Asmus Puhl Finance Blog

Our guest author, economist John Gault, recently discussed

“Stepping back: where the Global Economic Crisis is headed”

at a Geneva Conference about “Cross-border and offshore banking”.

You can find this very interesting article now on our in-depth analysis web site.

Enjoy!

So the stock is up but how do the numbers look like?

What could one expect given the current economic environment?

Colfax posted net income of $4.4 mil (0.10 $ /share basic and diluted) in Q2 2009

Adjusted net income (which backs out restructuring charges and asbestos related costs) was $8.5 mil ($ 0.20 / share), a decrease of 38.8%. This includes a negative currency effect of 4 cts/share.

Net sales were $ 129.2 mil, a decrease of 20% year over year.

Only in the segment „Global Navy and Commercial Marine End Markets” sales were up.

Orders in the second quarter were $ 104.1 mil, a decrease of 44.9%

Brutal numbers indeed!

But the CEO was rather upbeat on the conference call given the current environment.

Colfax Corp. rapidly started a cost reduction program of $ 13 mil until the end of 2009 and if necessary further cost reductions can be implemented.

He points to the healthy balance sheet: the debt/EBITDA ratio is 1.

As acquisitions are part of Colfax’s business model they also mention an improving „acquisitions pipeline”.

Perhaps the best news are – if all goes well – that the legacy asbestos problem goes to trial in october and Colfax awaits a definitive solution at the end of this year.

…….  continues  …..

Today Colfax Corp.  (NYSE: CFX) reached $ 12.10 in an overall positive market.

This blog first discussed Colfax on May16th of this year. Then the price was $ 7.27

Until today this means a performance of 66%, by far outperforming the overall market!

……… Dear Reader, I hope you were invested!

On this blog we will have a look at the latest Q2 2009 results of Colfax published recently and we will discuss whether they justify this performance!

Stay tuned!

Also Markel came out with its Q2 2009 Earnings Report yesterday:

http://phx.corporate-ir.net/phoenix.zhtml?c=104364&p=irol-newsArticle&ID=1317391&highlight=

They reported book value of $ 239.68 per common share at June 30, 2009, up 8% from $ 222.20 at december31, 2008.

The combined ratio in Q2 2009 was 99% compared to 95% in Q2 2008.

Today August 06, 2009, they will host their conference call. If you like to listen, here is the link:

http://phx.corporate-ir.net/phoenix.zhtml?p=irol-eventDetails&c=104364&eventID=2358584

Enjoy!

Colfax reported Q2 and Half Year 2009 results on August 4th!

Here is the link:

http://finance.yahoo.com/news/Colfax-Reports-Second-Quarter-prnews-2007607197.html?x=0&.v=1

We will discuss these results later on this blog.

But how to value Markel’s stock?

To value an insurance company is not an easy task. Insurance companies depend a lot of management’s quality:

Are they able to price adequately policies?

How exact are their loss estimates and their loss reserves?

Insurance companies are not such a leveraged risky business model as banks as we all had to learn in 2008 and 2009 but nevertheless management mistakes can wipe out the float or the company whole together.

Net earnings and their multiples are not very meaningful when you value an insurance company:

Earnings can be great if the company does not reserve properly for eventual future losses. When later losses hit the company, it has to record big losses or even becomes an endangered species.

So how to mesure the value of its float?

Markel measures itself by „book value/share”, its stockholder’s equity divided by the number of outstanding shares.

Let’s have a look at the price-to-book value ratio.

In normal times the stock market values a good insurer at 2 times book value. More can be a too rich valuation and less can hint at problems. Or a difficult market like today temporarely undervalues the true value of insurance companies.

Markel’s book value/share at the end of the first quarter 2009 was $ 222.14

It’s share price at present sits at $ 280 at present.

So if we simply assume the book value did not change until today, we get a price to book value ratio of 1.3.

Markel’s manegement is excellent. Markel views its shareholders as business partners. There has never been a significant stock dilution in the history of this company.

Growth in book value averages 10-15% over the long term

1.3 times book value/share to me seems an interesting price for an outstanding company like Markel Corp.

What do you think?

They invest obviously in what they know best and so they have a high percentage invested in insurance companies.

As their equity investment criteria are very similar to those of Berkshire it certainly does not come as a surprise that their biggest investment is in Berkshire stock itself.

For more details on their holdings watch their latest SEC 13F Filing (date May 2009).

As Markel’s general goal is „to earn consistent underwriting profits and superior investment returns to build shareholder value” (Markel Annual Report 2008) they aim for an average annual return of at least 15% on their equity portfolio over the long term.

But obviously this all didn’t work well in 2008. As most of us they did not expect a market decline of this magnitude.

Markel’s return on its equity investment portfolio was – 34%. They went heavely down but still managed to outperform the S&P 500 index.

As they put it in their Annual Report: „The best thing we can say about 2008 is that it is over!”

But they believe that the insurance markets will improve beginning in 2009. „Unprofitable companies have to go out of business some day (with government help or without)”.

And they are rather bullish for the equity markets for the next decade seen the performance of the last ten years!

They know that the average historical performance of the S&P 500 index over the last 100 years was 11% (dividends reinvested) and there were always extended periods of flat or negative markets. So simply put stocks will not stay flat forever.

…. continues ….

In the last 8 years Markel’s (NYSE:MKL) combined ratio has varied considerably:

(Source: Markel Annual Report 2008)

The 2000 combined ratio was affected by the acquisition of Terra Nova and Gryphon which today form Markel International. Markel had to turn these companies around from insurance underwritten at unprofitable rates.

2001 was hit by a loss on the World Trade Center and another writedown at Markel International.

Despite the losses on hurricanes Katrina and Rita the combined ratio of FY 2005 was not worse than 101%.

In 2008 Markel achieved a combined ratio of 99% despite $ 95 mil of hurricane losses and competitive market conditions

Over the past 20 years Markel produced underwriting profits in 14 out of 20 years.

But the most appealing aspect of Markel is its ability to produce consistently superior investment income!

Like Buffett’s Berkshire Hathaway and unlike most insurers, Markel makes significant equity investments.

Roughly said Markel’s equity investments equal its stockholder’s equity. Its fixed income portfolio equals the float from policy holders.

The above mentioned Thomas Gayner is chief investment officer of Markel.

……. continues ……

Markel (NYSE: MKL) covers risk which larger more standardized companies are unwilling to cover.

As a speciality insurer its key competitive advantage is the expertise and experience of its specialist underwriters and its relationships with brokers and with the covered groups of clients. In many of its product lines it has an incredible retention rate of 90% or higher.

In its speciality markets Markel faces less competitors and less price competition than others in the standard insurance market.

Nevertheless Markel is so disciplined that it will not cover risk if the premium it can get is not adequate to compensate for it.

But the most interesting aspect of an insurance company is its ability to use “float” in order to generate investment income.

Oh .…. what is float?

Premiums are paid upfront to an insurer. This money is essentially free money that the insurer can invest until it has to be paid out for incurred losses of its policy holders.

Isn’t it incredible?

In virtually no other business than insurance clients give free money to a company so that it can earn a return of investment on it in order to keep it.

And this money is free if the insurer is able to maintain a combined ratio of 100 or less:

Oh ….. so what is that, a combined ratio?

Combined ratio is the combination of the “expense ratio”

(the percentage of underwriting expenses to net earned premiums)

and the “loss ratio”

(the percentage of insurance losses to net earned premiums).

If this combined ratio is 100 the insurer does not earn or lose money with its insurance activities. If the combined ratio is less than 100 the insurer already earns money before any investment return. The cost of capital received by its policy holders is negative.

For more on the importance of float read the letters to the shareholders of Berkshire Chairman Warren Buffett. A lot of the investment success of Berkshire Hathaway bases on the superior investment returns of the float of its insurance subsidiaries.

….. continues …..

When we recently discussed Colfax Corp. (NYSE: CFX) on this blog we pointed out that Tom Gayner, chief investment officer of Markel Corporation (NYSE: MKL), is one of its board members.

So why not take the opportunity and have a look at Markel itself?

Markel was founded by Sam Markel in the 1920’s as an insurance broker catering to the transportation industry. He organized the first mutual insurance company for operators of “jitney buses“ in the US.

You can read more about the interesting history of Markel here:

http://www.markelcorp.com/AboutMarkel/History/Pages/History2.aspx

The company remained mainly an insurance broker until going public in 1986.

By then Markel was convinced it had so much underwriting expertise in insuring unusual risks that the strategic focus of the company began to shift from insurance brokerage and services to underwriting.

Markel expanded rapidly as a speciality insurer in a variety of niche markets and with its Terra Nova acquisition in 2000 it entered the international market.

Two grandsons of Sam Markel still serve as vice chairmans of the board.

Markel’s underwriting business is subdivided in 3 categories:

DIVISIONS	GROSS PREMIUMS in FY 2008	EARNED PREMIUMS in FY 2008
US Excess & Surplus	1,164 $ mil	1,029 $ mil
Speciality Admitted	355 $ mil	321 $ mil
International Markets	693 $ mil	618 $ mil

(source: MKL – 10K 2008)

As we can see more than half of Markel’s business falls into the  “US Excess & Surplus“ category.  It provides additional coverage in excess of standard insurance contracts which the larger insurance companies are not willing to provide.

This requires exactly the specialized underwriting knowledge and experience in niche markets which Markel built up for years.

“Speciality admitted“:  In this category Markel operates as a licensed insurer for hard-to-place insurance as mobile homes, health and fitness facilities, horse farms etc.

“Markel International” operates in the London market and covers hard-to-place insurance on an international level.

… continues …