Travelers: Value Stock Where Catalyst Is Already Visible

Includes: ALL, CB, MBI, MET, PRU, TRV
by: Tom Armistead

Travelers (NYSE:TRV) is a value stock where the catalyst is already visible. At a recent price of 51.42 it trades at TTM P/E of 7.9 and a P/B of .96. Earnings of 1.25 for 1Q 10 met guidance, in spite of heavy weather related catastrophe claims.

The company says they may come out of the recession with more business customers than they had at the onset. Premium to surplus stands at about one to one, and there is 3 billion of capital in the holding company, much of it available to fund share repurchases at favorable prices. As business customers experience recovery, increased written premiums will be forthcoming. The earnings conference call was upbeat on these and other issues.

Overview – from the 10-K:

The Travelers Companies, Inc. (together with its consolidated subsidiaries, the Company) is a holding company principally engaged, through its subsidiaries, in providing a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals. The Company is incorporated as a general business corporation under the laws of the state of Minnesota and is one of the oldest insurance organizations in the United States, dating back to 1853.

Financial Strength – from the earnings conference call transcript:

Michael Nannizzi (analyst)

...And just one last question if I could on leverage, how important is operating near that one to one premium to surplus. Is that a target or is that more just a result of other things that you are doing thanks.

Jay Fishman, CEO

It’s absolutely the result. What I have indicated before is that we have the various rating agency models that we apply along with risk based capital, and whether it’s the CAR ratio or the S&P or Moody’s model or Fitch models, we evaluate what the operating company capital requirements should be for a strong double A company as we are.

From that, we then look at the leverage of the holding company the holding company cash to come up with the actual capital position, and the fact that premium to surplus is approximately one to one. It’s not something we look at; it is absolutely the result of that process.

Business Insurance, Recession and Recovery – from the conference call:

One of the other interesting thoughts here as you look at our data, and probably broadly across much of our business, but certainly in the business insurance side we are growing our customer base it’s hard to see in the premium, because our typical and I am not just talking about writing a whole bunch of small ones so the number are larger.

We are in the aggregate growing our customer base. The premium is struggling because our typical customer might need a less insurance than they do in normally robust times, and that typically comes through on the AP side, audit premium side. So it’s an important note though that we feel good about this grow.

Many business insurance policies are subject to audit. The policy is written with an estimated premium base, typically sales or payroll. After it expires, it is audited and the premium is adjusted accordingly. The subsequent policy, which will have been issued before the audit, is frequently adjusted if the audit suggests estimated payroll or sales were out of line.

During a recession, audits come in below estimates and premiums are refunded. Some polices are endorsed to reduce estimates in accordance with the audits. As the recession ends, audits create additional premiums, which are fully earned. In addition, estimates for current policies are increased. This process gives Travelers some built-in premium increases as the recovery filters through the audit process. That will take a couple of years to play out.

Buybacks – During 2009 the company repurchased 69.4 million shares at a total cost of 3.3 billion, or 47.55 per share. That is less than the current price, and less than the current book value, whether GAAP or adjusted. Given the financial strength demonstrated by the one to one premium to surplus ratio, the buybacks make good sense as a way to enhance shareholder value.

During 2010 the company expects to devote 3.5 to 4 billion to share repurchases.

Value Creation – Checking tangible book value per share, it has increased 18.1% annually for the past 5 years – a trying time for insurance company investment results. This type of performance, which demonstrates management's ability to accumulate quantifiable value for shareholders, is frequently a sign of long-term value. Trading at a P/B of 1, if book value goes up 10%, the share price should do the same. If the multiple expands, share prices can increase rapidly.

Valuation – Using 4 years trailing earnings plus guidance for 2010, 5 year average EPS works out to 5.39 per share. Applying a historical midpoint multiple of 14, I arrive at a target of 75. Using a historical midpoint P/B of 1.4, I get 53.50 X 1.4 = 75. Allowing two years for the catalysts discussed in this article to take effect, the return would be 20% annualized, to which one could add a dividend of 2.82%.

Strategy – Shares are optionable, to include LEAPS, with implied volatility standing at 23.8%. Beta at .7 portrays a slow moving stock. Book value of 53.50 (or nonGAAP adjusted book value of 49.60) provides margin of security. The stock is suitable for dividend (2.82%) or buy and hold investors.

I see no reason to be fussy about an entry point - today's price is attractive.

Options - The use of LEAPS as a substitute for share ownership might be considered. The Jan 2012 40 call carries a very affordable time premium, provides considerable leverage, and permits the investor to wait patiently for a price move, without tying up a lot of funds. Some out of the money calls could be sold, for example the Oct 2010 55, in order to fund the time premium for the LEAPS and pick up some income if the stock takes a while to make a move.

Expecting a 20% return based on the stock reverting to its mean valuation multiples, the application of leverage could provide substantial benefits.

Insurance Sector Negatives – Insurance companies are well represented in my portfolio, and I have previously written favorable but hopefully balanced articles on Allstate (NYSE:ALL), Chubb (NYSE:CB), MetLife (NYSE:MET), Prudential (NYSE:PRU) and MBIA (NYSE:MBI). I am pleased with my investment results on these companies.

MBIA is a financial guarantor and a separate case, but the rest of the companies mentioned are exposed to one or more of various issues, such as but not limited to investments in RMBS, CMBS, and CRE; exposure to catastrophes of various types; exposure to fluctuations in the equity markets; intense and cyclical competition; commodity-like products; new hazards or loss exposures such as asbestos or environmental liability; increased societal litigiousness; hyper-vigilant state regulation; prospective Federal regulation; popularity as subjects of the game of political football; etc. Gloria Vogel has written a couple of articles raising these or similar issues.

My experience going back to 1969 when I got my first job in insurance is that the issues mentioned are recurrent; the companies have learned how to deal with these and analogous problems; and the better run among them find ways to make money.

From time to time insurance companies become unpopular as investments. If they are trading at a discount to metrics which take into account the cyclical nature of the business, there is every reason to buy them and wait for better days. That has been working last year and this, and it still has a way to go.

Disclosure: Long ALL, CB, TRV, MET, PRU, MBI