Alleghany - Another Mini-Berkshire Hathaway

| About: Alleghany Corporation (Y)

Summary

Alleghany is another company that fits into the mini-Berkshire Hathaway designation.

While underwriting profits have been consistent and impressive in recent years, the future is unlikely to be as lucrative as the past in this area.

Non-insurance businesses can not be properly evaluated at this time, but are important to keep an eye on.

With many positive attributes, Alleghany has been available below book value during 2016.

My last article discussed Markel (NYSE:MKL), a solid company often thought of as a mini-Berkshire Hathaway (BRK.A, BRK.B). This claim is not without a basis in fact. There are also a few other companies of similar nature. When something works - and Berkshire has most certainly proved that its business model works - you're going to get attempts to copy it. This is of course not necessarily a negative, as originality does not have to be a prerequisite for superior returns.

Alleghany (NYSE:Y) centers on reinsurance predominantly. Underwriting profits have been consistent and impressive for many years. Often below 90, Alleghany has never reported an annual combined ratio over 94 at any time over the last 10 years.

Late in 2011 and early in 2012 both Berkshire and Alleghany found themselves on the hunt for Transatlantic Re. Berkshire had made an offer of $52 per share, but Trans Re eventually found its home with Alleghany, who paid about $9 more per-share for the privilege. This appears to be a substantial increase but Alleghany still managed to acquire Trans Re below book value. Since the acquisition Trans Re has made up between 70-80% of Alleghany's total underwriting profits.

Surprisingly, in May of 2015 it was reported that Alleghany was considering a sale of Trans Re, which was acquired for $3.5 billion only 3 years prior, for $6.5 billion. This came after Trans Re was 77% of Alleghany's total net earnings in 2014.

Something else related to Berkshire also occurred during 2012 - Alleghany hired Joe Brandon to run all of Alleghany's insurance operations. Long time readers of Berkshire's annual reports may remember this individual, as he was praised annually from 2001-2008, sometimes with multiple paragraphs dedicated to him. General Re was purchased by Berkshire for $22 billion in 1998, and initially proved to be a major headache, with Buffett admitting he thought early on he may have made a terrible mistake. But with Joe Brandon coming aboard as CEO in 2001, there was a remarkable turnaround, and General Re became and still is a source of immense value for Berkshire.

Prior to the Trans Re acquisition, RSUI, which was acquired in 2003, generated the bulk of Alleghany's results. Involved in specialty coverage, RSUI has been responsible for the remainder of Alleghany's underwriting profits in recent years. Less than 10% of overall earned premiums are associated with CapSpecialty and PacificComp, and there has been an underwriting loss in this area for Alleghany this decade.

At PacificCorp results have been atrocious at times, particularly around 2011 when premium volumes shrank substantially due to issues in the California Workers' Comp market. Although results have significantly improved in recent years, annual underwriting profitability has not yet been restored.

Alleghany's equity portfolio is very concentrated, with usually around half a dozen or so companies accounting for half the portfolio. Very large and well known companies such as Visa (NYSE:V), Alphabet (NASDAQ:GOOGL) and Walt Disney (NYSE:DIS) have made up the top positions in recent years. But equities are not even 20% of Alleghany's total investment portfolio, as the majority is invested in fixed-income securities.

Alleghany Capital, similar to how Markel Ventures works, holds Alleghany's non-insurance businesses. Just as Berkshire Hathaway operates, Alleghany has a decentralized Management philosophy - the managers of any subsidiary are largely autonomous. Unfortunately we lack long-term data for this area as well as having to deal with limited disclosure. At this point Alleghany Capital is only a very small part of the total company, but as diversification into non-insurance operations is set to continue it is worthwhile to look into the information we have on what has been built so far.

Alleghany Capital results have recently been broken down into manufacturing and service along with oil and gas. Oil and gas is not profitable, due in very large part to the recent energy sector environment. For the first 3 months of 2016 pre-tax losses were $7.5 million. Manufacturing and service is profitable. Over the same time period pre-tax earnings were $1.5 million.

Oil and gas includes Stranded Oil Resources, focused on enhanced oil recovery, and ORX Exploration, a regional oil and gas exploration and production company. It is unclear what value could be realized from ORX and Stranded were energy prices to recover. Fortunately the 4 manufacturing and service companies have realized better results. There has been an acquisition in each of the last 4 years.

  • 2012: Bourn & Koch - manufactures and retrofits precision machine tools.
  • 2013: R.C. Tway - manufactures custom trailers and truck bodies.
  • 2014: Jazwares - toy and consumer electronics company
  • 2015: Integrated Project Services - provides technical services in the pharmaceutical and biotech industries

There is also Alleghany properties, which owns and manages commercial and residential lots in Sacramento California - over 300 acres of property in total. After not making any sales since 2008, one was finally made in 2015.

Alleghany's book value per-share was $281.36 in 2007 and $486.02 at yearend 2015. This 72.7% return is impressive, but it is still below that of Berkshire Hathaway over the same period, which is 99.3%. A major, perhaps the major selling point with mini-Berkshires is supposed to be that they should be able to outperform Berkshire's own book value growth at this point. In addition, there are some particular risks with Alleghany. The company is overwhelmingly involved with reinsurance. It has been noted by many, including Warren Buffett and Ajit Jain on multiple occasions, that reinsurance pricing is currently inadequate. Alleghany may be faced with the choice of reducing premium volume and therefore float, or face potential underwriting losses.

Despite the success of Trans Re, the changing landscape of reinsurance as competitors flood the market is probably the major reason Alleghany entertained selling in 2015. The next 10 years are hardly likely to be as lucrative as the last 10.

This may be the reason for Alleghany recently trading below book value per-share (it currently trades at about 1.08x). Alleghany is a quality company. Since Weston Hicks assumed leadership in December of 2004, book value has grown at an 8.2% annual rate, besting the return of the S&P 500. His shareholder letters are worth going through, and they are clearly reminiscent of Berkshire's own letters.

Alleghany states a long-term goal of 7-10% annual growth in book value. Purchasing Alleghany at or near book value should produce satisfactory results over time, and there is always the chance shares can once again be purchased at a discount. It should also be mentioned that during the last 5 quarters 4% of the shares outstanding were bought back below book value.

This is one benefit for potential buyers of Alleghany that surpasses what can be found with Berkshire - the divergence between price and value. They do not diverge as much with Berkshire as it does elsewhere. Berkshire never really, especially in recent years, becomes either substantially overvalued or undervalued; with Alleghany this is not the case.

Disclosure: I am/we are long BRK.B.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.