Four Cheap Reinsurers to Research: Historically Low Price to Book

Includes: MRH, PRE, RE, XL
by: The Keating Letter

Reinsurers historically traded at .85 to 1.6 times book, but today’s environment has been pushing that ratio downwards. Some commentators have suggested that these lower levels will persist into the future. Typically I assume a reversion to the mean, absent overwhelming evidence to the contrary. Not to say that evidence won’t materialize for the reinsurers, but I haven’t seen it yet and I expect, over the long term, that we’ll go back to the historic level.

With that approach, I want to look at four cheap reinsurers that I think are worth looking into further. These stocks are at cheap based on their price to book ratio. Each one of them is trading below .85 times book. As always, this is a starting point for research, and I’m providing an overview of the companies. Don’t jump in without doing your due diligence. Book value can always go down, and there is specific company risk, especially in this sector.

XL Group (NYSE:XL)
P/B: .7 P/E: 22 Yield: 1.8%

XL provides insurance and reinsurance coverage to industrial, commercial, and professional firms, insurance companies, and other enterprises worldwide, operating in three segments: Insurance, Reinsurance, and Life Operations. Their reinsurance segment focuses on property and casualty, marine, and aviation, as well as some specialty coverages. The Life Operations focuses on life insurance reinsurance.

XL stock price rose 500% in 2009 because of the exemplary leadership of Mike McGavick. Before McGavick came on board, XL was basically a mini-American International Group (NYSE:AIG), playing in the CDO sandbox without understanding what it was doing. It was on the very edge of going out of business. Drawing on his previous experience as CEO of Safeco (OTC:SAFC), he confronted the problems at XL’s Security Capital Assurance unit and completely changed the trajectory of the company.

How about the future? The forward P/E is less than 10, so don’t worry much about their trailing P/E. They currently have a $1 billion stock buyback in place, and it’s likely they’ll increase that in the future. Despite the dramatic price rise since the beginning of 2009, there still may be considerable upside with XL, if for no other reason than any share buybacks are immediately accretive by 40% because of the discount to book. If you decide to buy in, you’ll be in good company. James Barrow of Vanguard Selected Value Fund owns more than 5% of the company. On the risk side, XL has significant exposure to the Australian floods. Earnings estimates may be forced to be changed.

Montpelier Re Holdings (NYSE:MRH)
P/B: .8 P/E: 6 Yield: 2%

MRH provides coverage for losses from earthquakes, hurricanes, floods, tornados, fires, and storms and property specialty reinsurance products comprising risk excess-of-loss reinsurance products with property or engineering risk coverages. It also underwrites other specialty reinsurance products, such as aviation liability, aviation war, space, marine, personal accident, workers’ compensation, political violence, casualty, and crop, as well as hospital treaty reinsurance, auto liability coverage, and professional liability reinsurance products.

MRH has a noted investor owning a significant share of the company as well. Deep value investor Donald Smith owns 8% of the company. It’s likely he’s attracted to MRH’s price to free cash flow ratio of 4.4. Book value also grew at a healthy clip over their last reported quarter, with a 6.9% gain.

PartnerRe (NYSE:PRE)
P/B: .8 P/E: 6 Yield: 2.7

PRE offers a wide range of reinsurance products including property, casualty, auto, aviation, agriculture, oil and gas, and credit/surety reinsurance coverage to commercial credit insurers, bonds, and other forms of security.

PRE recently hit new 52 week highs, but its P/B is still very low. Like XL Group, PRE has a large share buyback plan in place. They repurchased 14 million shares in 2010, and have a new authorization to purchase an additional 7 million shares in 2011. Analysts expect prices to remain stable, but low investment income will act as a drag for PRE, as well as the other names on this list. However, with 74 million shares outstanding and the possibility of 7 million of them being bought in, stability in their operations should be enough to continue to propel their EPS higher.

Everest Re (NYSE:RE)
P/B: .8 P/E: 10 Yield: 2.3

RE operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International, and Bermuda. The U.S. Reinsurance segment writes property and casualty reinsurance brokers, as well as directly with ceding companies within the United States. The Specialty Underwriting segment writes accident and health, marine, aviation, and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International segment offers non-U.S. property and casualty reinsurance, and the Bermuda segment provides reinsurance and insurance to worldwide property and casualty markets and life insurers.

RE also has a famous significant owner. Value investor Mason Hawkins owns nearly 10% of the company. Hawkins has doubled the returns of the S&P 500 over the last 20 years. RE had a tough 2010 with exposure to the Chilean earthquake, but at least one analyst sees EPS of $11 in 2011. Like MRH, RE also had healthy book value growth in Q3 last year of 6.4%. They’ll report their next earnings on February 9. Finally, RE is moving into the crop insurance business with its purchase of Heartland Crop Insurance a few weeks ago for $55 million.

These four reinsurers aren’t the only cheap ones out there. I’ll be adding additional articles highlighting some others as well. For the most part, reinsurers had a tough time through the financial crisis, but have now entered a more normalized environment. With a lot of cash generation leading to share buybacks, and dramatic book value growth, it should be only a matter of time before the stock prices reflect their true value. Each of these names trades for less than .8 times book. That’s very cheap on a historic basis, especially considering the book value growth we’ve seen over the past year. Each of these companies deserve more research. With Mike McGavick at the helm, I’d start with XL.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.