The insurance industry's growth outlook has remained strong due to a high demand for insurance products. This also introduces a high degree of competition in the industry which results in newer products. Some of these products were at the core of the financial crisis which is why the financial services industry had to experience a severe shock. Following these events, investors remained reluctant in allocating their funds towards such a high risk industry. In recent periods, the financial services sector has started to show improvement. The earnings performance recovered rather quickly, but now the stock prices are also starting to demonstrate a soaring trend. In this situation, investors are regaining their interest in financial services stocks and are willing to take up some risk in order to obtain a stronger premium. In this analysis, I aim to evaluate ProAssurance Corp. (PRA) as a prospective investment opportunity.
ProAssurance aims to provide a very attractive risk-return paradigm to the investors by addressing investor considerations and limiting its risks. This is a difficult task. The inherent risk associated with the financial services industry due to the high degree of integration between businesses is always a key factor to consider in the evaluation of financial stocks.
The above chart shows the performance of ProAssurance as compared to the S&P 500 index and the Dow Jones US Financial Services Index since the beginning of FY11. Over this period, the company has outperformed the indices by posting a price appreciation of 85.5%. The financial services index has underperformed against the S&P 500, but in recent periods, this appears to be changing.
Business Strategy & Investment Portfolio
ProAssurance is limited in its regional capacity as the company only operates in US. However, the company's target market is carefully crafted and specialized. The company is mainly aimed towards the healthcare sector.
Source: NYSSA, March 2013, Presentation
The above chart shows the division of the company's premium and policyholders. The healthcare professional liability (HCPL) is the largest contributor to the company's premiums. This strategy has been adapted in order to gain from the nature of the market. Furthermore, in recent years, market trends suggest that hospitals are turning into larger networks which require a higher degree of financial security. These factors open new opportunities for the insurance companies. ProAssurance is the largest independent publicly traded writer of HCPL insurance which makes it strategically well positioned to benefit from industry trends. Also, the company has remained active on its M&A front in recent periods in order to trigger growth. The company acquired Independent Nevada Doctors Insurance Exchange in late FY12 and also closed the acquisition deal of Medmarc in early FY13.
Source: NYSSA, March 2013, Presentation
The above chart shows the investment portfolio of ProAssurance. A disproportionately large part of the $3.9 billion overall portfolio is invested in fixed income securities. The fixed income portfolio is also spread across corporate, state and municipal, asset backed and government & agency securities. The charts show that the company's investment portfolio is well diversified and limits the exposure to high risk segments.
In comparison to the industry, the company has demonstrated an outstanding performance over the last two decades. The results suggest that the company has remained consistent in its performance which is vital in order to engage the confidence of investors.
Source: Source: NYSSA, March 2013, Presentation
The above chart shows the combined ratio of the company as compared to the overall industry since FY91. It is quite evident that the company's combined ratio has been successfully kept below 100 for the most part. Currently, the company is operating at its lowest combined ratio over the reference period. Furthermore, in terms of the performance indicated by the ratio, the company has outperformed the industry throughout this period.
Data Source: Morningstar
The above table uses some key valuation metrics to evaluate the pricing of the company's stock by comparing the indicators with industry averages. The table shows that the company is undervalued with respect to its earnings but overvalued with respect to sales. In a going forward perspective, the PEG ratio of 0.8 indicates that the company is undervalued with respect to earnings growth.
The above chart shows the performance of the company's stock as compared to the Dow Jones Financial services index since the beginning of FY06. The grey area indicates the period of recession. The chart clearly shows that the sensitivity of the overall financial services industry to financial and economic shocks is not shared by the company. During this period, the index showed a substantial decline, but the company's stock price showed relatively less volatility. Along with the low level of volatility, the company also offers decent dividends and stock buyback plans in order to return funds to the investors.
The improvement in the performance of financial services stocks in the market shows that the investor confidence is recovering. With strategic acquisitions and a carefully planned business model, ProAssurance is set to gain from this recovery. At the same time, the undervaluation of the company with respect to earnings growth coupled with the relatively low sensitivity to economic shocks make ProAssurance an attractive investment opportunity. Keeping these factors into consideration, I propose a buy recommendation for the company.