Everest Re: An Attractive, Undervalued Reinsurer

Mar.10.14 | About: Everest Re (RE)

Summary

High-quality reinsurer.

Cheap stock.

Strong growth prospects.

Stock is undervalued.

Background: On July 30 last year, I published an article on Seeking Alpha about Everest Re (NYSE:RE) titled Everest Re: A Conservatively-Valued Insurance Stock With Price And Earnings Momentum. The stock was $133 then. As we now know, the mood of the market was not to be maximally focused on a conservative reinsurer, and the stock has underperformed the broad averages since then.

This was followed on October 28 by a second article on the company, A Fast-Growing Insurer Trading Near Book Value That May Be Ready For A Much Higher Valuation. Well, maybe it was "ready" for a much higher valuation, but the stock closed this past Friday a point below where it was on October 28, just under $150. With a beta of just 0.70, RE is typically indifferent to major market moves. However, the company had a very strong Q4. It reported operating earnings of $6.28/share vs. expectations of just under $5. Net income was higher, at $7.54/share, reflecting positive net capital gains. Yet the stock has gone nowhere, though granted it has indeed had a nice move up the past few years.

The Street has looked askance at the stock in part because the analytic community has lowered its estimates for earnings for 2014 and 2015 somewhat compared with 90 days ago:

EPS Trends Current Qtr.
Mar 14
Next Qtr.
Jun 14
Current Year
Dec 14
Next Year
Dec 15
Current Estimate 4.52 4.81 17.37 18.96
7 Days Ago 4.52 4.80 17.33 19.14
30 Days Ago 4.71 4.84 17.61 19.20
60 Days Ago 4.89 4.74 17.80 19.26
90 Days Ago 4.71 4.80 17.72 19.50
Click to enlarge

However, Value Line rates RE only in the 15th percentile of stocks it covers regarding earnings predictability, so I'm not paying a lot of attention to forward estimates for this equity. My take is that RE is best valued in relation to book value. Currently, it is trading right at my estimate of book value it will have assuming the current quarter is profitable. Thus I think the stock is quite undervalued relative to the market as a whole.

The company may think so as well. It recently raised the quarterly dividend to $0.75 from $0.48. It has been shrinking shares outstanding rapidly. There were 65 million shares outstanding in 2006, 59 million in 2009, 54 million in 2011, and about 47 million currently. In Q4, the average price the company paid for its own shares was $152.29, which was roughly $10/share above book value. Investors may also appreciate that the company carries no intangible value on its books, consistent with its conservative financial posture and history of organic growth.

The company focuses on book value. From its Q4 investor presentation:

Corporate Objectives

  • Maximize book value per common share over time, and
  • Achieve returns that provide a mid-teens compound annual growth rate in shareholder value.

The company's Investor Center on its website is a rich source of information about the company. Basically, RE is a strong company that has reduced its financial leverage over the past few years while growing its business, shrinking shares outstanding, raising the dividend, and achieving record profits.

Introduction: The former Prudential Re, and one of the world's leading reinsurers, Everest Re has turned into a profits machine lately. Excluding investment gains or losses, it has earned about $35/share in the past two years. Now that we are five years past the bottom of the Great Recession's bear market, it is seen to have a strong but not overly-exuberant bottom left to top right stock chart (arithmetic scale):

Chart forEverest Re Group Ltd.

Since going public in the fall of 1995, the stock has appreciated at a compound annual rate of about 11.5%, far ahead of the 6.3% rate at which the SPDR S&P 500 ETF (NYSEARCA:SPY) has appreciated. Dividend yields have probably been similar for RE as for the SPY, at perhaps 2%.

A review of Value Line's chart of RE shows that RE on average has traded around book value, as is the case now. Given consistent management acumen, and given that the stock has returned low double digits since going public, it makes sense that, given no valuation premium for past performance, history favors purchase here. My guess is that management is likely to continue to use its capital wisely. How wisely has RE's management deployed capital to date? One way to look at that is to compare the total return to RE shareholders to that of Berkshire Hathaway's (BRK-A) shareholders. This is the comparative chart:

Chart forEverest Re Group Ltd. (<a href=

This is a clear win for RE in price appreciation. In addition, RE has paid dividends continuously, whereas Berkshire retains all profits. So Thus there is a nearly 2-decade period in which the little-known RE has done a lot more for its investors than BRK-A has done for its investors. The conclusion is not that there's anything wrong with the latter company, but that RE is, or at least has been, a fine company. (Of course, Berkshire Hathaway has grown to be far more than an insurer, but that diversification was itself a choice by senior management as to how to deploy capital.)

RE continues to do with its stock what it has done throughout its history. When its stock is cheap, meaning that it is trading at, near or below book value, it uses excess cash to buy back stock. When the stock was expensive relative to book value, as it became after the 2001 recession for a few years, it sold stock into the marketplace, thereby raising relatively cheap equity capital. (Shares outstanding then rose from 50 million to 65 million.) Value Line records reveal the total share count rising and then falling as the marketplace overvalued and then undervalued the shares relative to book value, to the ultimate benefit of long-term shareholders.

As mentioned, recent earnings trends have been strong. After recent strong earnings prior to this year, analysts are expecting $17+ in operating earnings for 2014 and higher earnings for next year. Given the unpredictability of casualty losses, though, estimates for RE and other reinsurers are merely guesses on a quarter to quarter basis. The company has a low dividend payout ratio because of the volatility of earnings, and the company decides in real time what to do with excess capital. RE could end up with a book value in the $175-$180/share range by the end of 2015 based on current consensus earnings expectations.

Based on RE's history, the stock should trade at a premium to book value in order to make its prospective total return similar to that of the market as a whole. This analysis means that it is not unreasonable to foresee the stock trading around $200 within two years.

Independent authorities much better known than myself have similar views. S&P Capital IQ covers RE. Its proprietary methodology gives RE a present value today of $208 share; its (separate) rating for likely stock performance is 5 Stars, its highest rating. Thomson Reuters covers RE and raised its rating two months ago to its highest rating of 10. Value Line's computerized rating system carries RE as a 2 on a 1-5 scale, and gives it its highest '1' rank for safety.

Negatives: As a reinsurer (about 75% of its business), RE is at risk of large and unpredictable losses. However, I am looking at Value Line's data for earnings that go back to 1997. Despite numerous catastrophes, the company has lost money on an operating basis only twice on an annual basis, in 2005 (Hurricane Katrina and other disasters) and 2011. Nonetheless, one never knows until the future whether an insurer or reinsurer has reserved adequately for future liabilities, so book value is simply a matter of management's best judgment but not a mathematical certainty. (The company has been shortening the time commitment of its liabilities.)

As one of numerous competitors in its industries, RE is a price-taker much of the time. The possibility of a prolonged bear market in pricing of insurance products must be considered.

In addition, RE engages invests in a variety of products, not all of which are transparent. It also has a sidecar, Mt. Logan, which is growing its own book of business.

Finally, financial system risk and general market risk are quite relevant to any financial company.

Summary: Everest Re is a leading global reinsurer with a growing book of business in the insurance field. Trading right around tangible book value and a few points below the average price at which the company was buying back its shares in Q4, RE was attractive then and appears to be more attractive now. This is especially so given the surge in many other stock prices the past several months.

Insurance and reinsurance pricing cycles will come and go, but RE, as a recognized leader in its field, may be a sound choice for investors looking to deploy capital now on a long-term basis, and RE's recent stock underperformance suggests that it may outperform on a short-term basis as well if investors look for relative bargains in the stock market in the days and weeks ahead.

Unpredictable earnings and numerous other risks mean that as is the case with most common stocks, shares of RE carry a degree of potential downside volatility that is nearly impossible to fully quantify. Caution in considering the shares for purchase and patience amongst shareholders of RE may both be appropriate.

Disclosure: I am long RE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This is not investment advice. I am not an investment adviser.