Category: Stocks

Insurance Earnings So Far 1Q07 — IX

Insurance Earnings So Far 1Q07 — IX

Earnings season finally slows down.? Here’s some commentary on what companies reported on Tuesday.

Life

Protective Life beats and raises.? Last quarter, many parties got hung up on an accounting adjustment, and drove the stock down.? This quarter there is no adjustment, but instead an improvement in margins, so PL guides up.? Conseco misses; the clean-up of their administration systems persists, though these adjustments should be over with the second quarter report.? The old LTC block is still an albatross.? The sale of the annuity lines to Swiss Re with an expanded buyback may provide some price support tomorrow, but perhaps at a lower level.

Universal American misses, but the stock goes up because of the purchase of a private Pharmacy Benefits Manager, MemberHealth.? It certainly seems like they got a favorable p;rice, but they had to issue a lot of stock to make the deal work.

The Bermudans

Allied World beats handily.? The price action tomorrow may be muted by their conservatism in not writing so much premium in the first quarter.

Brokers

Marsh Mac misses on higher revenues overall. I don’t think they have worked out how to replace lost contingent fee income from their brokerage businesses.

Primary Casualty

HCC beats on higher revenues; all segments show some improvement?? The big news is that they see opportunities to grow profitably at present.? Wonderful news if true.

Now to bed; I am? beat.

Full disclosure: long AWH CNO

Insurance Earnings So Far 1Q07 ? VIII

Insurance Earnings So Far 1Q07 ? VIII

Before I start, some additional commentary on M&A items. It was interesting to see Liberty Mutual buy Ohio Casualty for several reasons:

  • At the premium that they paid, there were better things to buy. I don’t find a 6% return on capital to be that attractive, and I don’t see a lot of synergies.
  • It implies that there is not that much for sale among stock P&C companies.
  • Primary Casualty companies buying Bermuda reinsurers makes a lot of sense (like AGII/PXT). This isn’t as cogent.
  • It lowers my previously high opinion of Liberty Mutual.

On another note, I found the announcement from KMG America to be lightweight. After the stock fell so hard, I had a look at it, and concluded that the purchase GAAP accounting adjustments stripped profits out of the old stable blocks of business to hide losses in the LTC block. Now, that’s just a guess on my part. I could be dead wrong. That said, I would not be surprised to see that KBW finds only limited opportunities for capital enhancement.

On to earnings:

Life

KMG America missed, taking a number of charges, and hiring an investment banker. The stock went up. FBL Financial beat by a small amount.

Title

Investors Title beat earnings. In a very mixed quarter for title earnings, the smallest of the five did well.

Personal

Mercury General and Safety Insurance both beat earnings. Mercury expanded their writings and Safety contracted them slightly. Safety had the bigger beat, though.

Primary Casualty

NYMAGIC, Amerisafe, and Ameritrust all beat earnings, with growing revenues. Ameritrust Financial deserves special mention because it came public recently through unusual means; they listed the stock on NASDAQ, and allowed the private equity holders to go “free to trade.” I can think of another example of that, Quanta Holdings, but AFSI lookws more stable than Quanta.


Conglomerates

Berkshire Hathaway meets earnings, but what can I say? Earnings aren’t very relevant to the way the marginal investor views Berky. The insurance pricing cycle does mean something here, and Buffett was honest enough to inform investors that insurance earnings will likely not be as good next year.


The Bermudans

Max Capital Group beat earnings but on lower written premiums. It will be interesting to see how it fares tomorrow.


Full Disclosure: Long SAFT

Insurance Earnings So Far 1Q07 ? VII

Insurance Earnings So Far 1Q07 ? VII

Things are slowing down, but not much.? Here’s my summary of Thursday’s earnings:

Financial

RAM Holdings beats handily, and Assured Guaranty beats.? I used to own RAM Holdings, but I kicked it out because of the negative macro view of the firm that I work for.? Absent the negative macro view, I would have loaded the boat in the twelves and hung on.? I like the management team and the strategy.

Life

Nationawide and Phoenix both beat.? Big beat for Phoenix, and the stock price was up 5%.? Both are heavily levered to equity prices, so the beat should not be so surprising.
Manulife met estimates and the price fell a little.? Manulife is a company where I don’t get the valuation; it seems too high.? As pointed out yesterday, American Equity missed and fell hard today.? UnumProvident rose as it demonstrated its turnaround through beating earnings on Wednesday after the close.

Brokers

Aon reports and beats on higher revenues.? It seems like the big brokers are beating, while the smaller brokers are missing.? They are different business models.

Primary Commercial

PMA Capital and Tower Group beat, while Specialty Underwriters Alliance missed.? Revenues grew at all of them, and generally continued a 1Q07 theme: so long as earnings are decent enough, the market prefers companies that are growing the top line.

Title

First American misses. They foresee a slowdown in their business and will be looking to reduce expenses.? A writedown here, a writedown there.? FAF is well-managed in my opinion, so if the stock falls tomorrow, it won’t stay there for long.

Personal Lines

Kingsway and Twenty First Century Holdings both miss.? Kingsway is has a high loss ratio from a troublesome acquisition, and the stock goes down 11%.? TCHC cuts earnings giuidance in half because of the onerous nature of Florida personal lines regulation.? The stock falls 45% in the aftermarket on Thursday.? My guess is it finishes up from there, but running a personal lines company with a large Florida exposure is risky; that should not be news to anyone.

The Bermudans

Odyssey Re beats, continuing the pattern of strong earnings on low cats.? They wrote less business, so perhaps gains tomorrow will be muted.? The earnings of Endurance Specialty were pretty good, but their conservatism in new writings was not appreciated by investors, and the stock was down more than 2%.

In summary: Great quarter for primary commercial and the Bermudans.? Good quarter for Life insurance and Financial insurance.? So-so quarter for brokers, personal lines and title.? Poor quarter for mortgage insurers.? Conservatism is not appreciated at present.? Absent catastrophes, I would be inclined to see these trends continue into the next quarter.

Full disclosure: long ENH (take heart, Ken LeStrange!)

Yesterday’s Trades

Yesterday’s Trades

Yesterday I swapped my holdings in Patterson-UTI for Noble Corp. I also reduced my holdings in SPX Corp, which has been a great turnaround play for me. I sold 20% of my position, which I do to rebalance to a target weight. This limits my risk, and given that nothing moves up in a straight line, it allows me to add 2-4%/year to my returns. For more information ion this sort of trade, for those that have access to RealMoney, see this article.


As for the swap, have a look at this article from Forbes. I see reason to swap to a cheaper name, when earnings trends are working in favor of deep water drillers. If oil prices rise a great deal, I will be proven wrong here, but at current oil prices, I like the swap.

Full disclosure: long NE SPW

Update: now, what should happen after I sell PTEN but that it puts up decent, but not stupendous numbers, and it goes up 5%. The relative return difference since the swap is -3%. I don’t play for days, so this does not bother me. My methods work on average over the intermediate term. The proper measurement period for this swap is over the next 1-3 years.

Insurance Earnings So Far 1Q07 ? VI

Insurance Earnings So Far 1Q07 ? VI

Looks like Seeking Alpha missed yesterday’s post.? Oh, well.? Onto the tidal wave of earnings:

Life

Assurant beat handily, on higher revenues.? Only the health division lagged. Prudential Insurance beat as well, with its international division leading the way.? UnumProvident beat, showing that its turnaround has legs.? American Equity missed stating that their interest spread margins had shrunk.? That’s a difficult condition to turn around in the short run, particularly given the long duration of the liabilities.? I would stay away.

Personal lines

Twenty-first Century, Erie Indemnity, Infinity Property Casualty, Horace Mann, and Cincinnati Financial all beat, while Kingsway and ALFA both miss.? Infinity reported before Wednesday’s open, and raised guidance; it was up 11% on the day.? Kingsway had to raise reserves, and ALFA had damage from tornadoes down South.

Primary Casualty

Procentury, FPIC, First Mercury, White Mountains, and EMC Insurance beat.? CRM Holdings met estimates.? OneBeacon missed estimates.? In general, it has been a great quarter for long tail insurance writers.? Investment income up, claims low, what more can you ask for?? Premium trends are mixed.? Only FPIC and EMC Insurance wrote less business.

The Bermudans

Both Endurance Specialty and Aspen Holdings beat, and both wrote less business than this time last year.? Endurance had significant claims from European windstorm Kyrill.? Ren Re beat earnings handily Tuesday evening, but the stock went nowhere on Wednesday, given the shrinkage of written premium.? The same may prove true of Endurance and Aspen.

We’re past the halfway point of the earnings season for insurance.? In general, Bermuda and primary casualty are strong.? Life and personal lines are pretty good.? Only mortgage is having any significant difficulties.

Full disclosure: long AIZ ENH

Taking a Few Lumps in April

Taking a Few Lumps in April

My broad market portfolio did well in absolute terms in April but trailed the S&P 500 for the month by a little; I’m still leading the S&P 500 for the years by a decent margin.? Some of it boiled down to selling ABN Amro too soon, and hanging onto Barclays and Royal Bank of Scotland.? I followed my ordinary valuation rules that have protected me well in the past; they will protect me well in the future as well.? You can’t win them all, but you can reduce risk.? That’s why on Monday, I trimmed my postions in Vishay Intertechnology, Valero, and Bronco Drilling.? They have run; time to trim.

 

Today’s action in two stocks impressed me: Liz Claiborne, and Fresh Del Monte.? One down a lot, and the other up a lot.? I have owned both in the recent past, and sold them due to over valuation and possible accounting difficulties, respectively.? This is why it’s not wise to pat yourself on the back too much when you miss a mistake by selling early, or kick yourself too hard for missing a winner by selling too soon.? These things happen, and “woulda, coulda, shoulda” just confuses matters.? No one gets out at the top and in at the bottom.? Just do your best, and follow your plan.? Nothing will ever be optimal, but things can often be very good.

 

Full disclosure: long VLO, VSH, BRNC, BCS, RBSPF

Insurance Earnings So Far 1Q07 ? V

Insurance Earnings So Far 1Q07 ? V

When I started writing this series, I did not think that I was starting to write a series, but it seems that I have done so.? Since this is percolating out to a number of media outlets, let me simply ask that if you find this valuable, email me, or post a comment on my blog.? I will continue this series through the end of first quarter earnings, but with demand, I would do this next quarter, assuming that I am not swamped.? On to the earnings:

Life

At last the big dogs of this sub-industry begin to report.? I mentioned about the disappointments from Genworth and Principal yesterday, well, they got whacked in Tuesday’s trading, as did Sun Life, which met estimates, but they decided to eliminate their Clarica brand, which presumably will reduce some future revenues.? On the other hand, the buy side may simply have gotten ahead of the sell side.

After the close today, both MetLife and Lincoln National beat estimates.? I reviewed them in detail, and I couldn’t find much to quibble with.? MetLife’s International division did especially well.


Primary Commercial

Markel beat handily after the close, with a rising top line as well.? Two of the companies? beating the estimates yesterday soared — Hanover Group and Ohio Casualty.? National Interstate missed estimates after the close due to a higher than expected expense ratio.

Personal Lines

Safeco beat estimates by a tiny bit, but it looks like the buyside was looking for more.? Given the incredible performance of the stock over the past twelve months, it was just a matter of time before a pullback would happen.? I still think Safeco is overvalued versus peers, even after the fall in price.

The Bermudans

Ren Re beats the estimate by a wide margin, but on a lower earned premium year-over-year.? I suspect the stock moves up, but the questioning on the conference call should be interesting as they flesh out the strategy of management.

Here’s my quick summary of the sectors then: in general, primary commercial, and P&C reinsurance (the Bermudans) have done well.? (Amazing what you can do when there are few catastrophes, or negative legal trends.)? Personal lines, title, and life are mixed bags, but generally positive.? Mortgage has had problems, and I expect that the problems will persist for at least a few quarters.

Full disclosure: long MET and LNC

Insurance Earnings So Far 1Q07 ? IV

Insurance Earnings So Far 1Q07 ? IV

I estimate that we are almost halfway through insurance earnings season now, so here are the broad trends from the various insurance subindustries:

Primary Commercial

What a hot subindustry.? Beating the estimates were CNA, James River, Ohio Casualty, American Financial Group, American Safety, Navigators Group, and Hanover Group.
All but Ohio Casualty and CNA increased their net written premiums.? Ohio casualty was particularly impressive, with the loss ratio improving in the commercial and specialty lines.

Now, I am not a fan of the commercial lines in this part of the cycle, good as earnings look for now.? Here are things to look at for analysts because of the long-tailed nature of this business:

  1. Are the current year loss picks (loss estimates from new business as a percentage? of earned premium) deteriorating?
  2. How much income is arising from release of prior accident year reserves?
  3. How much is pricing deteriorating?
  4. Are terms and conditions deteriorating?
  5. Are they daring to grow in areas where pricing and terms and conditions are deteriorating?

Too many red flags and you should discount current earnings heavily.

Mortgage Insurance?

No good news here. ? PMI and Genworth both miss.? Genworth misses due to mortgage claims (LTC takes a day off from capital destruction), and PMI misses due to higher mortgage claims in the US and Australia.

Life

Principal Financial misses due to higher death claims.? Odd reason for a big company; the law of large numbers should be doing more for them.? High valuation, so it might take some abuse tomorrow.? That said, I would view it as transitory, so if PFG get smashed, I want to pick up the pieces.

The Bermudans

Axis Capital beats handily.? What else would you expect in a low cat quarter?? If it doesn’t rise much tomorrow, it means that the P&C reinsurers have reached equilibrium with the good quarter.

Conglomerates

Unitrin misses on lower net written premiums, and poor performance in their personal lines, and their Unitrin Direct line.

That’s all for now; let’s see what tomorrow brings.

Why Financial Stocks Are Harder to Analyze

Why Financial Stocks Are Harder to Analyze

One of my readers, Steve Milos, asked me the following question:

Free cash flow is a metric that I like to use when judging investments in most types of companies. However, I?m not sure how to apply it to insurance companies, or even how to calculate it, given the uncertainty of claims. Do you use it? How do you calculate it? Currently, I?ve used P/E, P/Book, dividend yield, combined ratio as metrics for insurance companies instead.

Before I start, for those that have access to RealMoney, I would refer you to the following two articles:

Parsing the Financials of the Financials, and

Time to Get Personal with Insurers (free at TSCM).

Quoting from a recent article at RealMoney:

The free cash flow of a business is not the same as its earnings. Free cash flow is the amount of money that can be removed from a company at the end of an accounting period and still leave it as capable of generating profits as it was at the beginning of the accounting period. Sometimes this is approximated by cash flow from operations less maintenance capital expenditures, but maintenance capex is not a disclosed item, and changes in working capital can reflect a need to invest in inventories in order to grow the business, not merely maintain it.

And quoting from the first article that I cited above: The cash-flow statement is of great use in gauging the health of industrials and utilities, but it tells us next to nothing about financials. One of the best values of cash-flow statements is that they enable one to attempt to derive estimates of free cash flow (the amount of cash that a business generates in a year that is left over after it has paid all of its expenses, including capital expenditures to maintain its existing business). Deducting maintenance capital expenditure from EBITDA often approximates free cash flow.

However, cash-flow statements for financials can’t in general be used to derive estimates of free cash flow, because when new business is written, it requires capital to be set aside against risks. Capital is released as business matures. In order to derive a free cash-flow number for a financial company, operating earnings would have to be adjusted by the change in required capital.Sadly, the change in required capital isn’t disclosed anywhere in a typical 10K. Even the concept of required capital can change depending on what market the financial institution is in and what entity most closely controls the amount of operating and financial leverage it is allowed to take on.

Federal or state regulators sometimes impose the biggest constraints on leverage — this is particularly true for institutions that interact closely with the public, i.e., depository institutions and life and personal-lines insurers. For companies that raise capital in the debt markets or do business that requires a strong claims-paying-ability rating, the ratings agencies may lay on the tightest constraints.

Finally, in rare instances of loose regulatory structures, the tightest constraint can be the company’s calculation of how far it can push its leverage before it blows up. Again, this is rare; many companies estimate the capital required for business, but regulatory or rating agency standards are usually tighter.

Actuaries have their own name for free cash flow. They call it distributable earnings. It is equal to earnings less the change in capital necessary to support the business. When sales are growing, typically distributable earnings are less than earnings. When sales are shrinking, typically distributable earnings are more than earnings.

As pointed out in the second quotation above, the hard part is knowing what entity requires the most capital to be held against the business. Is it the regulators, the rating agencies, or the company itself? The tightest constraint determines the capital that is required.

The second part of what makes it hard is that the capital standards for the rating agencies are dimly known to outsiders. Internal company capital standards are not known to outsiders either. Finally, the regulatory standards for capital are known but complex. The formula is known, but not all of the data that goes into the calculation is public. A further difficulty is that different companies run at different percentages above the minimum capital standards, and typically, that is not disclosed.

Aside from that, there is the problem of whether the reserves are fairly stated, but the nuances of that are beyond this discussion. What can an insurance analyst do to get something near free cash flow?

Ask questions on leverage policy. Ask the company how they decide what the maximium amount of business they could write next year is. Premiums-to-surplus? Statutory net income/loss limits? How much more could you borrow at the holding company at your current rating? Questions like this cut through the clutter of what you don’t know, and allow you to estimate how much capital they will have available to increase dividends, buy back stock, or buy other strategic assets. You can also read reports from the ratings agencies, since they focus on this.

In practice, I have a “back of the envelope” feel for how loose or tight capital is at firms that I analyze. I spend more time on pricing power, since it correlates better with stock price performance in normal situations. I look for the sustainability of underwriting margins. I also graph Price-to-Book versus Return on Equity, looking for companies that earn a lot on their net worth, and have a reasonable chance of sustaining those earnings.

I hope that helps explain how to analyze insurance companies, approximating some aspects of free cash flow. If you have a question, pose it below so others can benefit from your question and my answer.

Insurance Earnings So Far 1Q07 ? III

Insurance Earnings So Far 1Q07 ? III

Here we go again:

Financial Guaranty

MBIA pulls out a positive surprise and ends the day up. I suspect that in the current environment where there is a lot of skepticism over structured finance, that it doesn’t take much of a positive surprise to give MBIA a lift. Too many shorts.

Title

Stewart misses badly, and doesn’t fall much. Part of it is due to a charge for title claims that is likely to be nonrecurring. STC has a good track record, little debt, and is trading below book already. How much can it get hurt?

Primary Casualty

Travelers beats and raises guidance and the price falls. Huh? They showed decent top line growth as well. Could that be a worry in a softer pricing environment? It could, but so far that’s not the way other stocks have responded. Philadelphia Consolidated misses and the stock falls, though the company maintains their earnings guidance. When you have a high multiple, investors expect more I guess.

Mortgage

After lackluster results from RDN and MTG, Triad Guaranty beats earnings and the stock jumps 5%. Amazing what good earnings will do when peers have missed. That said, I would be skeptical of future quarters in 2007.

The Bermudans

Transatlantic beat by a decent amount and the stock went nowhere. Perhaps the recent market moves after the reports of the earnings of peers have silently moved the bar above where the sell side left it. Arch Capital beats as well; we’ll have to see how it does tomorrow. I wouldn’t expect much of a move. The valuation on a book basis is significantly higher than that of peers. It takes more of a beat to significantly move the needle. Anybody done a good reserve analysis on ACGL?


Diversified

Old Republic (that venerable and stodgy firm; I like stodgy.) missed estimates. General insurance did well, while mortgage and title both lagged. Hartford beats and raises guidance. Good quarter all around, particularly in variable annuities. Makes me think that when the life companies start reporting next week, that asset- and mortality-sensitive ones should do well. We’ll see how HIG does tomorrow. I’ll be listening to the call. Who knows, maybe I’ll lob in a question.

Full disclosure: long HIG

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