous waste, although a smaller portion of total revenues is growing much faster. It was up 17.5% YoY, helped by the energy production. With lower debts and higher energy production
Right now it is 2:1 HW:NHW revenue. A weaker Euro will likely facilitate industrial production, leading to more waste generation. They expect 7% growth in 2011. No predictions as to the growth in 2012.
They have a investment in Saur water treatment.
Wednesday, November 30, 2011
Wednesday, October 12, 2011
Seagate STX
Business: Manufacturer of hard disk drives. Competes with WDC, STEC and others in this commodity of a business.
Why I like it:
Seagate has dropped considerably over the past couple of months. It is percieved to be a cyclical in a dying industry. Looking at it compared to its growthy brothers (flash) we can see that it has produced consistent profits for owners of the business. FCF has averaged over 550M/year for the past nine years. This is even with including the 2.5B goodwill write off taken in 2009.
Unlike flash producers it is actually making money after CapEx. MU is a perfect case in point of a business that really isn't making money, it just looks like it is.
STX has a 0.72/share yearly dividend and is buying back shares by the bucket load.
Temp Issues:
High commodity prices are squeezing profits and the fear that this cyclical is headed the way of the dodo is starting to price in. On multiple years of conference calls we can see the angst in each analysts voice over weekly changes in shipments.
Valuation:
No position for now. If offered at say 8x normalized FCF (EV of 4B...MC of 3.5B) I would build a position.
Why I like it:
Seagate has dropped considerably over the past couple of months. It is percieved to be a cyclical in a dying industry. Looking at it compared to its growthy brothers (flash) we can see that it has produced consistent profits for owners of the business. FCF has averaged over 550M/year for the past nine years. This is even with including the 2.5B goodwill write off taken in 2009.
Unlike flash producers it is actually making money after CapEx. MU is a perfect case in point of a business that really isn't making money, it just looks like it is.
STX has a 0.72/share yearly dividend and is buying back shares by the bucket load.
Temp Issues:
High commodity prices are squeezing profits and the fear that this cyclical is headed the way of the dodo is starting to price in. On multiple years of conference calls we can see the angst in each analysts voice over weekly changes in shipments.
Valuation:
No position for now. If offered at say 8x normalized FCF (EV of 4B...MC of 3.5B) I would build a position.
Monday, August 15, 2011
Nokia (NOK)
Nokia is going through some straits currently. Sales are dropping, margins are eroding and Nokia's smartphone world is coming to an end as we know it. The combination of management change (first non-Finn to lead the firm ever), a fixation on the poor JV with MSFT, and an outdated OS has left Nokia with a 13.8B EV on 62B sales TTM. Below is my argument posted on another site on what I perceive to be hidden assets in Nokia's portfolio.
(Sources down at the bottom to keep everything tight)
(9)http:/
So this has proven to be the itch that can't get scratched and with the greatest effort to not be annoying I'm going to argue for Nokia's value in hopes of further discussion.
I'll preface everything with, the overall business is declining and currently mobile phone sales offer limited comfort. This is a business left for dead and from surface level, rightly so. Margins and sales are decaying in mobile phones, NAVTEQ is still losing money, has little impact on overall sales(245M MRQ), and Nokia-Siemens Networks (NSN) isn't exactly making it rain. All told Nokia is perceived as even worse than RIMM, MSFT, and CSCO.
I don't believe that Nokia is going the way of the dodo though for multiple reasons. Through my research I believe Nokia has an exceptionally strong intellectual property (IP) platform, a cash rich partner willing to throw any amount of money towards a source of revenue (MSFT) and multiple dysfunctional inputs (mobile phones, NAVTEQ etc) that will allow new management to unleash better future shareholder returns. In other words oodles of pessimism creating a diamond in the rough.
Stephen Elop has started off with a solid precedent in my opinion. If we examine the MSFT/NOK JV we can see some ways that Nokia is going to benefit and ultimately differentiate itself. First and foremost it was in talks with both Google and Microsoft but ultimately settled on softy for several reasons. First was the ability to differentiate itself. Having an Android OS would ultimately mean just another Android phone to kick around. With Microsoft they were able to cement in a leading position.
There is potential for alternative MSFT phones but with Microsoft paying for the marketing and development (Nokia only pays royalties on the software) this to me is as close to an "all in" for MSFT as it gets. This allows us to address Robert's valid point on how to "forget" the Symbian OS. There will be limited development to the Symbian OS (my guess would be almost none). Microsoft though will pay royalties on the use of NAVTEQ, which Nokia can use to counter Google Maps (another reason not to pair with GOOG). NAVTEQ is far superior to most products and is incorporated into numerous leading GPS products (1) (cross compatibility perhaps?). Now you have phones using NAVTEQ and Bing, making both more symbiotic and Google like.
Nokia spends tremendous amounts of money on R&D, ~7.5B USD TTM. With us forgetting Symbian and hopefully Nokia does too (job cuts were announced and have started) we can free up some portion of R&D to either directly benefit shareholders, or be placed into pertinent research.
That pertinent research to me represents the hidden jewel within Nokia that hasn't been recognized. One part is NSN, a 50/50 joint venture with Siemens (who wanted to shed the program but has since withdrawn that). NSN purchased some of Motorola's infrastructure assets for $925M (2). This isn't IP but grants NSN a much better foothold with Sprint, Verizon, Vodafone, China Mobile, Clearwire, KDDI (Japan). In other words, infrastructure that a lot of future customers are going to have access to. It is in my opinion that the discount (originally the buying price was 1.2B) is a low cost way for Nokia to have a leverage point into the infrastructure of the worlds 4g customers.
There's two parts to wireless situations, there is the infrastructure and there is the actual wireless part, phones and such. This is a hotly contested area. A little company named Qualcomm did all right by securing a couple of patents (ok 1000's) around CDMA and then charging a couple of percent for every phone sold that contained its technology. Right now the race to become 4g essential is heating up and represents a critical concern for some well known companies.
Several companies have felt quite a bit of unexpected financial pain due to a poor IP portfolio. Google had weak IP around their Android OS system and now smaller suppliers are paying MSFT some substantial monies to use Android(3). There are two sides to this, Google could either say too bad to the suppliers and gradually the suppliers would abandon Android. Or Google could secure a stronger IP portfolio for the future and negate this. Enter Interdigital.
Interdigital is a company I have followed for a bit, a very strong telecommunications researcher. They have been considered a leader in 4g IP but have had low modest valuations by most standards. Recently the stock has exploded for two reasons. First and foremost was the Nortel IP sale. A consortium of companies (including MSFT and RIMM) bought the 6000 patents for $4.3B. Interdigital's portfolio is widely considered stronger and much better than Nortel (4, 5).
The second catalyst for IDCC was the company who wanted the Nortel patents (Google) is rumored to be after Interdigital. In my eyes this offers two firm values for IDCC's portfolio as judged by outside consulting firms and by a company considering purchase. Apple is rumored to be bidding for IDCC as well(6).
Clearly both are rumors but the one thing that Apple and Google have in common is their (relatively) poor IP stance in the world of wireless. One example of Apple needing/wanting more IP is the ending of a lawsuit with...Nokia.
Nokia just finished a two year old lawsuit with Apple getting $600M USD and theres talk of ongoing royalties for each iPhone sold.(7) Referencing back to (5) we can see that an outside consulting firm believes Nokia's IP to be almost as essential to 4g as Interdigital and NSN constituting another 2% of essential LTE patents. Other consulting firms place Nokia's patents at different values, but have a few conflicts of interest in my eyes.(8,9) A good couple of reads. Regardless I will discount the last study but I feel confident that Nokia's LTE portfolio can be judged to be worth somewhere between 30%-100% of IDCC's. At current valuations that puts Nokia's LTE IP at $1B-3.1B. This makes no account for the wider audience Nokia is reaching as IDCC seems to be much more North America bound (I can't find the source currently for this, I will do my best to retrieve it.)
Now I fully believe IDCC's IP is worth a lot more than current valuations but time will tell. In my eyes though this is only half the story. Nokia, in a way, has seen validation of the value behind their IP with IDCC suing them, and attempting to block ZTE, Huawei and Nokia from entering the US picture. A clear attempt to boost the value of their portfolio but clearly IDCC looks at Nokia as a threat.
The value placed above for Nokia's IP only includes the simple math version. If the patents become essential over time Nokia will be paying less and less royalties than say Google or Apple. From a 10,000 foot view we can see that Nokia (NSN) has positioned itself strongly in the infrastructure realm of things and also has the IP to potentially collect royalties/pay little royalities. With an enterprise value of 13.5B (gurufocus, yahoo finance) you get a company that is priced for failure that generates 62.5B in sales TTM and is experiencing a lot of temporary(hopefully) pains. Right now I see a solid floor being created, limiting the downside to any investment. In return you are getting a free call on all of the IP that Nokia has and its primary(royalties), and secondary(synergies, higher profit margins) effects on the business. I hope from the above analysis someone will argue with me and a clearer picture can be gained.
There are multiple other lawsuits that Nokia is engaged in for patent infringement, I will try to follow up with more information concerning them. I will use the disclaimer that I'm not a telecom expert, have read way too much LTE technical info and welcome any criticism that saves me money.
Cheers,
So today (8/15) Google decided to buy out Motorola Mobility for 12.5B, a nice premium to Fridays closing MC of 7.27B. This is roughly 1x P/S, and 4x EBITDA. The question becomes what did they see? The hardware business is a tough sell on any level. Why would a company with 64% gross margins buy a commoditized company with gross margins <26%? Not only that but they alienate all the other Android supporting phone makers, HTC, LG etc.
I suspect there was only a little bit of attention paid to the hardware business, likely Google was after MMI's IP portfolio which Carl Ichan hoped to capitalize on only a few weeks ago (causing a nice little 10% intraday pop in shares). Although we can't place a firm value on Google's valuation of MMI's portfolio it is reasonable to assume that Nokia's IP is worth what MMI's portfolio is, if not 3-4x more. We can also say confidently, based on multiple sources below, that Motorola's IP was worth more than Nortels IP. Nortels sold for 4.5B. I would estimate MMI's to have been valued at 4-7B. Meaning Nokia's could be valued anywhere between 4-16B depending on how everything rolls out. Right now you're getting a company with normalized cash flows of 1.4B USD, for an EV of 14B USD. 10x normalized FCF for a terrible, no good, rotten phone business. And a ton of IP. IP that could be worth billions more than the market is accounting for. I have initiated a small tracking position in my PA. Long NOK
Monday, August 8, 2011
Marathon Oil MRO
Business: Marathon Oil is an E&P company with assets all around the world. Recently they spun off their downstream business at a 2:1 share distribution. The distribution has eliminated over 1/2 of MRO's outstanding debt, resulted in a 1.1B cash distribution to MRO from MPC and eliminated close to a billion in long term pension liabilities.
Thesis: The spin off is causing considerable confusion and irrational selling has been the norm the past month. On Capitalist Collective user JBrown had a great write up dissecting the merits of this spin-off regardless of irrational selling. As the link shows MRO has sold off considerably compared to all peers.
This has created an opportune time in my eyes to invest in MRO.
In table 1 we can see that by several metrics MRO trades at a substantial discount. Especially P/B which should create a formidable downside protector to an asset heavy commodity producer such as Marathon.
Table 1. Comparison
So why the divergence between them? I believe it is laziness coupled with lack of obvious information. I do not believe the majority of investors comb SEC filings and generally rely on handed out information from easily accessible (and often wrong) sources. While the exact values of MRO and valuation metrics aren't know the margin of safety that has been priced into the stock creates ample room for error.
In the 10-12B a simple calculated (read: crude) BV goes as follows: As of 12/31/2010 Total Assets of 50.014B and Total Liabilities of 26.243B. Following the spin-off Marathon Petroleum will retain 21.523B of assets and total liabilities of 14.379B. This leaves parent company MRO with assets worth 28.491B and liabilities costing 11.864B, giving a BV of 16.62B.
Clearly changes could have occurred between the audited results and today. Looking at the latest results from Q1 2011 and recently released results for Q2 I see no material reason for an abrupt descent in BV. A 3.5B acquisition for assets in Eagle Ford was accomplished in Q2 2011. This probably only added to BV. At an price of 22k/acre MRO gets already installed rigs and wells generating ~7000 BOEPD, leading to revenues of ~170-190M annually at 70/barrel. Well below current spot prices. Even if the optimistic increase in production (est. 80,000 BOEPD by 2016) doesn't occur the cash flows support the current acquisition so BV probably didn't change.
If we are concerned about possible drops in oil prices from a simple comparison can be applied. In Q1 2010 oil prices worldwide averaged 74.35 USD. Net income for the E&P segment totaled 502M. In Q1 2011 oil prices worldwide averaged 95.79 and E&P segment income totaled 668M. For a all hells breaking loose analysis in Q1 2009 when we were doomed MRO achieved E&P income of 74M on worldwide oil prices of 40.20 USD. Although the increased exposure to oil sands will prove determinedly to MRO if oil prices tank I take comfort in the profitability.
A reversion to the mean candidate MRO should be valued at least approximately as good as APC. OXY is the stand alone leader in the E&P segment, as >70% of reserves are proved liquids (MRO=>70%), most proven reserves (~3000 MMBOE vs. MRO's ~1500 MMBOE) and profit per barrel ($17/BOE vs. MRO's $13/BOE). Although OXY may have better fundamentals all around its hard to argue that MRO is worth considerably less. I see a dollar selling for 50 cents. As audited results emerge investors may begin to see the upside. Another upside is that management is now free from the restraints of the downstream business. A leaner, meaner E&P company at a significant discount even after adjusting for a precipitous drop in spot oil prices.
8/9/2011: Read the most recent (unaudited) 10Q released by MRO. Stockholders Equity was as calculated at 16.7B, Cash is slightly more than debt. FCF defined by multiple measures gives a range of 17-23% yield to EV. Even if oil prices are high and reset lower I feel confident this deserves higher multiples given the superiority of oil reserves and business history. Long MRO ~4% accounts
Thesis: The spin off is causing considerable confusion and irrational selling has been the norm the past month. On Capitalist Collective user JBrown had a great write up dissecting the merits of this spin-off regardless of irrational selling. As the link shows MRO has sold off considerably compared to all peers.
This has created an opportune time in my eyes to invest in MRO.
In table 1 we can see that by several metrics MRO trades at a substantial discount. Especially P/B which should create a formidable downside protector to an asset heavy commodity producer such as Marathon.
Table 1. Comparison
So why the divergence between them? I believe it is laziness coupled with lack of obvious information. I do not believe the majority of investors comb SEC filings and generally rely on handed out information from easily accessible (and often wrong) sources. While the exact values of MRO and valuation metrics aren't know the margin of safety that has been priced into the stock creates ample room for error.
In the 10-12B a simple calculated (read: crude) BV goes as follows: As of 12/31/2010 Total Assets of 50.014B and Total Liabilities of 26.243B. Following the spin-off Marathon Petroleum will retain 21.523B of assets and total liabilities of 14.379B. This leaves parent company MRO with assets worth 28.491B and liabilities costing 11.864B, giving a BV of 16.62B.
Clearly changes could have occurred between the audited results and today. Looking at the latest results from Q1 2011 and recently released results for Q2 I see no material reason for an abrupt descent in BV. A 3.5B acquisition for assets in Eagle Ford was accomplished in Q2 2011. This probably only added to BV. At an price of 22k/acre MRO gets already installed rigs and wells generating ~7000 BOEPD, leading to revenues of ~170-190M annually at 70/barrel. Well below current spot prices. Even if the optimistic increase in production (est. 80,000 BOEPD by 2016) doesn't occur the cash flows support the current acquisition so BV probably didn't change.
If we are concerned about possible drops in oil prices from a simple comparison can be applied. In Q1 2010 oil prices worldwide averaged 74.35 USD. Net income for the E&P segment totaled 502M. In Q1 2011 oil prices worldwide averaged 95.79 and E&P segment income totaled 668M. For a all hells breaking loose analysis in Q1 2009 when we were doomed MRO achieved E&P income of 74M on worldwide oil prices of 40.20 USD. Although the increased exposure to oil sands will prove determinedly to MRO if oil prices tank I take comfort in the profitability.
A reversion to the mean candidate MRO should be valued at least approximately as good as APC. OXY is the stand alone leader in the E&P segment, as >70% of reserves are proved liquids (MRO=>70%), most proven reserves (~3000 MMBOE vs. MRO's ~1500 MMBOE) and profit per barrel ($17/BOE vs. MRO's $13/BOE). Although OXY may have better fundamentals all around its hard to argue that MRO is worth considerably less. I see a dollar selling for 50 cents. As audited results emerge investors may begin to see the upside. Another upside is that management is now free from the restraints of the downstream business. A leaner, meaner E&P company at a significant discount even after adjusting for a precipitous drop in spot oil prices.
8/9/2011: Read the most recent (unaudited) 10Q released by MRO. Stockholders Equity was as calculated at 16.7B, Cash is slightly more than debt. FCF defined by multiple measures gives a range of 17-23% yield to EV. Even if oil prices are high and reset lower I feel confident this deserves higher multiples given the superiority of oil reserves and business history. Long MRO ~4% accounts
Sunday, July 31, 2011
FSR Flagstone Reinsurance
Business: FSR is a Luxembourg based Reinsurer/insurer with lines of P&C, short tail specialty, casualty, marine liability, engineering and aviation. They carry an A- AM Best rating, A3 rating with Moody's and A- from Fitch. P/TBV of 0.6(diluted BV of 13.34/share), with limited BV growth since inception but revenue growth of 29% for four years.
Their investments are interesting compared to the majority of insurance firms. They basically strive for indexing of investments through futures. This is great except when its not. In 2008 they got absolutely crushed seeing investment losses of (272M). For fixed income 8.7% of their portfolio is BBB and this has risen from 6.3% in 2009. Their desire to mitigate catastrophic meltdowns has resulted in moving assets to what everyone else has...corporate bonds. T-bills have gone from 59.7% of fixed maturities in 2009 to a mere 17% in 2010. With such a low exposure its no wonder they jumped >5% on 7/29. It will be interested to watch the overall effect the debt ceiling debacle has on them versus AHL or other insurers who clearly retain higher amounts of T-bill exposure.
Overall: What I think is strange and fairly myopic is; yes they do have low exposure to T-bills but they are so closely interwined with the general markets. What if the US defaults, T-bills swing erratically but then so do world equity markets? A drop in T-bills would likely resolve itself should congress see the damage they have done (if any, I'm not predicting simply playing out a scenerio).
The WSJ had an interesting article discussing the merits of defaulting. My fear is that it could seriously derail futures and their values. Whether or not this will be an issue is unknown. I remain on the sideline waiting for a greater discount to TBV. That coupled with the lack of history and poor BV growth (understanding that yes they did indeed start up during the last cycles peak) leaves me anxious and not terribly comfortable with a long term holding. They seem destined for disaster.
Their investments are interesting compared to the majority of insurance firms. They basically strive for indexing of investments through futures. This is great except when its not. In 2008 they got absolutely crushed seeing investment losses of (272M). For fixed income 8.7% of their portfolio is BBB and this has risen from 6.3% in 2009. Their desire to mitigate catastrophic meltdowns has resulted in moving assets to what everyone else has...corporate bonds. T-bills have gone from 59.7% of fixed maturities in 2009 to a mere 17% in 2010. With such a low exposure its no wonder they jumped >5% on 7/29. It will be interested to watch the overall effect the debt ceiling debacle has on them versus AHL or other insurers who clearly retain higher amounts of T-bill exposure.
Overall: What I think is strange and fairly myopic is; yes they do have low exposure to T-bills but they are so closely interwined with the general markets. What if the US defaults, T-bills swing erratically but then so do world equity markets? A drop in T-bills would likely resolve itself should congress see the damage they have done (if any, I'm not predicting simply playing out a scenerio).
The WSJ had an interesting article discussing the merits of defaulting. My fear is that it could seriously derail futures and their values. Whether or not this will be an issue is unknown. I remain on the sideline waiting for a greater discount to TBV. That coupled with the lack of history and poor BV growth (understanding that yes they did indeed start up during the last cycles peak) leaves me anxious and not terribly comfortable with a long term holding. They seem destined for disaster.
Wednesday, July 20, 2011
Endurance Specialty Holdings ENH
Continuing with my tourist session of insurance holders. ENH is an insurer/reinsurer located in Bermuda and operates globally. Insurance constituted 1.1B of premiums in 2010 and consisted of Agriculture, professional, casualty, property and healthcare liability lines. Reinsurance premiums totaled 941M and consisted of catastrophe, casualty, property, aerospace & marine, and Surety/other specialty.
Stats: 0.7 P/TBV, 6.4 EV/EBITDA, 2.7% dividend, 8 year average ROA 5.32% vs current 1.79%, ROE has averaged 12.77% vs current 8.5%. BV has grown by 11.6% annually since 2003. Combined ratio 90.6% since inception.
The Good: Nice wide diversification (exposure?) to multiple lines. Agricultural line gives it a great play that most P&C insurers can't match. Their investment portfolio carries few derivatives and the portfolio duration (cash +fixed income) was 2.39 years in 2010 and has averaged <2.5 years for the past three years. Net earned yield= 3.32%, 4,97%, 2.35% for 2010, 2009, 2008 respectively. Blackrock owns 8.3% of SO and advises some of the investment management. Fidelity (Pyramis Global Advisors) owns 10.1% and offers the same advice. BV has greatly increased due to substantial share buybacks over the past year.
The Bad: The buybacks were mostly the result of Richard Perry selling his stake back to the company at 44.99/share. A large portion of their insurance line is tied to agricultural prices. Lower crop prices = more liabilities. Even with crop prices staying as high as they are combined ratio for Q1 2011 was 139.3%.
Conclusion: I haven't dug into management as much as AHL. There are some nice aspects to ENH and to a certain extent the investment risk seems slightly less (100bp rise in interest rates equals -127M for ENH vs. -197M for AHL). With that said the scary thing is why did Richard Perry sell his huge stake back? And why at a lower price than BV? Presumably he's a smart guy who gets the insurance industry, why on earth would he sell at such a discount? Coupled with the issues concerning crop prices being very high and the combined ratio being higher than most insurers I will pass. With diluted BV at 51.52 currently under 35/share will warrant more investigation. No position.
Stats: 0.7 P/TBV, 6.4 EV/EBITDA, 2.7% dividend, 8 year average ROA 5.32% vs current 1.79%, ROE has averaged 12.77% vs current 8.5%. BV has grown by 11.6% annually since 2003. Combined ratio 90.6% since inception.
The Good: Nice wide diversification (exposure?) to multiple lines. Agricultural line gives it a great play that most P&C insurers can't match. Their investment portfolio carries few derivatives and the portfolio duration (cash +fixed income) was 2.39 years in 2010 and has averaged <2.5 years for the past three years. Net earned yield= 3.32%, 4,97%, 2.35% for 2010, 2009, 2008 respectively. Blackrock owns 8.3% of SO and advises some of the investment management. Fidelity (Pyramis Global Advisors) owns 10.1% and offers the same advice. BV has greatly increased due to substantial share buybacks over the past year.
The Bad: The buybacks were mostly the result of Richard Perry selling his stake back to the company at 44.99/share. A large portion of their insurance line is tied to agricultural prices. Lower crop prices = more liabilities. Even with crop prices staying as high as they are combined ratio for Q1 2011 was 139.3%.
Conclusion: I haven't dug into management as much as AHL. There are some nice aspects to ENH and to a certain extent the investment risk seems slightly less (100bp rise in interest rates equals -127M for ENH vs. -197M for AHL). With that said the scary thing is why did Richard Perry sell his huge stake back? And why at a lower price than BV? Presumably he's a smart guy who gets the insurance industry, why on earth would he sell at such a discount? Coupled with the issues concerning crop prices being very high and the combined ratio being higher than most insurers I will pass. With diluted BV at 51.52 currently under 35/share will warrant more investigation. No position.
Monday, July 11, 2011
Valuation of GNI
GNI is a royalty trust with a great yield, clean balance sheet and one big problem. Its going to be dissolved no later than April 6, 2015, 3.75 years from now. I wanted to see in today's high dividend loving (it seems people are blindly going into REITs and other trusts with high yields) what GNI is actually worth taking simply the expected payouts in a couple of different scenarios. The expected final payout is $8.22 and this year payouts totaled $5.25.
I assumed three different rates of royalty payments.
Bull scenario assumes royalty rates increase by 10% compounded annually. The final distribution would be $10 and this year would generate an two more payments totaling $8.
Bear scenario assumes royalty rates stay the same, the final distribution is $8.22 and the next two quarters would equal the first 6 months distribution ($5.25).
Super bull scenario assumes royalty rate compound annually at 15%, the final distribution is $16.44(just double whats currently expected), and the next two quarters will total 8.84 (1.15*12.25-5.25).
So all things being equal it appears I completely failed to understand the business or there is a lot of weird buying going on. Perhaps I need to be more aggressive in my assumptions but I think this represents a pretty good short opportunity where people haven't fully understood their investment. "A good yield? Well then a good addition to my portfolio."
Of note too is that over 1/2 of their pension funds are placed in ETF's indexed against the S&P 500. As the S&P 500 goes so does their pension plan. Any fall in a broad based index would increase total liabilities. They have numerous treasury bonds and corporate bonds. Should interest rates begin to rise it is likely the value will fall. Unless they plan on holding until the last possible minute, in this case April 6, 2015. No position.
I assumed three different rates of royalty payments.
Bull scenario assumes royalty rates increase by 10% compounded annually. The final distribution would be $10 and this year would generate an two more payments totaling $8.
Bear scenario assumes royalty rates stay the same, the final distribution is $8.22 and the next two quarters would equal the first 6 months distribution ($5.25).
Super bull scenario assumes royalty rate compound annually at 15%, the final distribution is $16.44(just double whats currently expected), and the next two quarters will total 8.84 (1.15*12.25-5.25).
So all things being equal it appears I completely failed to understand the business or there is a lot of weird buying going on. Perhaps I need to be more aggressive in my assumptions but I think this represents a pretty good short opportunity where people haven't fully understood their investment. "A good yield? Well then a good addition to my portfolio."
Of note too is that over 1/2 of their pension funds are placed in ETF's indexed against the S&P 500. As the S&P 500 goes so does their pension plan. Any fall in a broad based index would increase total liabilities. They have numerous treasury bonds and corporate bonds. Should interest rates begin to rise it is likely the value will fall. Unless they plan on holding until the last possible minute, in this case April 6, 2015. No position.
Thursday, July 7, 2011
MERC Mercer International
Business/Thesis: MERC operates as a producer of pulp kraft, processing softwood and hardwood pulp. Notoriously cyclical business but a recent pull back in prices and the small cap nature leaves me interested. They operate three mills, two in Germany and one in Canada. They are a Seattle based company that reports all results in Euro's (just confusing enough to deter some investors). I believe this could be a valuable alternative energy play, especially now that German is trying to eliminate nuclear energy.
Stats: EV/EBITDA 4.21, P/S 0.36, P/B 1.23, P/LFCF 10.3. 1 director bought shares in the past month. P/E is a bubblicious 3.4. 5 year revenue growth has averaged 2.6%.
Cyclical thoughts: So 22% of global softwood pulp demand is directly related to Chinese consumption. W. Europe is 28%. Softwood is the more expensive of the two and as that may be, end producers have been trying to substitute hardwood in for softwood. This has disadvantages though and there is a "floor" for the amount of hardwood that can be introduced.
Demand/capacity ratios for the industry are 93%, 91%, 89% for 2010, 2009, and 2008 respectively. The big concern with this ratio is that worldwide it was estimated that 5.3million tons of NBSK were indefinitely closed 2006-2009, but 1.9 million tons were restarted from late 2009-2010. Should pulp prices remain high additional capacity can be added on. How quickly is an unknown. Its a classical cyclical nonetheless.
Why MERC? A lot of paper/pulp companies are trading at low valuations currently, to me indicating a peak in the cycle (analysts have begun to justify these and others because of their low P/E's...). I can't jump on pure pulping companies like UFS based simply on dirt cheap relative valuations and optimistic outlooks that Chinese consumption will remain strong in the face of inflation. MERC for me is going to be tied to the price of pulp on the market and for a while will continue to fluctuate as prices drop/rise.
To me though there is one big caveat that is relatively unknown, the energy producing facilities. All three mills of MERC produce their own energy from internally generated black liquor. All three mills create a surplus to the tune of 520,005 MWh in 2010. With the Celgar mill revamped expected production is >700,000 MWh. Last year energy production was Euro 44.2million, at 2008 (lowest demand for pulp in many years) sill sold 456,059 MWh to the grid. With the newly enhanced Celgar mill I calculate that energy productions could add total ~59M Euro of revenue. No other paper/pulp producer that I found was even as close to net energy positive as MERC.
The beauty of this to me is two fold. First and foremost it truly is renewable energy coming from trees. Second because its coupled to an actual profitable industry its going to be economically feasible. Two of the mills are located in Germany, with Germany recently banning nuclear the lost energy will have to be made up somehow. Typical carbon sources and renewable energy will fill the gap. A large portion of MERC's energy capex has been subsidized by the Canadian and German government and with the new legislative movement I see no reason why that will stop. Even if it does MERC in my eyes still represents the cheapest renewable energy source, which people will pay a slight premium for.
Debt covenants have severely restricted debt issuance on MERC, resulting in a company that needs to reduce Debt to EBITDA ratios from 13X to 4.5X in 2017. Obviously a lot can happen but with the energy production relatively stable and incredibly high margin (they would pay for it anyways) I think it warrants a good look to see if debt begins to decrease. Already it has dropped from 1039M in Dec 2010 to MRQ 975. Most of their employees are covered under union contracts, seem to have good relationships. Pension is underfunded by 24million.
Management has good levels of insider ownership at 6.2% SO, Chairman/CEO since 1992 owns 1.986M shares, took home 1,047,610 in compensation last year. At 11/share a lot of his wealth/motivation is intertwined with MERC shareholder returns, almost 20 years of salary.
Overview: I think this is a good company to play several macro trends but hesitate currently with high spot pulp prices. A multi-currency hedge is offered and upon a deleterious sell-off I would enter. With estimated energy revenues expected to generate Euro 59M soon a 10X valuation on 40% margins would give a MC of ~300M (10x EBIT seems to be a good starting common valuation for some energy producers). At this price you get the paper business for free. Even right now the electric business itself is worth ~200M (10X 40% margins on the Eu 44.2M generated last year). Currently with MC of 500M, you get the pulp business for 300M. No position.
7/12/2011: Talked it out and ran some new models. Its cheap just not extremely cheap. (Net income+D&A-CapEx)/EV gives numbers roughly in line with other pulp producers. A nasty correction below 8/share offers a compelling risk factor. Until then I'll hold off.
Update 7/13/2012
Mercer's shares have been creeping down. I spoke with their CFO at a conference in January and his words were "We're basically waiting for some of the high cost mills in Scandanavia to shut down and we should regain pricing power."
We are starting to see evidence that the high costs of pulping are indeed taking out some of the high cost producers, just not yet in in Scandanavia. This week a Tembec mill in Chetwynd, British Columbia announced they will be shutdown. This takes out 240,000 tonnes of capacity. This is 0.3% of all pulping capacity in the world based on 59.4M mt of capacity (page 6).
Tembec's EVP Chris black stated "At today's price levels, it is virtually impossible to maintain viable operations given the current cost structure of the Chetwynd mill." The pulp used at this mill is commonly used in printing and writing papers and tissue and towelling. Similar end uses as NBSK, Mercer's product.
Stats: EV/EBITDA 4.21, P/S 0.36, P/B 1.23, P/LFCF 10.3. 1 director bought shares in the past month. P/E is a bubblicious 3.4. 5 year revenue growth has averaged 2.6%.
Cyclical thoughts: So 22% of global softwood pulp demand is directly related to Chinese consumption. W. Europe is 28%. Softwood is the more expensive of the two and as that may be, end producers have been trying to substitute hardwood in for softwood. This has disadvantages though and there is a "floor" for the amount of hardwood that can be introduced.
Demand/capacity ratios for the industry are 93%, 91%, 89% for 2010, 2009, and 2008 respectively. The big concern with this ratio is that worldwide it was estimated that 5.3million tons of NBSK were indefinitely closed 2006-2009, but 1.9 million tons were restarted from late 2009-2010. Should pulp prices remain high additional capacity can be added on. How quickly is an unknown. Its a classical cyclical nonetheless.
Why MERC? A lot of paper/pulp companies are trading at low valuations currently, to me indicating a peak in the cycle (analysts have begun to justify these and others because of their low P/E's...). I can't jump on pure pulping companies like UFS based simply on dirt cheap relative valuations and optimistic outlooks that Chinese consumption will remain strong in the face of inflation. MERC for me is going to be tied to the price of pulp on the market and for a while will continue to fluctuate as prices drop/rise.
To me though there is one big caveat that is relatively unknown, the energy producing facilities. All three mills of MERC produce their own energy from internally generated black liquor. All three mills create a surplus to the tune of 520,005 MWh in 2010. With the Celgar mill revamped expected production is >700,000 MWh. Last year energy production was Euro 44.2million, at 2008 (lowest demand for pulp in many years) sill sold 456,059 MWh to the grid. With the newly enhanced Celgar mill I calculate that energy productions could add total ~59M Euro of revenue. No other paper/pulp producer that I found was even as close to net energy positive as MERC.
The beauty of this to me is two fold. First and foremost it truly is renewable energy coming from trees. Second because its coupled to an actual profitable industry its going to be economically feasible. Two of the mills are located in Germany, with Germany recently banning nuclear the lost energy will have to be made up somehow. Typical carbon sources and renewable energy will fill the gap. A large portion of MERC's energy capex has been subsidized by the Canadian and German government and with the new legislative movement I see no reason why that will stop. Even if it does MERC in my eyes still represents the cheapest renewable energy source, which people will pay a slight premium for.
Debt covenants have severely restricted debt issuance on MERC, resulting in a company that needs to reduce Debt to EBITDA ratios from 13X to 4.5X in 2017. Obviously a lot can happen but with the energy production relatively stable and incredibly high margin (they would pay for it anyways) I think it warrants a good look to see if debt begins to decrease. Already it has dropped from 1039M in Dec 2010 to MRQ 975. Most of their employees are covered under union contracts, seem to have good relationships. Pension is underfunded by 24million.
Management has good levels of insider ownership at 6.2% SO, Chairman/CEO since 1992 owns 1.986M shares, took home 1,047,610 in compensation last year. At 11/share a lot of his wealth/motivation is intertwined with MERC shareholder returns, almost 20 years of salary.
Overview: I think this is a good company to play several macro trends but hesitate currently with high spot pulp prices. A multi-currency hedge is offered and upon a deleterious sell-off I would enter. With estimated energy revenues expected to generate Euro 59M soon a 10X valuation on 40% margins would give a MC of ~300M (10x EBIT seems to be a good starting common valuation for some energy producers). At this price you get the paper business for free. Even right now the electric business itself is worth ~200M (10X 40% margins on the Eu 44.2M generated last year). Currently with MC of 500M, you get the pulp business for 300M. No position.
7/12/2011: Talked it out and ran some new models. Its cheap just not extremely cheap. (Net income+D&A-CapEx)/EV gives numbers roughly in line with other pulp producers. A nasty correction below 8/share offers a compelling risk factor. Until then I'll hold off.
Update 7/13/2012
Mercer's shares have been creeping down. I spoke with their CFO at a conference in January and his words were "We're basically waiting for some of the high cost mills in Scandanavia to shut down and we should regain pricing power."
We are starting to see evidence that the high costs of pulping are indeed taking out some of the high cost producers, just not yet in in Scandanavia. This week a Tembec mill in Chetwynd, British Columbia announced they will be shutdown. This takes out 240,000 tonnes of capacity. This is 0.3% of all pulping capacity in the world based on 59.4M mt of capacity (page 6).
Tembec's EVP Chris black stated "At today's price levels, it is virtually impossible to maintain viable operations given the current cost structure of the Chetwynd mill." The pulp used at this mill is commonly used in printing and writing papers and tissue and towelling. Similar end uses as NBSK, Mercer's product.
Thursday, June 23, 2011
Aspen Insurance AHL
Aspen Holdings Insurance (AHL)
All figures from 6/23/2011
Company: Based in Bermuda, AHL operates as an insurer and reinsurer, providing services in the property, casualty, surplus and liability insurance lines for clients around the world. For the year ending Dec 31, 2010 they generated $2,076.8million from premiums.
Thesis: AHL is a fundamentally sound, undervalued business trading well below book value. It is my hypothesis that current myopic beliefs have kept this business at a suppressed valuation. A combination of low interest rates, a soft insurance cycle, and numerous catastrophic events have investors extrapolating losses ad infinitum. An investor with patience though should see that AHL offers an attractive margin of safety and a well-defined upside. Seeing Zeke Ashton, David Einhorn, and Whitney Tilson pile into it too gives me confidence as well (perhaps a bit of confirmation bias).
Summary Information:
Table 1. Relative Valuations for Reinsurance companies
As can be seen above AHL is trading at a considerable discount to its peers despite a history of prudent risk management (combined ratio <100%) and good business practice (13% BV growth rate). Despite this, a steep discount is being offered helping mitigate and reduce the down side of a potential investment.
Collectively we can see that the industry as a whole is trading under BV. Currently the industry is in a soft cycle and a perfect storm of low interest rates, low premium rates, residual hangover from the financial crisis, and numerous natural catastrophes have suppressed valuations. There is considerable evidence though that these will not become permanent fixtures and eventually a hard insurance market will prevail.
Typically it has taken major catastrophes and sharp reduction in surpluses to induce a hard market. As can be seen on the next table the last two hard markets could have been caused by a “Black Swan” style catastrophe. Catastrophe related insurance losses were unsurpassed. Perhaps numerous smaller, but still expensive events, could perform the same action? For all of 2010 total losses due to catastrophe cost $40B, in just Q1 of 2011 losses exceeded $35B (2011-10K).
Table 2. Insurance Cycles
Obviously a two point analysis doesn’t justify an end all belief that a hard market is around the corner. It does lend some credence to the fact that bad things have happened before and the industry has survived. There are some expectations that premiums will increase by 50% over the next 1-4 years1 due to the catastrophes of this year. The Deepwater Oil Rig explosion gave way to rate increases averaging 20% within AHL’s Energy &Energy Liabilities division.
Aspen has taken all of the aforementioned issues and still managed to be consistently profitable and shareholder friendly since going public in 2003.
Business: AHL’s business lines are split very equal along reinsurance and insurance. 40% of all premiums are written to cover the US&Canada. With a five year combined ratio average at 88% the business has been profitable and managed to avoid underwriting at a loss to gain growth or access to float. 2008 was considered a soft year, 2009 a somewhat hard year and 2010 returned softer.
Table 3. Premiums for Reinsurance and Insurance
Twelve Months Ended | Twelve Months Ended | Twelve Months Ended | ||||||||||||||||||||||
December 31, 2010 | December 31, 2009 | December 31, 2008 | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Written | Written | Written | ||||||||||||||||||||||
Reinsurance | Premiums | % of Total | Premiums | % of Total | Premiums | % of Total | ||||||||||||||||||
($ in millions, except for percentages) | ||||||||||||||||||||||||
Australia/Asia | $ | 95.6 | 8.2 | % | $ | 71.2 | 6.1 | % | $ | 57.7 | 5.2 | % | ||||||||||||
Caribbean | 4.3 | 0.4 | % | 1.9 | 0.1 | % | 2.2 | 0.2 | % | |||||||||||||||
Europe | 96.9 | 8.3 | % | 64.3 | 5.5 | % | 76.1 | 6.8 | % | |||||||||||||||
UK | 23.8 | 2.0 | % | 26.8 | 2.3 | % | 40.5 | 3.6 | % | |||||||||||||||
US& Canada(1) | 564.5 | 48.6 | % | 659.3 | 56.1 | % | 648.1 | 58.2 | % | |||||||||||||||
Worldwide excluding US(2) | 55.4 | 4.8 | % | 67.3 | 5.7 | % | 70.1 | 6.3 | % | |||||||||||||||
Worldwide including US | 291.9 | 25.1 | % | 273.3 | 23.2 | % | 201.6 | 18.1 | % | |||||||||||||||
Others | 29.8 | 2.6 | % | 11.9 | 1.0 | % | 18.0 | 1.6 | % | |||||||||||||||
Total | $ | 1,162.2 | 100.0 | % | $ | 1,176.0 | 100.0 | % | $ | 1,114.3 | 100.0 | % | ||||||||||||
December 31, 2010 | Dec 31, 2009 | December 31, 2008 | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Written | Written | Written | ||||||||||||||||||||||
Insurance | Premiums | % of Total | Premiums | % of Total | Premiums | % of Total | ||||||||||||||||||
($ in millions, except for percentages) | ||||||||||||||||||||||||
Australia/Asia | $ | 6.2 | 0.7 | % | $ | 13.2 | 1.5 | % | $ | 12.7 | 1.5 | % | ||||||||||||
Caribbean | 3.6 | 0.4 | % | 0.6 | 0.1 | % | 0.8 | 0.1 | % | |||||||||||||||
Europe | 7.7 | 0.8 | % | 14.5 | 1.6 | % | 26.7 | 3.0 | % | |||||||||||||||
UK | 117.8 | 12.9 | % | 104.8 | 11.8 | % | 147.6 | 16.6 | % | |||||||||||||||
US & Canada(1) | 275.0 | 30.1 | % | 265.2 | 29.7 | % | 278.6 | 31.4 | % | |||||||||||||||
Worldwide excluding United States(2) | 90.6 | 9.9 | % | 83.3 | 9.3 | % | 42.8 | 4.8 | % | |||||||||||||||
Worldwide including United States(3) | 381.4 | 41.7 | % | 386.5 | 43.4 | % | 351.8 | 39.6 | % | |||||||||||||||
Others | 32.3 | 3.5 | % | 23.0 | 2.6 | % | 26.4 | 3.0 | % | |||||||||||||||
Total | $ | 914.6 | 100.0 | % | $ | 891.1 | 100.0 | % | $ | 887.4 | 100.0 | % | ||||||||||||
A big part of insurance is setting aside appropriate reserves for losses. Too much you're just limiting returns and being overly conservative, too little and impairment may occur. AHL has had a cumulative redundancy has been run every single year since 2002 consistently and with no deficit. Leaders of insurance including RenaissanceRe holdings have also run a positive, consistent cumulative redundancy. RNR has an average cumulative redundancy of 5.7% of total assets and AHL comes in at 3.5%. This to me suggests that, while major differences in business may be present at the very least AHL is doing a respectable job of estimating loss reserves.
Expenses have stayed consistent and the expense ratio of premiums written has been consistent at ~30%, in line with other insurers and reinsurance companies.
Investments: The 800lb gorilla is the black box of float what AHL is doing with it. Aspen returned 4.8% on its investments in 2010 compared to 6.1% in 2009. Approximately 70% of the portfolio is fixed income investments carrying an average maturity of 2.9 years (2.5 years unaudited Q1 10Q 2011), down from 3.3 years in 2009.
Table 4. Fixed Income portion of AHL
As at December 31, 2010 | ||||||||||||||||
Cost or | Gross | Gross | Estimated | |||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
($ in millions) | ||||||||||||||||
U.S. Government Securities | $ | 701.5 | $ | 25.5 | $ | (1.6 | ) | $ | 725.4 | |||||||
U.S. Agency Securities | 278.7 | 23.6 | — | 302.3 | ||||||||||||
Municipal Securities | 31.1 | 0.4 | (0.8 | ) | 30.7 | |||||||||||
Corporate Securities | 2,208.4 | 121.0 | (3.7 | ) | 2,325.7 | |||||||||||
Foreign Government Securities | 601.0 | 16.9 | (1.0 | ) | 616.9 | |||||||||||
Asset-backed Securities | 54.0 | 4.8 | — | 58.8 | ||||||||||||
Non-agency Commercial Mortgage-backed Securities | 119.7 | 8.4 | — | 128.1 | ||||||||||||
Agency Mortgaged-backed Securities | 1,126.4 | 48.7 | (2.6 | ) | 1,172.5 | |||||||||||
Total Fixed Maturities — Available for Sale | $ | 5,120.8 | $ | 249.3 | $ | (9.7 | ) | $ | 5,360.4 | |||||||
As at December 31, 2009 | ||||||||||||||||
Cost or | Gross | Gross | Estimated | |||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
($ in millions) | ||||||||||||||||
U.S. Government Securities | $ | 492.1 | $ | 17.4 | $ | (2.0 | ) | $ | 507.5 | |||||||
U.S. Agency Securities | 368.6 | 20.7 | (0.2 | ) | 389.1 | |||||||||||
Municipal Securities | 20.0 | — | (0.5 | ) | 19.5 | |||||||||||
Corporate Securities | 2,178.1 | 90.3 | (3.8 | ) | 2,264.6 | |||||||||||
Foreign Government Securities | 509.9 | 13.9 | (1.5 | ) | 522.3 | |||||||||||
Asset-backed Securities | 110.0 | 5.1 | — | 115.1 | ||||||||||||
Non-agency Residential Mortgage-backed Securities | 34.2 | 8.6 | (0.6 | ) | 42.2 | |||||||||||
Non-agency Commercial Mortgage-backed Securities | 178.5 | 2.5 | (1.0 | ) | 180.0 | |||||||||||
Agency Mortgage-backed Securities | 1,172.9 | 40.2 | (3.5 | ) | 1,209.6 | |||||||||||
Total Fixed Maturities — Available for Sale | $ | 5,064.3 | $ | 198.7 | $ | (13.1 | ) | $ | 5,249.9 | |||||||
All fixed income, less the 119M of non-agency backed MBS, is rated AA or higher. I take this with a grain of salt. There were no Level 3 investments as of 3/31/2011.
Management: Management for AHL includes industry veterans from Lloyds, White Mountain and other respectable insurance companies. The top brass including CEO, CRO, CFO have all been with the company since founding and becoming a publically traded company in 2003. Insider ownership is present, but in my opinion, not at the levels or methods desired. CEO Christopher Kane age 54, is an industry veteran and owns 1.292m shares. Total director/executive ownership represents 3.3% of shares outstanding; most have been acquired through option based compensation which is based upon ROE numbers. Higher ROE= higher compensation. Bonuses start at 7% ROE and taper off at 20%. The companies targeted ROE is 12%. I see no material conflict of management that could result in a permanent loss of capital.
A large block of shares (5.7million) were bought at prices estimated at 12-25% higher than currently being traded(Q4 2010 range 28-31.50).This was followed up by a purchase of 542,736 shares concluding March 14, 2011. Clearly management things the shares are undervalued. As a bonus dividends are consistently paid at 0.60/year yielding 2.4% as of 6/23/11.
Valuation:
I conclude that historical valuations and reversion to the mean will allow us to estimate intrinsic value for AHL. Current BV is 43.22 per share, while fully diluted is 38.90. After several 10Q/K's there seems to be nothing terrible on the balance sheet. Since becoming a public traded company in 2003 the average P/BV for AHL has been 0.9(Morningstar). Based upon that simple valuation the upside is 72%, 55% fully diluted. Compared to other insurers though AHL has traded at a reduced P/BV, with most insurers trading at a slight premium to stated BV.
With an average BV growth of >13% over the past five years and trading at 0.59 stated BV there is significant upside to AHL, I estimate at least fully diluted BV at 38.90/share for intrinsic value. This makes no account for a rise in interest rates, a firming of premiums, or significant share buybacks/increase in BV. Even with a 15% reduction in BV there still stands plenty of upside at today’s current depressed price.
To show the true depressed levels that the share price exists at consider this. If all assets were converted to cash (or something with zero return) they would stand at $9298 million. If total liabilities, currently $6247 million, were to increase by 10% annually, it would take two years for BV to decrease to current market price. This (admittedly) simple exercise shows with no additional premiums (which historically have generated a 12% profit), and no interest on any investment (no chance for default either) and increasing liabilities compounding we could then achieve appropriate valuation. I do not think this will happen, the simple math was done to show what could occur in a reasonable time to achieve appropriate valuation as based on today’s price.
I believe based on past performance, management, and a shift in the industry that currently high combined ratios will settle back to their mean and offer profitable lines of insurance. If premiums begin to harden, interest rates rise, there aren't 800 catastrophes etc, there is good reason to believe net income could rise to previous levels and contribute to cumulative owners earnings in the form of increased book value, dividends, and share buybacks. In 2009 net income was $474m and I would consider this a very reasonable income achievement.
The company has been pushing to extend offices into Latin America and Asia. Capex has increased as a result but still remains low at under 2% of Premiums written. I have excluded growth from my analysis.
Risks:
1.
Poor investment decisions: I feel I can use history as a good proxy of the future. Investment income in 2008 was $139 million, while significantly reduced compared to 2009’s $248 million it gives a good proxy for income when the world is falling apart and the financial world as we know it is coming to an end. Currently only 14million of fixed income investments reside in PIIGS Euro-denominated bonds, all of which is invested in Spain. There is no direct exposure to either Greece or Portugal2.
Poor underwriting standards: AHL has been consistently profitable and attained combined ratios under 100 for the past five years. In 2005 a combined ratio of 122 occurred as they had significant exposure to Hurricane Katrina, the costliest natural disaster to date. In their Q1 2011 10Q it was stated Reinsurance premiums fell, some of the reason was pricing concerns, too low of a price to take the risk. It appears prudence is at least being attempted.
Premium rates stay low: There is indication already that rates have begun to increase, as shown in the 2011 10K concerning Energy & Energy Liabilities and discussed further by Chief Risk Officer Julian Cusack3
Decaying balance sheet: Since compensation is based on ROE it will be imperative to monitor debt levels. Currently total debt+hybrid securities represent 22.8% of capital. This number has remained consistent, in 2007 it was 21.8%(10K 2008). If that ratio rises it will be most prudent to examine quickly the cause as it may be management juicing its returns. They hold 1 billion in interest rate swaps, something to consider.
Poor underwriting standards: AHL has been consistently profitable and attained combined ratios under 100 for the past five years. In 2005 a combined ratio of 122 occurred as they had significant exposure to Hurricane Katrina, the costliest natural disaster to date. In their Q1 2011 10Q it was stated Reinsurance premiums fell, some of the reason was pricing concerns, too low of a price to take the risk. It appears prudence is at least being attempted.
Premium rates stay low: There is indication already that rates have begun to increase, as shown in the 2011 10K concerning Energy & Energy Liabilities and discussed further by Chief Risk Officer Julian Cusack3
Decaying balance sheet: Since compensation is based on ROE it will be imperative to monitor debt levels. Currently total debt+hybrid securities represent 22.8% of capital. This number has remained consistent, in 2007 it was 21.8%(10K 2008). If that ratio rises it will be most prudent to examine quickly the cause as it may be management juicing its returns. They hold 1 billion in interest rate swaps, something to consider.
These represent a few of the potential risks facing AHL and by no means represent an exhaustive list. Being an insurer, we (or more appropriately I) have little in way of knowing exactly what is going on inside. What risks are being taken (see AIG), and what investments are being made are not made inherently clear to all. With an appropriate margin of safety though one can surmise the potential downfalls are negated and the downside is protected. A.M. Best rates all AHL's subsidiaries "A", historically companies with an "A" rating have a 5.33% impairment rate for a 10 year period4. AIG had great ratings too, simply another measure for understanding.
Links:
Zeke Ashtons presentation: http://www.benzinga.com/life/hedge-funds/10/10/523209/neglected-hated-and-feared-zeke-ashtons-presentation-from-the-value-in
(4) http://www.ambest.com/ratings/methodology/impairment.pdf
6/27/2011: Threw in an order for the tax sheltered accounts. I feel this is a compelling buy with an adequate margin of safety. I also believe it adds strength overall to my portfolio. The position is about 3.8% for the accounts I manage. I'll reassess at under 21/share. There we will be about 1/2 TBV and a good time to add or eliminate. I'm going through other insurers and hope to post some thoughts soon. Long AHL.
6/27/2011: Threw in an order for the tax sheltered accounts. I feel this is a compelling buy with an adequate margin of safety. I also believe it adds strength overall to my portfolio. The position is about 3.8% for the accounts I manage. I'll reassess at under 21/share. There we will be about 1/2 TBV and a good time to add or eliminate. I'm going through other insurers and hope to post some thoughts soon. Long AHL.
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