Matt Franz : Zealous For Knowledge


Disclosure: I own shares of Markel.

Markel reported 2017 earnings this week which prompted me to update my intrinsic value estimate. Markel is similar to Berkshire – its corporate structure is optimized for superior capital allocation. Tom Gaynor oversees capital allocation and has an excellent track record of building shareholder value.

Markel, like Berkshire, has three profit engines: insurance underwriting, investments, and operating businesses (Markel calls these “Ventures”). I value Markel as the sum of these parts. This is a quick-and-dirty back-of-the-envelop method.

1. Underwriting

To value the underwriting franchise I average Markel’s combined ratio for the past five years and multiply one minus that times their 2017 premiums earned. Then I apply a 5x multiple to this normalized underwriting profit.

Average Combined Ratio = (97+95+89+92+105)/5 = 96

2017 Earned Premiums = $4*10^9

Value Of Underwriting Franchise = (1-0.96) * 4 * 10^9 = 160*10^6

2. Ventures

Markel Ventures produced $100 million of net income attributable to shareholders. But $37 million of this was a one time tax benefit. So I’m going to take $63 million and apply a 10x multiple to it. This gives me 630*10^6.

3. Investments

Markel has $20 billion of invested assets: $6 billion of equities, $10 billion of fixed income, and call it $3 billion of cash and equivalents. I give equities and cash a multiple of 1x. I want to discount the fixed income book to bring its pre-tax yield up to 10%. Since this is a quick-and-dirty valuation, I’m going to guess that the right multiple should be between 10% and 100%, so I’ll use the geometric mean of those which is 30%. So gross investments total $12*10^9.

Markel has $3 billion of debt, so I subtract this from gross investments to get net investments of $9 billion or 9,000*10^6.

The sum-of-the-part is therefore: 800 (underwriting)+630(ventures)+9,000(net investments) = 10,430*10^6.

There are 14 million shares outstanding, which means that intrinsic value per share is roughly 10,430/14 or about $750 per share. This is close to Markel’s reported book value per share of $685. It makes sense that these are very close together since the dominant component of my valuation is net investments.

Markel’s market price is about $1,100, so it’s trading around 1.5-1.6x intrinsic value.

If I use more aggressive multiples (10x underwriting profits, 1x fixed income securities) I calculate intrinsic value as $18.2 billion or $1,300 per share. The dominant factor here is the value I assign to Markel’s bonds. These are held against insurance liabilities and are financed by float. If you pay $1 per $1 of bonds, that’s okay, but you are not getting anything “free” from the float then. You’re buying a bunch of low yielding bonds which will dilute your performance as a pure equity investor. I prefer to pay a price which will give me a 10% pre-tax return, which is the minimum I’m after when I buy a stock.

When you look at book value or intrinsic value as I calculated it, you are thinking about Markel as a picture – just a shot in time. A more comprehensive (and qualitative) analysis would consider Markel as a movie – what will it do in the future?

Here’s where we need to think about future capital allocation. If it is going to be good, then intrinsic value should grow at an above market rate (>10% CAGR). It would be fair for the market to value Markel at a premium to its immediate intrinsic value (today’s picture) in anticipation of some future growth (the movie) if growth was going to be above-market.

Over the past five years Markel’s book value per share has compounded at 11% annually. This isn’t bad considering how low interest rates and P&C insurance rates have been. Since inception Markel has compounded at closer to a 20% rate. Given that, I’d say a price/book multiple of 1-2 is probably within the real of reason.

In summary, I would say Markel is about fairly valued today. I’m not rushing out to buy more shares, but I’m also not rushing to sell them. Markel is a long term compounder, and the best thing you can do when you own a compounder is to sit on your hands and do nothing.

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