Introduction: Everest Re (RE) is a $6.5 B market cap insurance company with record earnings trading below book value and at about half the general market multiple.
This article makes the case that RE is a superior investment opportunity.
Background: Everest Re was the reinsurance arm of The Prudential, now called Prudential Financial (PRU), and was spun off in 1995 under the guidance of its current Chairman and CEO, Joseph Taranto. Since going public, the company reports that total annual returns to shareholders, counting dividends, have averaged 13%. This is well above the return from broad stock market averages.
The company has been advancing into a combined reinsurance/insurance company. The revenue ratio is now about 3:1, with the insurance component increasing as a percentage of the entirety. It is based in Bermuda, and is globally diversified, with the U.S. accounting for roughly half its business. It has recently made a significant push into the U.S. crop insurance program, which promptly was harmed by last year's drought.
When spun off, RE was burdened by some legacy issues, notably an overhang from asbestos claims. It has worked through those and is now rated highly for its financial strength. Of the several reinsurers that Value Line reviews, it is the only one with a top (#1) ranking for safety.
RE has been savvy with its capital. In Q1, it was shortening the duration of its bond portfolio, stating on its Q1 conference call that it was worried about a rise in interest rates. It also increased its equity exposure.
Early last decade, RE's stock soared and traded for some time well above book value. Management took advantage of this ebullience and sold new shares into the market. Conversely, later in the decade and continuing until now, the stock has sold below book value, sometimes well below book. In response, management has directed substantial funds toward repurchasing shares. The net effect has been interesting. In 2000, there were 46 M shares outstanding; in 2001, 50 M. Share count appears to have peaked in 2006 at 65 M. There are now 48.6 M shares outstanding. Thus management has sold high when the stock was high and bought low when the stock was below book value. This strategy has so far been friendly to long-term shareholders.
Financial results: Earnings have been on a tear. Excluding capital gains and losses, earnings in Q2 reported this week were $5.10 per share, up from $4.25 last year. This brought after-tax operating income to $10.99 per fully diluted share for H1 this year versus $8.72 in H1 2012, itself a high number. The company repurchased 1.6 M shares in Q2 at an average price of $133. This is interesting, in that RE closed Tuesday July 29 at $132.12. As of the time this article is being written, RE was still trading a bit below the price the company was paying on average throughout Q2.
Book value is around $136, and after the bond market sell-off last quarter, very little unrealized appreciation is present in the book value; it may thus be thought of as fairly solid. Of course, the value of the bonds could erode further, as could the value of the company's equity holdings and joint ventures.
Amongst the many moving parts, the company highlighted improvement in its insurance operations in California's workman's compensation. In light of the Great Recession, this is a bit surprising- but good news for shareholders.
Analysts' projections and valuation: Reinsurance makes for highly unpredictable results. Q4 of 2012 was only marginally profitable for RE due to Hurricane Sandy. So, for what it's worth, analysts have raised their earnings projections steadily. Ninety days ago, consensus was for $16.88 for all of 2013 and $16.17 for 2014. They now sit at $17.23 and $16.92, respectively.
The trend is important, given that EPS in 2012 were already at record level. For RE, which trades more in line with book value than earnings, this suggests that the analytic community likes what RE has been doing, and suggests that there is near-term substantial upside potential to book value.
The latest average analyst opinion of RE is a very tepid 2.7. This may allow for upgrades, however, so I do not pay much attention to this metric.
Value Line currently ranks RE #1 for timeliness and gives it approximately a similar 3-5 year price potential as the overall market for total return. Another independent stock research organization, Standard and Poor's, is also positive on RE. It has a one-year price target of $148 for RE and pegs fair value, using a proprietary valuation method, at $198 per share. Thomson Reuters gives RE its rarely-awarded composite score of 10 (highest). Verus, an independent research and ratings company, using a different methodology, rates RE above-average at a 7, on a 1-10 scale.
Sponsorship: A well-known value investor, Southeastern Asset Management, is the largest shareholder, controlling 8.7% of shares outstanding. Davis New York and Goldman Sachs are significant holders, as well. This is positive for the thesis that RE has sound fundamentals. Insiders own 1.1% of the stock and have sold very few shares over the past six months. Institutional and mutual fund holders are reported to control 97% of the shares outstanding. RE is not a stock that many day-traders flip.
Competitive advantage: Management points to its relationships globally as providing a competitive edge. It also points to a low-cost business model. From the Seeking Alpha conference call transcript:
Our client relationships, our long-term client relationships will diversify business platform, and great ratings continue to serve us well. Our focus, nimble culture has produced great opportunity for us. Everest by far has the lowest internal expense ratio in the market. Our studies indicate that we have a 3 to 7 point expense advantage over our competitors. This is an enormous advantage. Our flatter organization has benefited us greatly, as it allows us to react to changing market conditions more rapidly, offer new products and better meet client needs.
This is an interesting and positive assertion, given that Institutional Shareholder Services flags RE for excessive executive compensation:
Everest Re Group Ltd.'s ISS Governance QuickScore as of Jul 1, 2013 is 10. The pillar scores are Audit: 1; Board: 10; Shareholder Rights: 2; Compensation: 10.
(Note: 1 is best, 10 is worst for ISS.)
My take is that if management can pay itself well while running a very low-cost shop, great. They are being paid for performance, it would appear.
Technical considerations: The stock may be completing a 4-month high-level consolidation. If it can clear its all-time high of $137.50, then no overhead resistance will exist. Only about 3% of the shares have been sold short, so little fuel from short-covering should be anticipated. I like the look of the 1-year and long-term price charts (Yahoo! Finance):
The shares dipped below RE's 50-day exponential moving average during the recent consolidation, but are again trading above it.
Risks: The company operates in highly competitive markets with unpredictable pricing cycles. Over the years, its underwriting margins have not led the industry. Earnings are thoroughly unpredictable from quarter to quarter. The dividend payout has been held steady at $1.92 per year since 2007, so income investors may not be overly interested in RE. The shares frequently trade unmoored from either earnings or book value for substantial periods of time, so there is the risk of dead money even if a bullish investment thesis is eventually proven to have been correct. Fundamentally, there is both business risk and investment risk to the portfolio; difficulties in either of those aspects of the business may harm the company.
The company is involved in certain joint ventures that are opaque. It may have increased the risk profile of its bond holdings somewhat in response to the very low interest rate environment.
Even though beta is low, around 0.75, RE remains subject to general bear market action.
Summary: Everest Re shares may represent a solid investment, even at today's near-record share price. The stock has a record of outperformance to investors in a highly-competitive, specialized industry. Everest Re asserts that it has a low-cost business model, providing it a durable competitive advantage. There is what I view as strong institutional sponsorship of the shares. Standard & Poor's has a valuation model that indicates that fair value of RE is a full 50% above its current trading value.
Numerous risks to the company exist, both operationally and regarding its investment portfolio.
Overall, though, in what I view as a richly-valued stock market, RE appears to me to have above-average investment merit.