Alleghany (Y) is an insurance and investment company with a strategy very similar to both Markel (MKL) and Berkshire Hathaway (BRK.B, BRK.A). Insurance is an important part of the operating business, but both public and private equity investments are a big contributor to future growth. However, due to Alleghany’s and Markel’s much smaller size, they can both invest in smaller family-run businesses, something Berkshire can't because of its much bigger size.
Alleghany does not pay a regular dividend, but recently paid a special dividend and occasionally buys back shares. Its main goal is to redeploy capital into the existing businesses. They have excellent and flexible allocation priorities.
I believe Alleghany is a reliable compounder, but I expect slightly less return than both Berkshire and Markel, mainly because of its conservative management. Any investment in Alleghany must be measured in terms of opportunity cost compared to these other two.
The CEO writes every year a detailed annual letter about their business and its performance. It’s always a very interesting read, as he wants the owners to understand the business and think long-term.
One of the first things I look at is historical performance. Of course, that does not tell anything about the future, but to me it indicates the potential of the business model, the corporate culture and its management.
Alleghany has been around for a long time, and the share price and its 10-year running CAGR can be shown in this graph (since 1980):
The performance has been spectacular, but since 2000 clearly falling. If we look at the performance compared to S&P 500 (SPY), it’s slightly better since 1993:
A 10 000 investment in 1993 is now worth 144 000 in Alleghany and 110 000 in S&P 500.
However, Berkshire has still managed to grow faster than Alleghany since the transformation of Alleghany in early 2000 (more later):
Alleghany measures performance in book value growth. The long-term target is between 7-10% annually, but in the last few years they have not managed to reach this target.
Alleghany has transformed itself many times over since its IPO in January 1929. To understand the company, its management and philosophy, I believe it’s necessary to summarize the main points of its history.
Alleghany was named after the tiny town of Alleghany in Virginia, and was at the time a railroad company. Because of the financial distress during the Depression, an investor group took control of the company in 1937: Allan Kirby, Robert Young and Frank Colby. The Kirby’s are still heavily involved to this very day (more later) and three generations of them have been very influential.
Compared to both Markel and Berkshire, Alleghany is a lot more opportunistic when it comes to owning businesses - Alleghany has sold and acquired a lot of businesses over the years and has “reinvented” itself many times over.
The current business segments can be traced back to the beginning of this century. During the 1990s many businesses were either sold or divested and in 2001 most of the balance sheet was simply cash. Since then the core of the business has been insurance and reinsurance, and currently they report in three segments: insurance, reinsurance and Alleghany Capital.
The operating businesses are the following:
- The biggest subsidiary is TransRe (Transatlantic Holdings). According to Morningstar, Alleghany outbid National Indemnity (a subsidiary of Berkshire) in 2012. At the time Transatlantic was listed on NYSE under the ticker TRH. Transatlantic is mainly a reinsurer.
- RSUI is an underwriter of wholesale specialty insurance, including P&C, professional liability and directors and officers liability coverage. RSUI was acquired by Alleghany in July 2003.
- CapSpecialty underwrites a full inventory of specialty lines, including commercial property, casualty, fidelity, surety and professional lines with a focus on small business. CapSpecialty was acquired by Alleghany in January 2002.
- Alleghany Capital manages their owned non-insurance private investments. This segment owns several unrelated businesses like machine tools, manufacturing of custom trailers, technical providers for pharmacy and biotech companies, toys and music, steel fabrication, funeral and cemetery products and lastly hotel management. The aim is to have a majority stake in family-owned businesses while the founding family still has a skin in the game. In 2013 Alleghany split the equity management in two: Alleghany Capital manages private investments, while Roundwood manages public equities.
- Roundwood Asset Management manages the public equity investments for the insurance subsidiaries. Investments are concentrated on few positions with low turnover, aiming for above long-term market returns.
- Alleghany Properties owns and manages 125 acres of real estate properties in Sacramento, California. Recently 104 acres was sold for 47 million, and the rest is expected sold in some few years.
- Stranded Oil Resources Corporations (SORC) is exploring and producing oil in Colorado. Alleghany formed SORC in 2011. SORC is registered at a cost of $88 million in the balance sheet and is currently operating at a loss.
Reinsurance is quite unpredictable in the short-term due to catastrophe losses, and has historically both created great wealth and destroyed wealth. The key is pricing, prudence and disciplined risk management. I would say the TransRe acquisition has so far been a success as combined ratios have decreased, despite losses in 2017 and 2018. 79% of the total premiums received come from reinsurance.
Just 21% of the premiums come from (primary) insurance. RSUI has a good underwriting performance (15% of premiums), while CapSpecialty (6% of premiums) up to 2015 had a poor underwriting record. Because of the poor record in CapSpecialty a new CEO was put in place in 2015 to restructure the operations. This seems to have been fruitful as the combined ratio is currently falling. Below you find the combined ratios for Alleghany as a whole and its underlying subsidiaries:
Source: Annual reports
Insurance is a highly competitive business where the industry as a whole very often makes a loss on the underwriting, just so they can get a slice of the valuable float. Because insurance companies are paid premiums upfront, underwriting operations provide a “costless”, sustained source of investable cash, called float.
In order to make money in insurance you need a prudent and disciplined underwriting culture. Alleghany has overall produced good combined ratios, and in addition produced good investment results on the float (more later).
Why insurance can be a tremendous business in the hands of the prudent and disciplined management, despite its competitive nature, is shown by Berkshire. In the shareholder letter of 2014 Warren Buffett wrote this:
Berkshire’s extensive insurance operation again operated at an underwriting profit in 2013 – that makes 11 years in a row – and increased its float. During that 11-year stretch, our float – money that doesn’t belong to us but that we can invest for Berkshire’s benefit – has grown from $41 billion to $77 billion. Concurrently, our underwriting profit has aggregated $22 billion pre-tax, including $3 billion realized in 2013. And all of this all began with our 1967 purchase of National Indemnity for $8.6 million.
According to Berkshire's annual reports, their insurance float was $39 million in 1970, $1.6 billion in 1990, $28 billion in 2000, $65 billion in 2010 and $122 billion at the end of 2018. This is an enormous growth in "collect now - pay later" capital. The importance of the float is best summarized (again) by Buffett:
So how does our float affect intrinsic value? When Berkshire’s book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and could not replenish it. But to think of float as strictly a liability is incorrect; it should instead be viewed as a revolving fund. Daily, we pay old claims – some $17 billion to more than five million claimants in 2013 – and that reduces float. Just as surely, we each day write new business and thereby generate new claims that add to float. If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this liability is dramatically less than the accounting liability.
The advantages of a float can be summarized:
- An interest free "loan".
- It's perpetual, as long as the underwriting discipline is intact.
- It can be invested, both in bonds and equities, allocation depends on regulation and risk profile.
- Alleghany keeps all the profits.
So far, Alleghany has a good track record of handling risk. However, catastrophe losses are per definition unknown and often happen as black swans, much more so than normal P&C claims.
Alleghany Capital, the private equity division, is the equivalent of Markel’s Ventures segment - it’s majority owned companies are owner-operators in durable industries. Currently, there are only seven businesses in this segment. Alleghany’s contribution to the businesses are capital, management resources, other complementary owned businesses and very long-term focus. However, the owner-operators are very much running their operations with no fiddling from HQ - it's decentralized, just like Markel and Berkshire.
Unlike the typical private equity fund buyer, the investment horizon is only limited to the timing of when mutual interests diverge. In 2018 the pretax operating profits were 82 million, up from 24 million in 2014. As of now this segment has the capacity to own a lot more businesses without increasing the fixed costs, according to the 2018 letter. Costs are fixed at 7 million annually.
Because of Alleghany’s long-term focus, they are not giving guidance.
The equity portfolio is pretty concentrated, with the main holdings about 10-15 stocks.
These nine stocks are 60% of the total equity portfolio. I have not managed to find any proper break down of Alleghany's equity performance, but according to their annual letters they have managed to beat the S&P 500.
Compared to both Markel and Berkshire, Alleghany has a more conservative risk profile to equities:
Source: My own calculations
At the end of the last quarter only 26% of the shareholder’s equity was invested in equities, and thus reduced a lot since 2018. The reason, according to the annual letter of 2018, is preservation of capital.
We believe that the world economy is at risk of a significant slowdown or recession, if not there already. Commodity prices have collapsed; long-term interest rates are falling; the yield curve is near inversion; and international economies are either slowing or in contraction. In such an environment, our goal is to preserve capital and de-risk where possible. Consequently, we have sold our most cyclically exposed equities (energy, materials, etc.) and reduced our overall allocation to equities. This has continued into the first quarter of this year.
For comparison, Markel has a ratio of 65% to shareholders' equity.
Alleghany is very much a family-run business. The Kirby family owns close to 25% of the shares and this should encourage good stewardship. Chairman Jefferson Kirby is the grandson of Allan Kirby, who took control of the company in 1937. Since then the business mix has been incredibly diverse, from railroads to mutual funds to insurance. However, all over this period, the involvement from the Kirby family has been constant, and Alleghany is one of the very rare companies that still exist over such a long period of time. The average age of a company in the S&P 500 has more than halved in 50 years (currently less than 20 years), but Alleghany has managed to reinvent itself several times. This is of course much easier if you have a truly long-term view and an owner-oriented management, which is the case of Alleghany. Every new CEO inherits an already good corporate culture which should be quite anti-fragile based upon the decentralized structure, very much like Berkshire.
Jeff Kirby controls and owns almost 370 000 shares, 2.55% of the company. All directors and executives own 3.44% of the shares, including Jeff Kirby. The CEO, Weston Hicks, owns and controls close to 0.8%.
Hicks is the current CEO, a position he has held since 2004. He has thus been one of the architects of the transformation into a bigger insurance player. Another important executive is Joe Brandon, the manager of the insurance operations. Brandon is mentioned in several of Berkshire’s annual letters because of his position as CEO of General Re (he transformed it to a profit making unit). Brandon came to Alleghany in 2012.
Management sets the goal of book value growth to 7-10%. That is lower than for example Markel, and also W.R. Berkley, which both have 15%. That means full compensation is paid out on a much lower growth, but at the same time from less leverage (more on this later). This conservative approach might prevent taking on unnecessary risks, but at the same time sets the benchmark “easy” to reach. The compensation is mainly based on book value growth on the parent company-level and there is no use of options, mainly restricted stock awards.
The board of directors has a rational and very sensible approach to capital allocations. Alleghany’s first priority is to support the (re)insurance businesses. If the subsidiaries have adequate capital, dividends are paid “upstream” to HQ for further deployment. Their second priority is to maintain a resilient balance sheet with moderate debt. The latter is for use of capital when markets are constrained and prices depressed. The third priority is to acquire attractive businesses within the Alleghany Capital segment. This is both “bolt-on” for existing businesses or new portfolio companies. The final use of capital is to return it to shareholders if none of the first three options make sense. This is mainly done via buybacks when the board of directors believes the stock trades at a discount to intrinsic value. In 2018 a dividend of 10 USD was distributed. As of now there are no plans to pay a regular dividend:
We have not historically paid a cash dividend because we continue to have significant optionality on capital redeployment. In addition, cash dividends are a tax-inefficient way to return value to taxable shareholders. Because our focus is on the long-term shareholder, we prefer share repurchases at prices below our estimate of intrinsic value, as the value of these actions inure to the benefit of the continuing shareholder. On the other hand, share repurchases above intrinsic value transfer value from the continuing shareholder to the selling shareholder.
It makes a lot of sense to redeploy earnings or have a flexible approach to capital allocations. This is due to two reasons: It’s difficult to get a higher rate of marginal return on dividend reinvestment compared to retained earnings, and to a certain extent buybacks. Dividends are tax-inefficient and mostly reinvested at multiples to book value (while paid from book value). When the board of directors has a flexible approach to capital allocations, this clearly benefits shareholders given they alternate between the options. Sometimes it makes sense to pay a dividend, and sometimes it makes sense to buy back shares. But if the board of directors commit to a regular dividend it tends to get “sticky”, and Alleghany chose not to go down this road.
Over the past five years almost all of “upstream” dividends are redeployed in the Alleghany Capital segment. However, in 2018 $655 million was returned to shareholders, mainly because of cyclical pressures in the (re)insurance business and thus no need for more capital. Furthermore, their somewhat pessimistic risk/return profile for equities meant it was better to return capital back to shareholders.
Outstanding shares have decreased from 16.4 million in 2014 to 15 million today, an 8.5% reduction.
Alleghany aims to run its operations conservatively. Debt is at 20% of shareholder’s equity, which is considerably lower than for example Markel’s 35%. This conservative capital structure will in the long run most likely lead to lower returns.
Inflation is a real risk for insurance companies. If inflation suddenly picks up, Alleghany might have to replace insured assets at a higher price than the premiums received. Because insurance usually involves paying out claims many years after writing the insurance, inflation needs to be addressed. Any sudden increase could be detrimental. Debt works the opposite way. It slowly erodes via money printing (and thus inflation), and as such works as a hedge against inflation risk. This also applies to interest risks. Hence, to me it seems the executives might be a bit too conservative and put too little debt in the balance sheet.
I consider both Markel and Alleghany as mini-clones of Berkshire, and all these three companies have beaten S&P 500 over the long-term (there are others, like for example Canadian Fairfax (OTCPK:FRFHF) and less similar W.R. Berkley (WRB)). Most investors have a limited source of capital, and no one aims to make “diworsification”.
The relevant question is thus: does it make sense to invest in Alleghany instead of one or both of the other two? Another thing to consider is that Alleghany is more dependent on reinsurance than for example Markel. Reinsurance is more prone to “black swans”.
The case for both Alleghany and Markel are their sizes ($10 bn vs. $15 bn), just a fraction of Berkshire and both can thus profit from the documented small-cap effect. It’s always easier to grow a small asset base than a bigger one. On the other side, the quality of the majority-owned businesses of Berkshire is completely superior to the other two.
(There is actually a third Berkshire-clone in the making, Boston Omaha (OTC:BOMN), which I will write about in some weeks).
The relevant valuation metric is price to book. Alleghany has occasionally traded at low multiple to book:
The chart indicates Alleghany has traded close to book value for most of the last decade. At today's 1.25 the stock looks fairly valued to me.
Let me sum up what I believe are the main attractions of Alleghany:
- Owner-oriented management that takes a long-term view in all decisions. The same family has been in the driver's seat since 1937, and the decentralized culture is deep-rooted. Operational performance is thus less dependent on any new members in the management team.
- Good historical performance in equity investments. They have a proven strategy and investment skills.
- Decentralized structure where the operators have skin in the game.
- Underwriting discipline in their insurance businesses.
- Sound capital allocation priorities. They don’t promise shareholders a rising dividend, but have full focus on maintaining a flexible approach on what is best at the time.
Clearly, the similarities to Berkshire is pretty obvious. However, an investment in Alleghany can’t be made solely on its own basis. The opportunity cost of allocating to the other “Berkshires” is highly relevant. Nonetheless, Alleghany will likely produce above market returns over the long-term.
All in all, I consider Alleghany a slow, but reliable, compounder. As Charlie Munger puts it, “A sit on your ass stock."
Disclosure: I am/we are long MKL, 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.
Additional disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion - they are not suggestions to buy or sell any securities.