My thesis on E-L Financial (ELF) is pretty simple. E-L is trading at 65% of its book value, that’s essentially the whole thesis. Since I might as well write a bit more, the major component of this book value is very high quality and could be worth significantly more than E-L carries it at.
E-L Financial is an insurance and investment holding company. The insurance part comes from its 99.2% ownership in Empire Life, a life and health insurer which also provides asset management services. The largest components of the investment portfolio are the 36.3% interest of Algoma Central Corporation (ALC), a 51.9% interest in United Corporations (UNC), and a 24% interest in Economic Investment Trust (EVT). I know those last two sound like made-up company names in a bad movie, but they are both real, publicly traded (TSX) closed end funds.
E-L Financial was founded by Hal Jackman, as a holding company for Empire Life, the insurance company his father had built. And since inception in 1969, book value has compounded at 12.5% per year. In comparison, the S&P 500 has risen at a rate of 10.2% per year in that same time period. That’s not quite Berkshire-esque, but beating the market by 2% per year over almost 50 years is pretty impressive.
Since 2003, Hal’s son Duncan has been CEO. Despite a few stories out there, Duncan doesn’t seem to attract the limelight quite like his old man. It’s tough to find an interview or any information at all on the man. In some ways that reflects the stock too. For instance, even more Berkshire than Berkshire, E-L Financial doesn’t have a website at all.
Now on to the crux of my thesis. E-L Financial’s book value at the end of September was $1242.85 per share. Today the stock is trading around $810, just 65% of book value. Meanwhile, Sun Life trades at 165% of book value and Manulife trades at 136% of book value, despite actually shrinking book value over the past year. Power Corporation and Power Financial both historically trade at discounts to book value, yet right now are trading at premiums; Power Financial trades at 140% of book, Power Corporation is at 110%. Great-West Life trades at a premium, I could go on. The point is, at the moment insurance and investment holding companies trade at premiums to book value.
One poster over at Corner of Berkshire and Fairfax claimed it makes more sense to compare E-L to National Western Life, which trades at 69% of book value today. At first glance it does make sense. I didn’t do much research on NWLI, but it is possible that it is equally undervalued.
The fact remains that most peers are trading at valuations well above ELF.
It took me a somewhat roundabout (very possibly incorrect, though it should be close) way of calculating it, but Empire Life seems to make up about $325 of E-L’s $1242 book value.
The opportunity for a catalyst with Empire Life is if Mr. Jackman decided to sell it. The acquisitions of life insurers are typically at a multiple of book value, which obviously provides some upside. A deal done at 1.3x book value would be accretive to the three biggest players (Sun Life, Manulife, Great-West) as well as any of the big banks. A deal done at 1.3x book value would add almost $98 to the book value.
Alternatively, Empire Life could be acquired based on its earnings. E-L carries Empire Life at just 8x earnings. As you can imagine, the potential acquirers trade at much higher multiples and as such could pay a big premium. If one of the big players bought Empire Life at 12x earnings it would add over $160 to E-L Financial’s book value.
1.3x book value and 12x earnings are both very conservative estimates. An acquisition very likely wold be done at higher prices, but the point remains that the intrinsic value of Empire Life is higher than its current accounting value. The thesis doesn’t rely on a high acquisition multiple, I can be conservative as this is point is just illustrative.
Ultimately, Empire Life is earning around a 12% return on equity, so it is likely in the best interest of shareholder’s to hold on to it. Both scenarios are attractive to ELF shareholders, and goes to show how even high quality assets can be undervalued.
In March ELF will announce earnings for the quarter ended December 31st, and I expect they will be fairly impressive.
For one, on December 31st the NAV of United Corporations was $139.06 per share. In the book value quoted above, UNC was valued at $130.43. This should increase the book value of E-L by ~$13.60. During the month of January, the value of UNC has increased another $3/share. It won’t be included in the earnings ELF presents, but that’s another $4.72 of value “hidden” in E-L.
Economic Investment Trust has also increased NAV by $3.21 per share. This increase adds $1.07 to E-L Financial’s book value. In January, the increase in Economic has added another “hidden” $1.00 of ELF value.
The increase in Algoma’s share price adds ~$13.18 to ELF book value.
Empire Life’s contribution to book value is much harder for me to estimate (since I can’t just compare past quoted prices). As a rough but conservative guess, I’ll assume Q4 earnings are up 10% YoY (less than YTD growth) and that 85% of earnings flow through to growth in book value. If this holds true, ELF book value should increase $12.21.
Yes, I know those numbers appear random. For all intents and purposes they are. I am hesitant to forecast growth, but 10% should be close. If it isn’t, then the 85% of earnings flowing through to book value is there to be conservative. Almost all of the earnings should go to increase Empire Life’s book value, and by extension ELF’s. Every $1 million I’m off only sways the book value estimate by 25 cents, so it’s not critical.
If just these revaluations took place, and the rest of ELF simply broke even, book value would increase by $40, or 3% since the end of the third quarter. This would be 10.7% growth since last year, roughly in line with long term growth. Any other profits from E-L corporately is additional upside.
Insiders own 49% of the stock, though most of the shares are held either through Canadian & Foreign Securities Co (again, not a made up name) and Dominion and Anglo Investment Corp.
Additionally, Economic Investment Trust holds another 9.6%. E-L Financial in turn owns 24% of Economic, so these shares are unlikely to be traded anytime soon. The Jackmans own a silly amount of EVT as well.
This leaves around 1.7 million shares as the float. Between this and the high share price, the volume on ELF is very low.
Meanwhile, the Jackman family continues to buy shares as fast as they can (which isn’t particularly fast), the Jackmans have bought 585 shares over the past two months around today’s price and above. To me this indicates that management/Jackman likes the large discount and will continue to take advantage as long as E-L isn’t respected by the market.
I don’t have a target for E-L Financial. I don’t know what would be a fair price, but I know 65% of book value is too low. With how well Empire Life is performing, the upside offered by the potential sale of it, the performance of the rest of the portfolio (it’s essentially an investment fund where you pay ~.4% for Duncan Jackman to run the fund), 65% of BV is cheap. Holding companies like E-L almost always trade at a discount, though right now others are trading above historical valuations. Taking this into account, I think E-L could trade at anywhere from 75% to 90% of book value. At the lower end of that, with my assumptions for earnings when they’re released, E-L would trade at $962, 19% above today’s price. Of course, at 75% I would still argue it is undervalued.
I expect to tuck ELF in the figurative back of my portfolio and forget about it. The large discount to book value provides downside protection (I think), and growth of book and revaluation offer upside potential. Someday Mr. Jackman will sell Empire Life and pay out a large special dividend (similar to when he sold the P&C business) or it will be announced that E-L Financial will be taken private by management. Before that happens though I expect to realize an adequate return, which is all I want from the market right now.
Disclosure: Long ELF.