Holding My Nose, Still
Three companies of mine reported after the bell, Flagstone, Deerfield, and National Atlantic. I’ll take them in that order.
Flagstone beat handily, as I would have expected a property-centric reinsurer to do in this environment. Let’s see what optimism tomorrow brings. At 96-97% of book value, it seems cheap, but I can’t imagine property reinsurance rates will be that robust next year.
Deerfield is a little more tricky. They took a loss due to mark-to-market events in their portfolio. REIT taxable income is reasonable at 50 cents/share, and much of the writedown is a GAAP anomaly that shaves $1.20 off of the current book value. Economic book value is $11.84, which provides some support to the stock. The dividend of 42 cents is still intact. There is reasonable excess liquidity, even after the increase in repo margins during the third quarter. Let’s see what the market thinks.
Now for the problem child, National Atlantic, which takes an 83 cent loss. Here’s the main offending paragraph from the press release:
“For the three months and nine months ended September 30, 2007, reserves have increased by $17.6 million and $9.4 million, respectively, principally as a result of the strengthening of the reserves for bodily injury claims. During the third quarter it was determined that the Company’s policy related to claims handling procedures and reserving practices were not applied consistently, primarily within the bodily injury claims unit. As part of the resolution of this matter, the Company retained an independent claims consulting firm.”
For a company the size of National Atlantic, these are huge reserve changes, particularly for a short-tail line like auto. What I am about to write here is only a guess, but this likely was building up since sometime in 2006. One of the reasons I am willing to be a little more bullish on short-tail insurers is that it is a lot harder to get the reserve wrong. Looks like I am getting one of the rare events that teaches greater caution. (That said, my average cost is $8.85, so I’m not that badly hurt.) Given the large reserve change this period, ordinarily, the decks are cleared for future periods, but who can tell for sure? Also, this places the combined ratio since 2002 at 103.7%. It makes me think that the company will do well to eke out any underwriting profit.
I’ll be listening to the call tomorrow. What’s the endgame here? Given the marginal ability to earn underwriting profits, perhaps the company would best be reconciled by merging with another firm. That wasn’t my opinion over the past three years, but it is my opinion now. There are many firms that could have an interest at the right price, which probably approximates the book value of $13.28. That said, many of them may have kicked the tires already and passed, some probably thinking that a bid at book value would not be honored. All I can say is, give it a shot. Rumor is that Commerce wasn’t offering more than book, so if you want a greater presence in NJ personal lines, it may be available at a reasonable price.
Full disclosure: long FSR DFR NAHC
November 8th, 20078:06 am at
In my opinion, NAHC is a value trap. Operates in a tough market (NJ auto) and management seems less than stellar. A colleague of mine has a friend who works (or worked - he may have quit) there, and said it was like working for Dunder Mifflin. Very short-term oriented, no cohesive strategy, low morale.
November 8th, 200711:15 am at
Doug; you look right today.
November 9th, 20071:39 am at
Not to bring up bad memories (Scot Re), David, but do you ever scare out of a position considering the possibility of fraud? Whenever I see a stock going down that I can’t explain I begin to think fraud or some other inside info being leaked.
Does this ever enter into your analysis? How do you mitigate that? That’s always been my problem with value investing, I get scared there’s something lurking the public doesn’t know about. I share a lot of Rev Shark’s thinking in this regard, but I’d be happy to hear your take.
November 9th, 20072:10 am at
Allan,
Scottish Re wasn’t fraud per se, but mismanagement amid long duration contracts, leverage, and opacity. Financial companies will always be somewhat opaque; that’s the nature of them.
No, I never scare out of a position. I analyze whether likely future returns justify the continued deployment of capital versus available alternatives. There is a difference between incompetence and fraud, and if I sense that the financials don’t add up, I will sell, simply because that lowers my value estimate.
With SCT, my former employer took a decent-sized loss, but it could have been a lot worse. Once the deal was struck with Cerberus and MM, we sold into the rally, because the new data told me that SCT was worth a lot less than $6.
From my experience with NAHC management, I do not question their honesty.
Whether growth or value investing, we always don’t know something. Diversification and a focus on margin of safety mitigate those problems. I get taken to the cleaners on one out of 50 companies that I invest in. That’s part of my market tuition. I make money on 80% of my picks, and my returns have been more than satisfactory to me.
For every company that I own that goes down unexpectedly, there are usually two that go up unexpectedly, and sometimes after prior price declines. I don’t try to call short term price action; I just try to think like a businessman.
November 11th, 200711:31 pm at
Thanks David. I found your reply helpful. It now occurs to me the difference for not getting scared out is never having a position large enough to be scarey. Yeah, it seems so obvious now that I wrote it.