Why the Outlook for Travelers Is Mixed

May.13.10 | About: The Travelers (TRV)

The Travelers Companies Inc. (TRV) reported first quarter earnings 2010 on April 23, which missed the Zacks Consensus Estimate by 14 cents. The miss primarily stemmed from significant catastrophe losses in the reported quarter.

Investors were somewhat discouraged and the shares moved down following the earnings release. However, Wall Street has had sufficient time to absorb the news, and analysts have had a mixed response.

Earnings Report Review

Though Travelers missed the first quarter estimates for catastrophe losses, the company witnessed a significant increase in investment income and favorable prior years’ reserve development. It has also reaffirmed its 2010 operating earnings guidance.

Travelers reported a slight increase in premium writings. Net premiums written were $5.3 billion, up 1% year over year. However after-tax underwriting gain fell to $80 million, from $353 million in the prior-year period. Combined ratio deteriorated to 96.4% from 90.6% reported in the prior-year quarter.

(Read our full coverage on this earnings report: TRV Misses on Catastrophe Losses)

Agreement of Estimate Revisions

Of the 16 analysts covering the stock, 9 raised estimates for both the upcoming quarter and the following quarter. Additionally, 3 analysts raised estimates for both FY2010 and FY2011. What was encouraging in the first quarter earnings release was a significant increase in investment income, improvement in operating conditions than expected earlier and the reaffirmation of the 2010 operating earnings guidance.

As the second-largest writer of auto and homeowners’ insurance through independent agents and the third-largest writer of commercial U.S. property-casualty insurance, Travelers continue to benefit from its strong market position and reap economies of scale. It has managed relatively well through the downturn, better than many of its peers, given its small and mid-sized commercial accounts focus, its balanced personal lines book and its lack of exposure to large-account casualty business.

However, a few analysts have made downward revisions. For example, 1 analyst lowered his or her estimate for the upcoming quarter, while 2 lowered for the following quarter. However, 11 analysts lowered estimates for FY2010, while 7 lowered for FY2011.

In addition to the first quarter miss, it is notable that premium growth remains restricted as a result of the adverse impact of soft market conditions. The company has significant exposure to economically sensitive lines such as workers’ compensation, surety and general liability. Given the challenging economic environment and a slow recovery, top-line growth is expected to remain muted through lower exposures. Also, Travelers continues to face reduced underwriting margins related to pricing and loss cost trends.

Clearly, while analysts anticipate the results in the next two quarters to be much better than they had expected, the first quarter miss and other bearish factors for the stock prove detrimental to the full-year estimate revisions.

Magnitude of Estimate Revisions

A strong agreement among analysts has raised estimates over the past 30 days for the next two quarters. As a result, the Zacks Consensus Estimate is up 5 cents for both the upcoming quarter and the following quarter. However, for both FY2010 and FY2011, the Zacks Consensus Estimate fell 4 cents.

Travelers in Neutral Lane

With a conservative balance sheet and high retention rates, Travelers is better positioned than many of its peers. Besides, it has survived the economic downturn relatively well. However, the rate of premium growth remains restricted and underwriting margins are under pressure. Additionally, we think potential reserve additions for asbestos liabilities present another risk.

Considering the estimate revision trends and the magnitude of revising the estimates, we find that there is no clear directional pressure on the shares. This justifies the Zacks #3 Rank, which translates to a short-term Hold recommendation. Our long-term recommendation for the stock also remains Neutral.