Artful Investing

Dana Petroleum's incredible rise, to four times my original buy price in October 2003.

Yeeee-haaaaaaaa.

In addition, my second largest portfolio component, Fayrewood, shot up to 125.5p to sell versus my April (or was it May?) purchases at an approximate average of 111p. Whoop-de-doo.

But Ben Bailey, issued a seriously disappointing set of interim figures at the start of the month and it looks like that company will not be recovering to it's former highs for a long while yet.

My insurance holdings, SVB and Chaucer have performed well. Chaucer has held on to some of it's takeover speculation gains and SVB has advanced handsomely.

Writing this has induced two important ideas. Firstly, I badly need to review my strategy with Fayrewood, Dana and Ben Bailey. Fayrewood is a bid situation. What if a bid is announced at, say 140p, would I accept and sell or hold on expecting a higher price to eventually be achieved? And what of Ben Bailey, with it's struggling cyclical market and margins, falling faster than a fat hod carrier?

It's about time I started some serious thinking and more serious blogging. Here's this month's round-up:

Portfolio at
Ben Bailey, 21/06/04 at 390p (435p)
Chaucer Holdings, 06/10/03 at 42.88p (59.5p)
Chaucer Holdings, 06/04/2004 at 54.75p (59.5p)
Dana Petroleum, 20/11/03 at 223.75p (687p)
SVB, 12/04/05 at 24.12p (30p)
Fayrewood, 15/04/05 at 112.5p (102p)
Fayrewood, 19/04/05 at 111.5p (102p)
+ cash holdings

and today's values

Ben Bailey, 21/06/04 at 390p (384p today)
Chaucer Holdings, 06/10/03 at 42.88p (58p)
Chaucer Holdings, 06/04/2004 at 54.75p (58p)
Dana Petroleum, 20/11/03 at 223.75p (906p)
SVB, 12/04/05 at 24.12p (31.5p)
Fayrewood, 15/04/05 at 112.5p (125.5p)
Fayrewood, 19/04/05 at 111.5p (125.5p)
+ cash holdings

Return for the year to date +52%

I never dreamt I would have achieved this rate of return after eight months of the year.

The Artful Dodger

As hurricane Katrina passes through Louisiana and Mississippi and slowly loses ferocity, early reports from the area cite catastrophic damage to the the Gulf coast of the USA. The historic centre of New Orleans, especially vulnerable due to it's low-lying location has been particularly badly hit:

The storm passed just east of New Orleans, straining the system of levees and pumping stations that protect the low-lying city. About 70 percent of the city sits below sea level. The National Weather Service reported that water had overtopped levees in Orleans and St. Bernard parishes. The Lower 9th Ward, on the east side of New Orleans was under five to six feet of rising water after three pumps failed

and now estimates are starting to arrive on the likely costs to the insurance industry:

Hurricane Katrina could end up costing US insurers as much as $25bn... estimates across the industry range from $12bn to $25bn. At such levels, Katrina would be more expensive than 1992's Hurricane Andrew - which at $21bn in today's money is the most expensive in US history.

It should be noted here that last year's hurricane Ivan's losses caused Goshawk to exceed their reinsurance cover, resulting in a loss for the first half of the year. Though the picture is still unclear, I expect the market will have been badly shaken by this hurricane and will start to mark down the value of listed insurers tomorrow. This time last year, that presented substantial opportunities as shares like BRIT and Chaucer touched unreasonable lows. But the insurance climate has now changed somewhat and we are into a declining premium environment. If more hurricanes of similar strength hit the US coast this year a number of insurers could find themselves very stretched. That's a double edged sword. A severe hurricane season could bring both outstanding opportunities to buy shares cheaply, but only after inflicting heavy losses on investors in the sector.

I am going to have to hold tight here.

The Artful Dodger

Worries for my portfolio this weekend. The US hurricane season, which had so far remained largely innocuous to my insurance holdings, has started for real this weekend with the arrival of hurricane Katrina.

Katrina has already hit Florida as a category-1 hurricane and is worryingly gathering strength. Yesterday, forecasters were warning Katrina could reach a category-4 but today, as the eye of the hurricane moves into the Gulf of Mexico, the latest prognosis is that Katrina has now hit category-5, and is expected to hit land in Louisiana within the next 24 hours. Only three category five hurricanes have hit the US in history. As the mayor of New Orleans ordered an evacuation of hundreds of thousands of people, insurers like Chaucer and SVB will be bracing themselves for large claims.

With around six weeks of the hurricane season remaining, I had hoped my companies would have fared much better this time round, making the comparables at the full-year stage impressive against 2004's numbers. However, a representative at Chaucer recently likened Atlantic hurricanes to buses. You can wait a long time with no apparent sign of any likely to arrive and all of a sudden four can turn up one after the other.

Though last years season remains extraordinarily unpleasant, Katrina has scotched any chance the insurers had of emerging from the 2005 storm season unscathed. For investors in the sector, we must remain watchful our companies can remain within their reinsurance budgets, a breach of these would force a reserving decision using net company assets, as recently was announced by Goshawk in the light of 2004's hurricane Ivan and SVB's cataclysmic slip-up in asbestos underwriting in America.

The Artful Dodger

I mentioned in my last blog on Tuesday, that the Fayrewood interim results would play a crucial role in portfolio returns.

Fayrewood announced an impressive 7.1p earnings for the first half of the year and robust trading in a tough market. The shares surprisingly fell on the news and fell some more the next day, over concerns about Fayrewood's ability to generate cash as a business.

All this was put well into the shade however by the news today that the company has received an approach that may lead to a bid being made. The shares were already well up on the morning but went on to rise another 15% or so to end the week trading at 126p to sell, versus my average buy price of 111p.

With Dana Petroleum continuing to make new highs, pushed higher by the force of rising oil prices and this resurgence from Fayrewood this could be my portfolio's best ever month yet. It looks like August will more than make up for July's single percent dip.

The Artful Dodger

Fayrewood is the second-largest holding in my portfolio. My stake in the company was taken following very successful ventures into Ben Bailey (in at 178p, out at 470p) and Mayborn (in at 282p, out at 430p). The proceeds from these sales were sunk into positions in Fayrewood at 110.5p and 111.5p around April.

Tomorrow, Fayrewood announces interim results for the first six months of the year. These results will provide a crucial indicator toward the final year and also provide vital information on trading. With the shares currently trading at 110p to sell and expectations for the full year of 17p earnings per share any results over 7p earnings for the first half could see the shares rise sharply and with them, the rest of my portfolio.

I'll have more information at 7 a.m. tomorrow when the news is announced to http://www.uk-wire.co.uk/ and from 8 a.m. onwards when the market opens and Fayrewood trade begins.

The Artful Dodger

Today brought another announcement from an insurer that profits at the half-year stage would comfortably beat market expectations. This followed Thursday's announcements from Chaucer and Amlin that we should expect strong results. Sandwiched between these was a positive trading statement from BRIT arriving on Friday. As I mused in yesterday's blog this may well be a feast-to-famine industry but the main players are still feeding well.

Wellington has had a great first six months of the year but warns that with half of the hurricane season still to come, the full year won't necessarily outstrip consensus forecasts:

Review of the performance for the first half of 2005 indicates that the outcome for the results of Group Underwriting Operations will be better than market expectations due to continued good underwriting results, principally in the area of good claims experience to date for current and prior accident years, improved investment performance, the impact of the strengthening US dollar and the effect of the treatment when reporting under International Financial Reporting Standards (IFRS).

However, the full year results may be significantly impacted by hurricane and other loss events occurring in the second half of the year as well as by conditions in the foreign exchange and investment markets.

BRIT issued a similar statement of cautious optimism:

It is anticipated that the Group's pre-tax profit for the first half of 2005 will be in the region of £110 million. This is due to a combination of favourable trading conditions, low levels of claims incurred, excellent investment performance and profit on exchange rate adjustments when reporting under International Financial Reporting Standards ('IFRS').

Dane Douetil, Group Chief Executive Officer of Brit, said: 'Brit's performance has been extremely strong, however, it is unlikely that all the positive factors experienced in the first half of the year will be repeated in the second half. In addition IFRS could introduce further volatility. Although we believe that it would be imprudent to infer that our excellent first half performance will be repeated in the second half of 2005 we look forward to the year end with some confidence.

The hurricane season has had no material adverse effects on these businesses yet and if the sector can enter October with little storm damage, we can expect to full-year profit upgrades arriving. I just wish my two holdings, Chaucer and SVB would join the party with a fully qualified profit upgrade for the interims. There's time yet, with results starting to arrive around the third week of September.

The Artful Dodger

Since I've been gracing the infinite ether that is the internet with this blog, I've repeatedly expressed my opinion that the insurance sector is unfairly under-rated by the market. The shares on offer here are simply too cheap given their prospects and track record. The FTSE 100 trades historically at an average P/E ratio of 15. Most of the insurance sector's constituents trade on P/E ratios between five and six (see Chaucer Holdings and Atrium Insurance) and some cheaper still (SVB).

I can think of two reasons why a discount to the market should be applied to this sector.

Firstly, insurance is a notoriously cyclical sector. The price of premiums insurers can extract from customers don't rise and fall along with inflation unlike, for instance, the price of a loaf of bread. Unlike bread making, there are very few barriers to entry in the insurance business. You don't need a factory, a large workforce or fleet of delivery vehicles to sell insurance, a company already operating just needs a large wodge of capital to reserve against claims and a few advertisements and a company can dramatically increase the amount of insurance business it does. When premiums are rising, this can lead to a glut of capacity competing for business in the market and the inevitable declining premium rates. When premiums are falling, insurers try to step away from the market in fear of underwriting losses and capacity declines again. Thus, after a few years of high premia, a decline would be expected. This cyclical decline will bring reduced profits and in extremis painful losses. The market currently considers insurers to be on the cusp of a cyclical decline and is factoring in expectations of severely reduced profits into valuations.

The second reason insurers are less well-loved than listed companies in other sectors is the fear of suffering from an adverse event, like a major earthquake or severe oil-spillage. This is always a risk in the sector and the market is right to acknowledge it.

To demonstrate this point, consider this announcement made on Friday by Goshawk:

Goshawk has been advised of certain offshore energy catastrophe losses affecting its marine account which will negatively impact the result for the six months ended 30 June 2005. The Company has also incurred losses, to a limited extent, on winter cyclone Erwin and the Suncor plant loss in Canada during the first half of 2005....The marine loss advices received are for hurricane Ivan which occurred in late 2004 and on which the Company had set aside a reserve in excess of loss advices previously received. The total of the loss advices received exceeds the amount reserved.

Goshawk has come a cropper here, the company was exposed to the oncoming hurricane like a teepee in the middle of Cape Canaveral. Goshawk had taken on too much marine insurance business and was hit badly. Furthermore, the company then went on to underestimate the amount they would have to pay out. Not only did this hit the company's profitability but it's reputation too. Can shareholders trust Goshawk not to leave itself this vulnerable in the future? And how good a handle does management have on the business?

Investing in this sector isn't a one-way street, something dangerous can emerge from around a corner at any time. Investors would be well advised to diversify across the sector and avoid companies that have made imprudent underwriting/reserving decisions in the past.

Goshawk has surprised the market previously, suffering losses from specific events at a greater level than its peers. The company suffered some pretty serious burns following the Columbia disaster of 2003.

The Artful Dodger

Two familiar insurers reported favourable conditions today. Long-term portofolio holding Chaucer announced syndicate forecasts today accompanied with some cheer on trading:

• The 2005 year of account continues positively with total gross
  written premiums ahead of the same stage for 2004 and with pricing remaining
  generally strong
• Overall, forecasts for both the 2003 and 2004 years of account have improved
• Motor Syndicate 587's 2003 forecast has improved particularly strongly

Chief Executive Ewen Gilmour provided further reassurance:

The continued good trading conditions, combined with further positive development of business written in 2003 and 2004, should, assuming normal loss patterns, produce another strong underwriting result for Chaucer in 2005.

This cheered the market, with the shares at one time today over 2% higher at 59.5p to sell.

Elsewhere in the sector, Amlin (remember them?) trumped this with a positive trading update, telling the world that profits would be well in advanced of market expectations (that's code for broker forecasts).

the outcome for the 2005 half year is likely to be significantly better than market expectations due to a combination of continued strong trading, low levels of claims incurred and a good investment performance in the year to date

This is just the sort of announcement shareholders love to hear and normally results in a sharp rise before the market even opens. Note the announcement on low level of claims endurance. The world has escaped serious incident since the Boxing Day tsunami. The American hurricane season has thus far failed to deliver the promise of it's name and premiums remain strong. I'm dissappointed we haven't had one of these profit upgrade announcements from Chaucer or SVB but keenly look forward to their interim results, weather permitting. Still plenty of money being made in this notoriously cyclical sector.

The Artful Dodger

I've written previously on margin of safety and how I've disciplined myself to never accept anything less than a 30% discount to fair value on purchasing shares. There's nothing mathematically optimal about that number, I've no way of showing it generates superior portfolio returns than other numbers such as 25% or 35%. After all, opportunities to buy at a 25% discount could be expected to present themselves more frequently than a share trading at 35% off but are more likely to result in a loss and would return a lower expected gain.

Well, today at 32.5p, SVB has comfortably broken through my targeted 30% return level. A very satisfying advance from my purchase at 24.12p on April 12th and one of the most consistent rises a share has ever delivered me. At the time of purchase I wrote:

The investment case revolves around the new management having got this reserving decision right and developing a profitable business from what remains. If SVB can manage this I'd expect the share price to recover to the level of declared tangible asset value at 31.6p or higher and I'd take my exit.

So should I sell? I think news (or lack of it) since my purchase has strengthened the case to hold until September's expected interim results. There are two main reasons for this. The first concerns the reserving decision made in September 2004. Twelve months later, SVB has not had to add to to this provision - it is beginning to look increasingly as though they have got this right and things won't be getting any worse. The second factor is the benign Atlantic hurricane season. Halfway through the hurricane season and no major storms have hit the East coast of the USA. This time of the year is normally very expensive for insurers as they have to settle claims for billions of pounds worth of damage. After four hurricanes in 2004 and a major typhoon in Japan in 2004, SVB was forced to pay out £10m. If the hurricane season continues to be the non-event it has been thus far, insurer profitability will improve dramatically.

I expect interims around the third week of September. With just over a month to go and the forecast in Florida still fine, SVB stock could continue it's gains north toward 40p.

The Artful Dodger

I've said previously how August will see the arrival of some crucial news for my portfolio, interim results from Ben Bailey and my largest holding, Fayrewood.

Ben Bailey kicked off the month and kicked my returns hard in a painful place. Bailey's results statement revealed an 8% fall in profit for the period compared with the previous year despite a 22% rise in turnover. Ben Bailey managed to sell more houses at higher prices but the cost of building and selling those houses rose substantially. The shares plummeted 13% on the day of the announcement and currently linger at 370p versus my original purchase price of 390p.

Fortunately, Ben Bailey is no longer the huge portion of my portfolio it used to be. The largest portion of my stake was sold at 473p in April to buy Fayrewood at 111.5p in April. That trade is now showing a profit, but its success is heavily dependent on Fayrewood's own interims, due on the 24th.

A big question mark looms over Ben Bailey however. What now is a fair price for the shares and what does the future hold for the company, in what has clearly become an increasingly difficult market to operate in?

The Artful Dodger