Odd rolls of the dice here at Gumshoe HQ have led to three different Cabot teaser pitches being covered in a relatively short period of time… this one is an insurance stock, and it has generated quite a few questions from the “teaser article” Cabot sent around saying this secret, unnamed stock is the one to buy “for the hurricane rebound.”
That notion of a “rebound” is nothing new for insurance stocks — investors have often noted that property and casualty insurance companies tend to do poorly when a big hurricane (or similar disaster) is about to hit, and when it does hit, but that they tend to bounce back pretty nicely after that because they are set up to cover those kinds of events, after all, and coming off of a disaster gives all of the participants incentive to price their risk more reasonably… meaning that the market “hardens” and insurance companies stop competing as aggressively to be the lowest-cost insurer.
That problem of a “soft” market, with too much capital chasing too little risk and lowering the price insurers can get for their risk coverage, has been with us for a while… and in a world with manipulated interest rates that are too low for pension plans to meet their obligations, it is exacerbated by the movement of ‘alternative’ funds into the insurance market, through catastrophe bonds and hedge fund-backed reinsurance companies all seeking that promise of an ‘uncorrelated return.’ And, frankly, though this year will probably end up being a pricey one for insurance claims thanks to Harvey and Irma and Maria and whatever else may come in the next couple months, it may well not be enough of a blowout of insurance reserves to force a “hard” market. We won’t really know that for a while.
So there’s no guarantee that the insurance market will become more profitable in the near term, but that has been a typical trend… which means investors look for it and bet on it. Including me, I bought shares of one of the smaller insurance/reinsurance companies that was beaten down a couple weeks ago and have generally been adding to my insurance exposure in the portfolio… so I was curious to see whether Cabot’s analyst and I had picked the same stock.
So what is it?
The stock being hinted at has been recommended by Crista Huff for her Cabot Undervalued Stocks Advisor (both names are new to me, though this letter has apparently been publishing for about two years now). This is what Tim Lutts says about it in his free column…
“This company, based in Ireland (for tax reasons, naturally), sells $11 billion worth of insurance and reinsurance around the globe, every year. It’s growing revenues at double-digit rates. And it pays a 2.3% dividend.
“But panic selling in response to Harvey and Irma hit all insurance stocks; at the bottom, this stock was down 22%. As I write, it’s down 17%. And that looks like an opportunity.”
OK, so that kind of performance is similar to several of the insurance stocks — particularly the reinsurers. What other hints does he drop?
He includes a little quote from Crista Huff’s recommendation… here’s part of that:
“[Company X] is an undervalued, aggressive growth mid-cap stock. The price chart exhibited a shakeout pattern this month, which usually signals a turnaround in the share price. There’s 20% upside as [Company X] retraces its July high, at which point the 2017 P/E will be only 14.3.”
So who are we dealing with here? This is very likely a hint about XL Group (XL), though some of the info is slightly off from that teased portrayal… they did re-domicile from the Cayman Islands to Ireland several years ago for tax purposes, though last year they further re-domiciled to Bermuda after acquiring Catlin, presumably for regulatory and tax reasons. Their European operations are headquartered in Dublin, partly because they’ve moved some assets out of London due to Brexit.
And they did post $11 billion in revenue over the past twelve months, though that’s not technically the same as their gross premiums written (which was a bit higher than that). And they pay what is currently a forward dividend of 2.25%, so that would have been 2.3% a few days ago when the stock price was slightly lower. The company hasn’t been growing revenues at “double digit rates” in the most recent periods, though — the past quarter that number was only up about 5% (though revenue per share has been growing quite steadily at high double-digit rates for a couple years now, thanks to the Catlin acquisition).
Finally, analysts have a current-year estimate of $3.28 for XL earnings per share… and if you multiply that by 14.3, per the hint in the teaser pitch, you get $46.90… which is right about where XL closed on July 24 when it hit it’s high for the year (high for the past nine years, actually).
XL Group is an interesting story — it was started up in 1986 by a consortium of giant multinationals who weren’t happy with the insurance that was available to them, went public in 1991, and gradually grew through lots of M&A and changed its name in 1999 From EXEL to the current XL. They were also one of the massive, massive casualties of the financial crisis, partly because they lost a ton of money on Enron, and for a little while down there at the late-2008 lows the stock traded at only about 15% of book value — almost as bad as crisis poster-child AIG and much, much worse than any other insurance company I’ve checked (many of them bottomed out at around 60% of book value, which is crazy enough).
But now they are a pretty well-diversified global insurance and reinsurance company, with a pretty stable performance when it comes to underwriting in recent years, and an admirable focus on cost containment and deploying technology to improve their operations… and they made a transformational acquisition to almost double the size of the company when they acquired Catlin back in 2015. You can get a bit of a picture of how and where they see themselves from their 206 annual letter to shareholders released earlier this year.
The stock I just bought during the hurricane slump was not XL Group, incidentally — I bought shares of Axis Capital (AXS) instead, though the two are fairly similar in some ways. Both are Bermuda insurance/reinsurance companies who pay good dividends, trade at a little bit of a discount to their book value (and to near-peers), in part because of their reinsurance exposure, and both are fairly aggressive in their stock buyback programs (which is a nice way to immediately make your financials look better, particularly if your stock is trading at a meaningful discount to book value). Both also have made intelligent acquisitions that should make them more valuable — Catlin for XL a while back and Novae for Axis just this year (though Axis missed its chance to merge with Partner Re in a more transformative deal back in 2015, when Catlin and XL were tying the knot).
I tend to value insurance and reinsurance companies based on their book value and their growth in book value per share, since per-quarter earnings don’t tend to mean all that much — most of these companies have very inconsistent earnings because the investment portfolio drives lots of swings and because insured losses are not recognized on a steady basis. On that front, XL seems reasonable but not necessarily exceptional — they have grown book value per share by about 24% over the past five years and earned a relatively higher valuation of closer to 1X price/book as they’ve recovered from that 2008/9 crisis, so the stock has gone up by about 65%.
Axis, by comparison, has grown book value per share by 35% during that same time period, and received a smaller boost in valuation, leading to a pretty similar share price rise of 60%. That’s one of the things that stood out for me with AXS, that they have tended to be pretty shareholder-friendly with buybacks and dividends but have still done well in per-share book value growth, but XL is fairly similar in that regard, just a bit larger and, I think, a little bit less impressive on the growth front (particularly if you take out the big bolus of growth that came with Catlin).
Both of those companies, incidentally, have done this per-share growth largely through stock buybacks — neither has posted meaningful real growth in book value, just in book value per share. Neither is taking huge risks with the balance sheet, though XL has taken on debt and AXS has instead issued more preferred shares.
And I’m not trying to convince you to get into an Axis-buying frenzy. Axis is not a nosebleed grower, by any means — 35% growth in book value over five years is not crazy-high, it’s just above average… the only ones that immediately come to mind that have done far better are the serious value-compounders like Markel (MKL) and Berkshire Hathaway (BRK-B), both of which are much better companies… but they’re also priced like much better companies, at 40-60% premiums to book value (and while AXS has risen 60% in five years, Markel is up 130%).
Other high-quality insurers like Chubb (CB) and WR Berkley (WRB) also come in at about 35-37% book value per share growth over the past five years, while giants like Travelers (TRV) are around 25-30%. Even with dividends, though, Axis is the lowest performer in that particular group over the past five years when it comes to the stock market, with an 80% total return including dividends, just about exactly the same as the return for XL Group despite the better per-share performance AXS has shown. So that’s why AXS came in as a stock I think is attractive here, though I don’t want to overstate my interest — it’s a small and opportunistic position, and AXS is by far the smallest holding among insurance stocks in my portfolio (Markel, Berkshire Hathaway and Fairfax Financial together make up 23% of my Real Money Portfolio).
And likewise, XL Group is not necessarily a worse company than Axis among the Bermuda insurance/reinsurance firms — it’s significantly larger, it has pursued some restructuring and reorganization, and it’s a well-run company that has some appeal and has done a good job recently of underwriting very profitably and managing costs quite well… and there is something to be said for a company that has a buyback authorization of close to 10% of its shares and may well reach that number, particularly when it can buy back the shares at less than their book value.
I don’t know what the real impact will be of the recent major hurricanes on XL Group… or, indeed, on any of the insurance stocks I follow, but it is a bit beaten-down still, it does pay a dividend, and it seems that one newsletter, at least, is recommending the shares as “undervalued.” And when it comes to forward PE ratios, in case you’re curious, XL is even more inexpensive — the shares are currently trading at 10X 2018 estimates (AXS is just below 12, in case you’re curious). Insurers don’t always get valued based on their PE ratios, partly because earnings are so lumpy due to unpredictable insured losses and investment gains, but according to YCharts analysts have been unusually accurate in predicting earnings for these two insurers over the past couple years.
With that, I’ll pass it back to you — do you like the looks of XL shares here? Think Huff is on to something with this recommendation if, indeed, the Thinkolator is on target? Have a better match for those clues, or other ideas that you prefer in the insurance space? Let us know with a comment below.
P.S. Crista Huff’s Cabot Undervalued Stocks Advisor is apparently quite new, but if you’ve ever subscribed to her work we’d love to know what you think — just click here to share your thoughts on this newsletter with your fellow investors. Thanks