MKL – Markel – August 1st 2024:
We are betting more on the jokey than we are on the business. We are extremely biased with the calibre of the management because we adore and admire Thomas Gayner. We may be as blindsided with Thomas Gaynor as we were with Frans Van Houten (Philips NV). We might know what the business does but we really do not understand the insurance industry. Both of us have a slightly different method of valuing the business- neither of which is in detail. We have merely done a conservative (according to us) yet general back of the envelope valuation and made the 1st position in this stock at $1550.
What we still have to figure out and agree upon is - when should we sell the stock? How do we know that we were wrong in our thesis?
As of the writing,
- the business has a manageable debt of approximately $3.8 billion versus a net profit of about $2 billion per year
- Officers and directors own approximately 1.71% of the common stock
- Thomas Gaynor personally purchased shares from the open market in the beginning of 2024 (he agreed at a conference that he found the shares to be undervalued at the at the price he purchased - estimate that to be approximately $1300)
- has a record of taking more reserves than are really needed
- pension assets are greater than pension obligations
- has reduced outstanding shares from 13.99 million in 2013 to 13.13 million in 2023
- no dividends are being declared
- Buffett had a general rule of paying 1.2 times of book value for Berkshire stock to be repurchased.
The following are the risks that we identified:
a) The insurance side of business (Depending on the type of insurance they underwrite) does not have past the data to price the risk and this could be a possible detractor to future performance in the form of huge insurance payouts. (writing insurance they shouldn’t write and an epidemic/CNBC type event)
b) Human Nature: The insurance executives try to show growth in written premiums by sacrificing the quality of underwriting.
c) Accounting risk (two parts): Firstly Thomas Gayner has said that Markel (and he) has more conservative estimates of the reserves than are needed, but on the flip side, buys/acquires subsidiaries for Markel ventures by using the EBIT and EBITA multiple concepts. Secondly, Markel (and Thomas Gayner) value Markel ventures by the amount of EBIT and EBITDA they generate - this is contradictory to how WEB valued his operating subsidiaries.
d) ILS (Insurance Linked Securities): This is something new that they have introduced to contain risk. They are the first players in this game and therefore any new hot buzzword is always a red flag. This were the 4 risks identified on the operating side of businesses (as of August 1st 2024).
e) The market venture side of the business faces the risk just in the same way as private equity because there exists the risks of overpaying (paying too much for too little value in return i.e ISCAR type of deal with WEB) and secondly the risk of being blindsided by them wanting to close the deal (this however might be in check for as long as Thomas Gayner is at helm but you never know for sure).
Valuation of HH:
HH has gone for something that he calls asset-based earnings valuation. He assumes that Markel will earn approximately 7 percent (net) on assets of approximately $24 billion (current market value of the stocks plus bond portfolio). This translates to a net profit of approximately 1618M dollars. Applying a PE multiple of 11 implies a market cap of approximately $18.4 billion. This implies a current value of approximately $1421.00 per share at about 13 million outstanding shares. Ten years out applying the rule of 72 implies that the net profit would be approximately 3360M. Again applying a PE multiple of 11 implies market cap of approximately $36.9 billion. Assuming if outstanding shares remain constant at 13 million the per share value could be $2843. Value line predicts outstanding shares to be 8M by 2027-29 period. I personally find this to be very optimistic but it’s possible only if we experience a period of depressed values from the current overpriced valuations of the entire market in August 2024. By looking at the previous 10 years I expect the outstanding shares to be approximately 12 million which would imply a per share value of $3075 dollars. HH Has made a note of holding the stocks for as long as the bonds plus stocks portfolio are growing. He notes that MKL will not grow the portfolio but rather provide some stability.
Valuation of MH:
Markel initially came on our radar during Q2 2023 when Tom Russo added Markel to his portfolio. My remark at the time was “We got to buy it at about 16B Mcap implies a price of 1200 USD per share.” I cannot recall how that valuation was done. Markel was also added to two other portfolios during Q3 and Q4 2024 as well. However there are no comments for that. It once again came on the radar in Q1 2024 and my valuation at the time was as follows: has total debt of about 3.8 billion and a net debt of about 0.2 million. PE multiples have been around 20X+ but has come down since interest rates went up to 13-7-10-8x. Revenues grew from 4.3 billion to 16.6 billion in 10 years whereas operating margins ranged from 12-3-13-18% (current). Interest expense is approximately 180 million. And there is some preferred dividends an minority interest being given out. PAT margins at 6-10-18-8-12% (current). OS from 12.59 to 13.3M over the last 10 years. I came up with the future market cap of 13.2-19.8-23.4-26.4B (I can’t say if this was a 5/10 year valuation and neither can I remember how I got this numbers. The above valuation was done in Q1 2024).
Five years out I assume revenues to be in the range of 20-21-22 billion. I assume profit margins of 6% to 9% to 12%. Applying AP multiple of 8X, 10X and 13X implies a market cap of 9.6 billion, 18.9 billion and 34 billion. Average market cap comes to about $20.8 billion ($1600 per share 5 yrs out). Applying a at 20% margin of safety in this case, results in a market cap of $16.64 billion ($1280 per share). This valuation (revenues and profit margins) includes (a) interest and dividend income and (b) gain or loss on sale of investments. These numbers however do not include the per share value of the stock and bond portfolio at its current market value of approximately $24 billion.
This however should not be seen as a stand alone asset on a per share basis because this is recorded as a part of assets on the balance sheet with liabilities on the other side of the balance sheet. Total assets - total liabilities = common equity; which might be a reliable substitute but it doesn’t make much sense in an insurance operation or the one that Markel has. This is how I would value the stocks and bond portfolio: I assume a market decline of about 30% and as a result an equal draw down on the market value of the stock and bond portfolio from 24B to 16.8B. In addition, I assume that reserves of 24 billion are off by 50% and therefore would require an additional $12 billion (which is to come out of the depressed stock and bond portfolio). This equates to 16.8B – 12B = 4.8B (This is what is left for equity holders, if Markel has had a disastrous year and survives, if it doesn’t, then all bets are off!). This implies a 4.8B/13M shares $369 per share of value. Adding this to the original $1600 avg value 5 years out, gives 1600+369 = $1969 value (on our conservative basis). On a best case basis, this would be 34000M/13M = 2615 +369 = $2984 value (Our best case. This could be higher because we have assumed a worst case for the $369 stock + bond portfolio value). On a worst case basis, this would be 9600M/13M = $738 + $369 = $1107 value per share. This concludes to $1107 on the downside, $1969 on a base case and $2984 on a best case basis. From the current price of $1550, this implies a downside of -$443 vs an upside of +$1434 (a 3.2x upside versus the downside).
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