Weston Hicks’ annual letter to Alleghany shareholders for the year ended December 31, 2015.
To Our Stockholders
Alleghany’s common stockholders’ equity per share at year-end 2015 was $486.02, an increase of 4.4% from common stockholders’ equity per share of $465.51 at year-end 2014. For 2015, Alleghany reported net earnings attributable to common stockholders of $560.3 million, or $35.14 per share, while changes in the market value of our investments and other items reduced book value per share by $14.63 per share. For the five years ended December 31, 2015, Alleghany’s common stockholders’ equity per share increased at a compound annual rate of 8.4%, compared to a compound annual rate of return of 12.6% for the S&P 500 over the same time period. A year ago in my letter I suggested that the S&P 500 might be at an elevated level and unfortunately my observation is looking correct — ince the end of 2014, the S&P 500 has had a negative total return.
Alleghany’s Performance
The table below summarizes Alleghany’s longer-term performance. For the ten years ended December 31, 2015, Alleghany’s common stockholders’ equity per share increased at a compound annual rate of 8.6%, compared to a compound annual rate of return of 7.3% for the S&P 500 over the same time period, and a compound annual rate f return of 7.4% for the Russell 30003. Alleghany’s share price appreciated at a 6.6% compound annual rate of return over the past decade (adjusted for stock dividends). Alleghany’s share price performance lagged the growth in book value per share because the share price was 119% of book value on December 31, 2005, and was 98% of book value on December 31, 2015.
Although our growth rate in book value per share was modest in 2015, we are satisfied with the result given the low levels of returns available elsewhere in the capital markets. Over the past decade, our book value per share has increased in every year but one – 2008 – when it declined 5.0%, compared to a 37.0% decline in the S&P 500.
The table below summarizes the change in stockholders’ equity attributable to Alleghany common stockholders in 2015 ($ in millions):
Strong underwriting results at TransRe and RSUI Group were the principal driver of book value growth in 2015. Investment returns were negligible: including interest and dividend income, our bond portfolios returned 0.3%, and our equity portfolios returned a negative 1.5%. Although nominal growth in stockholders’ equity was only 1.0%, per share growth was 4.4% as we reduced Alleghany’s share count by 3.2% in 2015. This 4.4% increase in the per share value of Alleghany follows a 12.7% increase in 2014.
In 2015 we repurchased $244 million of Alleghany shares at an average price of $468.45, or about a 4% discount to year-end 2015 common stockholders’ equity per share. In addition, unlike much of Corporate America, we reduced our aggregate debt outstanding. Debt to total capital was 15.5% at year-end 2015, compared to 19.1% at year-end 2014. Total long-term debt decreased by $377 million from $1,767 million to $1,390 million, and we ended 2015 with over $800 million of marketable investments at Alleghany Corporation and its non-regulated subsidiaries. We are sometimes asked why we are deleveraging at this point, with interest rates so low. The answer is when heading into stormy seas it makes sense to batten down the hatches. We believe that financial flexibility and corporate resiliency will be more valuable in 2016 and beyond.
The table below summarizes our 2015 growth in book value per share in more detail:
TransRe and RSUI Group, which together account for 90% of our consolidated stockholders’ equity, produced high single-digit returns on equity on an operating basis (excluding net realized capital gains or losses and OTTI charges). Investment returns, however, were weak in 2015 resulting in slightly lower growth in book value for each company relative to the return on equity, which is consistent with the lackluster performance of all investment classes in 2015.
Both TransRe and RSUI hold a significant amount of equity securities. In measuring return on equity, we are including only the dividend income in the numerator of the calculation, with unrealized appreciation or depreciation, net of taxes, flowing through the balance sheet. Accordingly, return on equity understates the potential economic return of an insurance enterprise, assuming equity investments appreciate over time.
As the table above shows, we had net assets of $779 million at the end of 2015 in addition to the equity of TransRe and RSUI Group. The “Other” column includes our smaller insurance subsidiaries (CapSpecialty and PacificComp), Alleghany Capital Corporation and its subsidiaries and investments, our holding company investments, and corporate administration costs. There are many reasons why this figure is negative, but the most important ones include 1) the relative underperformance of CapSpecialty and PacificComp (although each company improved significantly in 2015); 2) operating losses at Stranded Oil Resources Corporation; and 3) investments held for their total return (mostly equities) where dividend income is less than the cost of holding company debt. I will have more to say on each of these items later in this letter.
The table below summarizes the major items comprising our $779 million of net assets:
Only the parent invested assets above are carried at market value. All of the other investments reflect our share of each company’s results, in some cases with purchase accounting adjustments.
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