3 post-Sandy insurance plays
With most property and casualty insurance stocks pulling back since the hurricane hit in late October, Merrill Lynch analyst Jay Cohen names his favorite sector picks.
By Philip van Doorn
Hurricane Sandy and the interest rate environment have combined to set up some insurance stock recovery plays for long-term investors.
Bank of America Merrill Lynch analyst Jay Cohen said on Monday that "given the hit to book values we expect from Sandy in the fourth quarter of 2012 and the minimal impact we currently expect from investment marks this quarter, our price objectives are little changed."
The analyst focused on three companies that he believes have the most upside over the next year in the property and casualty (P&C) sector.
Before Sandy's onslaught, 2012 was shaping up to be a recovery year for P&C carriers, with many of the best-known companies showing underwriting profits, following a difficult 2011. Before Sandy, Insurance Information Institute president and economist Robert Hartwig said that insured catastrophe losses were "down somewhere in the order of 50% from last year."
It is, of course, too early to gauge the total damage that Sandy will cause the economy or the insurers, but industry loss estimates range as high as $25 billion.
"We're getting ranges anywhere from $5 billion to $25 billion, from the modeling firms," says Loretta Worters, a spokesperson for the Insurance Information Institute," who says that the average P&C industry loss estimate from Sandy "is probably $18 billion."
"There have been so far about 360,000 homeowners insurance claims in New Jersey and about 330,000 claims for homeowners in New York, with probably about 180,000 in other parts of the country," Worters says, adding that "there are a lot of business claims that haven't been processed yet, and we think the claims will be much higher on the business side than they will be on the personal side."
Allstate (ALL) on Nov. 28 estimated that its losses for October, net of reinsurance, totaled $1.1 billion. The company said that "autos represent approximately 40% of the total gross losses, with 78% in New York, 19% in New Jersey and 3% in other states."
Allstate's stock closed at $40.49 Monday, down 5% from their year-to-date closing high of $42.62 on Oct. 16, but returning 51% year-to-date. Following Sandy's arrival, the shares dipped as low as $37.92, in intraday trading on Nov. 2.
Allstate's shares trade just below their reported Sept. 30 book value of $42.64, and for nine times the consensus 2013 earnings estimate of $4.50 a share, among analysts polled by Thomson Reuters.
Bank of America Merrill Lynch analyst Alison Jacobowitz rates Allstate a "buy," with a price objective of $46, and estimates that the company's adjusted book value will still increase to $42.86 at the end of 2012, despite the losses from Sandy, and rise to $46.35, as the end of 2013.
Following Allstate's announcement of its October loss estimate, Jacobowitz said "we don't expect to see serious downward revisions to earnings as a result of the October losses, nor do we expect spreads to be moved by this number." The analyst estimates that Allstate will report a fourth-quarter profit of nine cents a share, and earnings per share (EPS) of $3.62 for all of 2012, increasing to $4.25 in 2013 and $4.65 in 2014.
In a very competitive market, P&C insurers typically rely on investment income for profits, as they often take underwriting losses. Cohen said that the companies his firm covers "still face two notable headwinds in their efforts to improve their returns on equity (ROEs): low interest rates which will continue to put downward pressure on investment income and the real likelihood of less favorable prior year reserve development," and that "companies are trying to offset these headwinds by both raising prices and buying back stock."
Cohen expects P&C returns on equity "to bottom in 2013," as the buybacks and price increases "will not be enough to offset the pressure on investment income and the probable slowdown in favorable prior year loss reserve development," which could lead to "underlying margin improvement as premiums are earned into 2014."
Here are Cohen's three favorite P&C stock picks for the next 12 months, ranked by upside potential implied by the analyst's price objectives:
Cohen on Monday raised his price target for ACE's shares by a dollar to $95, and said that the company's "earnings through the first nine months of 2012 consistently beat our forecast and our forward estimates gradually rose during that time," and that the "solid performance occurred despite the drought conditions in the US, which were the worst in over 20 years."
ACE reported net income of $1.9 billion for the first three quarters of 2012, or $5.67 a share, increasing from $805 million, or $2.36 a share, during the first three quarters of 2011. Underwriting income grew to $1.1 billion during the first three quarters from $663 million a year earlier, while the combined ratio -- underwriting losses plus expenses, divided by earned premiums -- improved to 90.2% from 95.3%. A combined ratio of over 100% indicates an underwriting loss.
Cohen said that ACE's valuation was "attractive," trading "just below its book value" of $79.36, and that although "some investors point out that ACE's shares are trading at just over 1.2x tangible book value, making it look more expensive than it does on a straight price/book basis... we note that on a tangible basis, ACE's 2013 estimated ROE would be about 200 basis points higher than on a reported book basis or about 11.5%, suggesting that a premium to tangible book is warranted."
The analyst also said that "there is no doubt that Sandy will have an impact on fourth quarter result, but at this point, we have no reason to believe that ACE's loss from this event will be outsized in nature." Cohen estimates that ACE's adjusted book value will increase from $80.30 at the end of 2012 to $86.22 at the end of 2013, while the tangible book value will grow from $66.08 at the end of this year, to $72.00 at the end of 2013.
(Interested in more on ACE, Ltd.? See TheStreet Ratings' report card for this stock.)
The shares trade for 0.8 times their reported Sept. 30 diluted book value of $43.57, and for nine times the consensus 2013 EPS estimate of $3.94. The consensus 2014 EPS estimate is four dollars. Based on a quarterly payout of 24 cents, the shares have a dividend yield of 2.68%.
Cohen said that "after a catastrophe-mired 2012, AXIS reported sold results" during the first nine months of 2012. For that period, the company reported net income of $513.6 million, or $4.11 a share, improving from a loss of $70.6 million, or 58 cents a share, during the first three quarters of 2011.
The company's underwriting income totaled $337.4 million during the first three quarters of 2012, increasing compared to an underwriting loss of $342.3 million a year earlier. The combined ratio improved to 90.8% during the first three quarters of 2012, from 116.3% a year earlier. A combined ratio of over 100% indicates an underwriting loss.
Cohen's price target for AXIS Capital is $44, which is "0.9x the estimated year-ahead book value, a multiple that reflects an ROE that should remain under pressure." The analyst called Axis a "longer-term opportunity," and said that "a reduced earnings drag from the new [accident and health] business along with more consistent earnings should be the catalysts for appreciation."
Cohen said that "we assume a small loss in the fourth quarter due to Sandy, but unless the loss is outsized in nature and larger than we expect, we believe that the storm is fully factored into the stock price."
The analyst estimates that Axis Capital's adjusted tangible book value will increase from $43.86 at the end of this year, to $47.47 at the end of 2013.
(Interested in more on Axis Capital Holdings? See TheStreet Ratings' report card for this stock.)
Cohen called XL Group his "top name" among P&C carriers, "looking at both risk and reward," saying that the company was a "turnaround story, with the shares trading at 70% of last reported book value, there appears to be some lasting skepticism among investors regarding XL's ability to improve its returns, most notably in its insurance business where margins have lagged peers."
XL Group reported earnings attributed to ordinary shareholders of $569.7 million, or $1.82 a share, for the first nine months of 2012, increasing from a profit of $40.8 million, or 13 cents a share, during the first nine months of 2011. For its P&C business, the company reported an underwriting profit of $306.8 million during the first three quarters, compared to an underwriting loss of $283.2 million a year earlier, while the combined ratio improved to 92.7% from 107.2%.
Cohen said that "given the continued momentum in commercial insurance pricing and our view that price increases will remain ahead of claims inflation, we would expect the fundamental backdrop to remain favorable for XL's efforts to improve margins.
The analyst's price target for XL group is $30, and he estimates the company's adjusted tangible book value will increase from $33.01 at the end of 2012 to $35.79 at the end of 2013.
(Interested in more on XL Group? See TheStreet Ratings' report card for this stock.)
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