If you could somehow buy the stock of automobile insurance company Mercury General (MCY) at a used car lot, the greeting from the man in the crazy plaid jacket might go something like this:
“Psst! Want a great deal on a slightly used Dividend Achiever? This baby yields over 6% and just started boosting its dividend again.
Of course, it was totally wrecked last year, but that’s why this shiny little sweetheart is priced to move!”
Yes, indeed. But don’t run away screaming quite yet.
Since it began paying dividends in the first quarter of 1986, midcap MCY increased its dividend at least once a year. These increases averaged nearly 20% annually when compounded over more than 20 years, though about half that for the most recent increases.
Then, in 2008, MCY ran off the road, piling up a net loss of well over $4 a share due to its sinking investment portfolio, as well as declining revenues from premiums. So MCY froze its dividend at the Q1 2008 level for seven quarters.
Meanwhile, a tanking stock price ballooned the yield to over 7.5% amid speculation that MCY would be the next wreck to chop-shop its dividend and put its decades-long Dividend Achiever status in the rear-view mirror.
Stomp the brakes on all that.
As part of its most recent, strong quarterly earnings report the company lifted its dividend for Q4 2009, marking 23 straight years of increases and signaling confidence that its business has cruised out of the danger zone and is headed in the right direction again. The dividend increase was piddling, just 1.7%, but the turn signal wasn’t.
I attended the Morningstar Stocks Forum in Chicago a couple of weeks ago, which was shortly after MCY’s announcement, and spoke with several of their stock analysts, including their top analyst for the insurance industry.
While MCY was hardly his top pick, he stated quite firmly his opinion that MCY is a strong dividend play, and he sees no danger of a cut. The risk to MCY, as he sees it, is that the company is highly dependent on the still-gridlocked California economy, and so may show slow growth in premiums, and therefore revenues, as strapped consumers cut back on coverage and even on cars. He also pointed out that MCY has typically underperformed in its much smaller markets outside California, so a rough road in California means a rough road overall.
OK, time for a quick look under the hood.
First, that recent earnings release: in Q3 2009 MCY earned $2.85 per share, compared with a loss of $2.57 in Q3 2008. For the first nine months, the figures are earnings of $6.70 vs. a loss of $1.35.
This is against a new quarterly dividend of $.59. Reuters puts the trailing 12-month payout ratio at 63%, with 3-year and 5-year dividend growth both about 11%.
Deeper under the hood: when capital markets came back from the crash, MCY’s investment portfolio recovered, but not everything’s running at full speed. Premium revenues are still down versus a year ago, and those revenues need to get into gear. But an important insurance industry metric, known as the “combined ratio,” did improve, which helps profits in the meantime.
Combined ratio shows the percent of premium dollars that are paid out in claims, so a ratio under 100% indicates an insurance company is profiting on its underwriting, not simply on the “float” of its investment portfolio. MCY’s combined ratio was slightly over 96% for both Q3 and the first nine months of 2009, compared with 102% and 98% for those periods in 2008.
MCY has typically been among the industry’s most profitable underwriters, and Morningstar calls the company’s Q3 underwriting results “a positive sign.”
As you might expect from the potholes it hit, MCY valuations are a sweet ride right now. Morningstar puts the trailing 12-month P/E just above 10, which is just above a 10-year low. The Price to Sales ratio is at a 10-year low.
Although Price to Cash Flow isn’t at bargain-of-the-decade lows, both Cash Flow from Operations and Total Cash Flow have been positive in each quarter of 2009. ROE is 12% and debt to equity just 20%.
MCY stock has not been a high-performance story recently. Over the trailing 1-year period it lagged the S&P 500, the S&P Financial Sector ETF (XLF) and the S&P MidCap ETF (MDY). MCY did outrun the XLF over the trailing 2-year and 5-year periods, but straggled behind the other benchmarks.
There are plenty of investors that won’t want to jump behind the wheel and take MCY for a spin. Those looking for turbo-charged growth certainly won’t, nor will those looking for the kind of smooth, predictable ride some utilities or other high-yielders might provide.
But income investors who can tolerate some uncertainty might see an entry point here for a relatively high current yield on a recovering business; some capital appreciation potential down the road; and the likelihood of improved future dividend growth to keep goosing the yield-on-cost. Those investors might want to at least kick the tires and research MCY for themselves.
Finally, if you’ve had enough car-talk, maybe you’d like to check out a sweet-smelling 3.5% yielder with a big fleet of garbage trucks. If so, see my Seeking Alpha article “Waste Management's Rising Dividends” (WM).
References and Links
Press Release, “Mercury General Corporation Announces Third Quarter Results and Increases Quarterly Dividend,” November 2, 2009.
Morningstar Stock Analyst Notes, “Investment Gains Help Mercury's 3Q,” November 2, 2009.
Morningstar, “Mercury General 10-Year Valuation,” 2009.
Yahoo Finance, “Mercury General Quarterly Cash Flow,” December 2008 through September 2009.
Disclosure: Long MCY, WM.