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Business Insurance reports that average U.S. property and casualty insurance rates rose by 5% last month. Market Scout, an electronic insurance exchange, provided the data, which shows a continuing trend of rate increase within the commercial property and casualty market. Since the P&C market is doing well, we decided to look for promising, undervalued stocks in the industry

To create the following stock list we began with a universe of property and casualty insurance stocks. We looked for companies that appear undervalued relative to their cash flows, indicated by high ratios of levered free cash flow/enterprise value. Levered free cash flow plays an important role in further expansion of the business.

Levered free cash flow is the free cash flow after deducting interest payments on outstanding debt. Enterprise value is the sum of the firm's value from all ownership sources: market cap, outstanding debt, and preferred shares. When companies have ratios of levered free cash flow/enterprise value in excess of 10%, it may indicate that the company as a whole is being undervalued.

Next, we screened the remaining stocks for those with bullish sentiment from institutional investors, as illustrated by significant net institutional purchases over the last quarter representing at least 5% of share float. This indicates that institutional investors such as hedge fund managers and mutual fund managers expect these names to outperform into the future.

The List

For aninteractive version of this chart, click on the image below. Analyst ratings sourced from Zacks Investment Research.

Do you think hedge funds are making the right moves with these stocks? Use this list as a starting point for your own analysis.

1. Stewart Information Services Corp. (NYSE:STC): Provides title insurance and related information services required for settlement by the real estate and mortgage industries.

  • Market cap at $621.26M, most recent closing price at $27.71.
  • Net institutional purchases in the current quarter at 1.6M shares, which represents about 7.69% of the company's float of 20.80M shares. The 2 top holders of the stock are Dimensional Fund Advisors LP and Manulife Asset Management, LLC.
  • Levered free cash flow at $107.19M vs. enterprise value at $488.68M (implies a LFCF/EV ratio at 21.93%).

Stewart Information Services had $423.7 million in revenue during the first quarter of 2013, which is a 10.1% increase from its revenue of $385 million in the first quarter of 2012. The insurance and real estate services provider also saw a $15.4 million year-over-year improvement in its first quarter net earnings from a net loss of $12.2 million, or $0.63 loss per share, to $3.2 million, or $0.15 a share. Earnings from title insurance were $386.2 million, an increase of 11.4% from $346.7 million a year ago.

The company reported strong earnings growth this past year, with EPS growing by 3548.34%. This beats competitors Argo Group International Holdings, Ltd. (NASDAQ:AGII) and Fidelity National Financial, Inc (NYSE:FNF), which saw 166.62% and 11.27% EPS growth, respectively, over the course of the year.

Stewart Information Services' mortgage services segment revenue rose by 11.9% from the first quarter of 2012 but declined 11.5% sequentially from the previous quarter. The company attributes the decrease in revenue to expired contracts for distressed loan services and expects distressed serving projects to continue to diminish. Therefore, as the housing market continues to improve, Stewart Information Services plans to expand its mortgage process outsourcing services. CEO Matthew Morris notes that the company is focusing on its direct title and mortgage service operations.

2. AmTrust Financial Services, Inc. (NASDAQ:AFSI): Operates as a multinational specialty property and casualty insurance company in the United States and internationally.

  • Market cap at $2.19B, most recent closing price at $32.56.
  • Net institutional purchases in the current quarter at 2.2M shares, which represents about 6.33% of the company's float of 34.76M shares. The 2 top holders of the stock are JP Morgan Chase & Company and Mawer Investment Management Limited.
  • Levered free cash flow at $330.44M vs. enterprise value at $2.36B (implies a LFCF/EV ratio at 14.%).

At the end of the first quarter of 2013, Amtrust Financial Services reported a 37.1% year-over-year growth in revenue from $414.2 million to $567.8 million. Net income rose as well, increasing 64.2% from $39.1 million, or $0.64 diluted EPS, to $64.2 million, or $0.81 diluted EPS. The company's net premium earnings rose by 29.9% to $408.9 million from $314.0 million in the first quarter of 2012.

Since May 6th, Amtrust Financial Services has returned -2.81%. While the insurance company's performance is better than peers Alleghany Corp. (NYSE:Y) and The Travelers Companies, Inc. (NYSE:TRV), it lags behind Hartford Financial Services Group Inc. (NYSE:HIG), which returned 0.17% during the same holding period.

AmTrust Financial Services' projected earnings growth rate over the next 5 years stands at a higher-than-average 13.74%. This beats Hartford Financial Services Group's 5-year projected EPS growth of 9.53% and Alleghany Corp's 8.50%.

However, once we compare the company's short float to industry averages, the numbers suggest that short sellers think there's more downside to the stock. AmTrust Financial Services' short float stands at 28.66%, which is equivalent to 20.13 days of average trading volume. For context, The Travelers Companies' short float is at 0.90%, representing 1.73 days of trading volume, while Alleghany Corp.'s short float stands at 0.98%, which represents 3.25 days of trading volume.

Amtrust Financial Services has gone on quite the acquisition spree this past year. Back in the first quarter, the company purchased Car Care Plan, a specialty risk and extended warranty administrator and underwriter in Brazil, China, and Europe. In April, the company acquired Sequoia Insurance Company, which had $140 million of gross written premium in 2012 and operates on the west coast of the U.S. Most recently, Amstrust Financial Services bought Mutual Insurers Holding Company (MIHC) and its First Nonprofit Insurance Company (FNIC) subsidiary. FNIC is the country's third largest property and casualty insurance provider servicing the non-profit industry; last year, the company wrote $70 million of premiums in 27 states.

3. AXIS Capital Holdings Limited (NYSE:AXS): Provides various insurance and reinsurance products to insureds and reinsureds worldwide.

  • Market cap at $5.22B, most recent closing price at $43.77.
  • Net institutional purchases in the current quarter at 5.7M shares, which represents about 5.16% of the company's float of 110.51M shares. The 2 top holders of the stock are FMR LLC and Pzena Investment Management, LLC.
  • Levered free cash flow at $967.30M vs. enterprise value at $5.84B (implies a LFCF/EV ratio at 16.56%).

At the end of the first quarter of 2013, AXIS Capital's revenue increased by 5.17% from $977.5 million a year ago to $1.028 billion. The company reported $303 million in net income, or $2.55 per diluted common share, reflecting a 148.36% increase from $122 million, or $0.96 per diluted common share, in the first quarter of 2012. First quarter net premiums earned totaled $874.04 million, reflecting a 3.27% increase from $846.36 million last year.

AXIS Capital has returned -2.17% since May 6th, eclipsing competitors XL Group plc (NYSE:XL) and Aspen Insurance Holdings Ltd. (NYSE:AHL), but lagging behind American Financial Group Inc. (NYSE:AFG), which returned -0.72% over the last month.

The company's EPS grew by 5339.05% over the last year, topping XL Group's 238.31% EPS growth and Cincinnati Financial Corp.'s 152.99% EPS growth.

AXIS Capital's U.S. division, which is dominated by the company's wholesale E&S property and casualty business, saw a 9% improvement in the most recent quarter. This growth marks the eight consecutive quarter of rate increases for the property business, with accounts heavy in loss activity driving the performance. The company's casualty business also grew for the eight consecutive quarter and saw premium increases in primary, buffer, and excess layers.

*FCF data sourced from Yahoo! Finance. Institutional data sourced from Fidelity. All other data sourced from Finviz.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Business relationship disclosure: Kapitall is a team of analysts. This article was written by Mary-Lynn Cesar, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Hedge Funds Are Buying These 3 Undervalued Property & Casualty Insurance Stocks