Background: On July 30, I wrote about a reinsurer/insurer Everest Re (RE) in an article titled Everest Re: A Conservatively-Valued Insurance Stock With Price And Earnings Momentum. Since then, the stock has risen from $133 to $151, quadrupling the return from the S&P 500.
This article provides an update of the salient changes in the company's outlook and valuation. It assumes that the reader is generally familiar with my previous article and its links to the company's website. Briefly, RE is a Bermuda-based reinsurer with a growing, primarily U.S.-based insurance business with a property and casualty ("P&C") focus. The former Prudential Re, it was spun off in 1995. Since then, its performance versus the S&P 500 has been stellar:
This article makes the case that RE shares are attractive now and "should" be re-rated upwards. With the stock trading only about 7% above tangible book value, I see no reason why similar excess returns over the market as a whole will not occur in future decades. Here is the rationale. Much of it is hidden in the Q&A following earnings (Seeking Alpha transcript).
Discussion: RE announced excellent earnings last week. After capital gains, it earned $4.20/share versus $4.05 the prior year. The stock sold off sharply from near-record highs on the news, as this was below expectations. What the sellers missed, though, was that the "miss" was only a miss because the tax rate was higher than expected. Why was it higher? Because insurance losses through the first nine months of the year were lower than expected. So the "miss" was not really a miss, and the stock rebounded nicely Friday.
The real "miss" is that investors in this company with unpredictable quarterly and yearly results were focusing on "the number." What they initially missed was how strong the company's growth trend has become, or so the company argues. From the earnings press release:
Commenting on the Company's results, Chairman and Chief Executive Officer, Joseph V. Taranto said, "Through the first nine months we had $895 million of net income for a 19% return on equity and grew premium by 24%. Over the last several years we have strategically focused on expanding our global footprint and improving our risk adjusted returns. I want to thank our staff, which I believe is the best in the business, for their terrific work that helped us achieve these goals."
Operating highlights for the third quarter of 2013 included the following:
- Gross written premiums were $1.5 billion, an increase of 22% compared to the third quarter of 2012. Total Reinsurance premiums were up 24% to $1.1 billion with continued strong growth emanating from expansion initiatives in the property reinsurance markets. Insurance premiums also rose with an increase of 12% for the quarter primarily driven by California workers' compensation and non-standard automobile business.
Of course, there is much more in the press release. More to the point, the Q&A revealed this:
Jay Gelb - Barclays
If I look at the third quarter result on an operating earnings basis, around $4.20, you add back the $0.50 tax impact. And of course, there is this spillover effect of a couple of Canadian catastrophes. And you mentioned the impact of lower corn pricing on the insurance result. We get to roughly $19 of annualized EPS. And then, Dom, you talked about improvement in the attritional loss ratio going forward. So I know you don't usually give guidance, but I am hoping maybe you can reflect on where you see that earnings power going forward relative to that $19, I just mentioned...
Dominic Addesso - President
Well, I think the math I think gets you to a number, as you've described it, well in excess of the $19. So again, we're not about giving guidance, but I think what you were describing leads you to a higher number than what you suggested. The other thing that I'd mentioned is we're a little bit off in the quarter, again with the invested income. And again, limited partnerships' that come back a little bit that helps as well.
Michael Nannizzi - Goldman Sachs
And then, just last one on kind of looking at January 1, I think Joe you had mentioned you were pretty optimistic about January 1. Is that from a risk-adjusted return perspective or from an absolute kind of year-over-year pricing on your own book perspective?
Joseph Taranto - Chairman and Chief Executive Officer
Well, I think where I was coming from is just all that we have cooking here at the company. I mean we've just made some very good strides in the last couple of years. As I said, there is a lot of momentum. Frankly, look at the numbers, 25% growth topline and look at the bottom line, we really have written more business at the regional level. As Tom noted, we're doing more business that's not really affecting the PML in the peak zones. You see what we've done in Florida. We have a new unit writing some unique deals and we're very pleased with what they've done on the books, which has taken us into some other products.
I think where I was coming from is not getting so concerned about whether rates are going to change 4% on the cat side, January 1, but just looking overall with what we've put together, insurance, reinsurance, domestic and international, and saying, I like what's cooking, I like what's going on. And frankly, if you look at the number, you can see what's happened and I expect more good things to come.
These and similar comments from management come in the context of the following 90-day earnings estimate revisions from analysts, per Yahoo Finance:
EPS Trends Current Qtr.
Current Estimate 4.49 4.54 19.75 17.52 7 Days Ago 4.40 4.46 20.08 17.41 30 Days Ago 4.37 4.43 18.00 17.32 60 Days Ago 4.37 4.43 18.00 17.32 90 Days Ago 4.16 4.35 16.91 16.89
Clearly, RE may be on the cusp of becoming a growth stock. Despite the "miss" in Q3, so far it appears that analysts have begun to increase their earnings expectations for Q4 and for 2014.
Thomson Reuters rates stocks according to six quantitative parameters. It grades them from 1-10. RE is one of only 214 stocks it rates a 10. Four of the six parameters also are rated 10, including riskiness, a fifth receives a 9.
S&P Capital IQ, another independent rating service, has already weighed in following the Q3 results. It is impressed. It rates RE a Strong Buy with a 12-month price target of $178. It uses a different, proprietary method to assess the underlying value of a company. It gives RE a rare 5+ rating (on a 1-5 scale) with a calculated fair value of $266.60 per share.
I believe that number is actually realistic. After all, shares in the company are selling marginally above book value, suggesting little implied growth. Yet the company's rapid historical growth and its optimism about future growth suggest that excess investment returns starting from the current share price may be a reasonable expectation.
Risks: RE is subject to countless operational and market risks. It may have made poor or simply unlucky underwriting decisions. As are many financial companies, aspects of its operations are murky "black boxes." Macro legal, economic, stock market and regulatory issues may harm its operations. As a stock, it may never trade at "fair value."
Conclusion: As Internet Bubble 2.0 rolls along, yours truly is reverting to a strategy that worked in 1999 and beyond, which is to invest in solid "Old Economy" stocks. Everest Re is a tested company led by a cohesive, veteran management team that has achieved market-leading returns. This management team is on the same page as several independent analysts as well as the Wall Street consensus in anticipating operational excellence in coming quarters. Trading at about 8X expected 2014 EPS and below expected book value as of the end of 2014, RE offers investors the combination of a substantial underlying asset value plus both cyclical and secular growth potential. This is a rare quality in a stock in today's market. I am long RE and expect to purchase more in the coming week.
Additional disclosure: Not investment advice. I am not an investment adviser.