Hartford Financial (HIG) announced on Wednesday that it was doubling its dividend, exploring share buyback possibilities and guiding to much improved earnings for 2011. Results are certainly positive and improving. Let’s get more into Hartford’s details, come up with a price target, and do a brief risk analysis.
Hartford Financial is one of the largest property and casualty insurers in the world. They’ve been around since 1810, although they required a government bailout through the TARP program in order to still be around today. They’ve paid that back now, changed management, and are back on the right track. In addition to property and casualty, they also are heavily involved in the annuity markets. This caused the company tremendous pain during the financial crisis, and is its biggest risk going forward. New management has streamlined the organizational structure and it now operates under three segments: Commercial markets, consumer markets, and wealth management. They put a strong focus on affinity groups, and are the endorsed provider of auto and homeowners coverage to members of AARP.
Looking at financials, the company reported EPS of $1.06 in the past quarter. They also provided 2011 EPS guidance of between $3.70 and $3.90, indicating continued strong growth. The dividend was doubled to $.40 annually, making its current yield 1.4%.
Hartford’s book value stands at $46.70, and its P/B is .6. I’ve often said that for insurance companies, P/B is the best initial indicator of whether shares are overvalued or undervalued. By comparing the current P/B to its historical level, and by looking at P/B of competitors, we can get a pretty good picture of how a particular insurer stacks up. For Hartford over the last 10 years, P/B has traditionally been between 1.3 and 1.5. Over the past three years, however, P/B has been .5. If we look over the long term, Hartford is extremely cheap on this metric. How are competitors looking? Metlife (MET) is trading at .8 times book. Prudential Financial (PRU), .9. Allstate (ALL) is also at .9 times book, and The Travelers Companies (TRV) is at 1 times book.
The second most important metric to look at is the combined ratio. This is a measurement of underwriting profit and is a good way to gauge whether an insurer chases business. Hartford’s combined ratio is not good. For its commercial segment, it’s 95%. For consumer, 96.8% for the quarter. Part of this poor combined performance is attributable to its large size, but I’m still not comfortable with this level. If you look at some smaller, well-run insurers like HCC Insurance (HCC) and Ace Ltd. (ACE), their combined ratios are around 90%. Even Travelers is at 93.2%.
How about a price target? One way to look at arriving at a price target is simply by using a PE ratio. Hartford historically has traded at a 10 multiple, so if you apply that to its 2011 guidance, you get a one year target of $38. If you use the P/B metric, there are a few things to take into account. They should trade at a lower multiple than competitors since Hartford’s combined ratio is lower than these companies. Hartford also has a riskier business plan, specifically the annuity portion. That portion is dependent on positive stock market returns, so it could either provide upside or downside surprises. Right now Hartford is trading at about a 33% discount to the competitors mentioned above. There are also other risks for insurers in general that will knock down the P/B multiple over the next year or two. I’m going to arbitrarily attach a 1.2 multiple to its current book value and conservatively assume 5% book value growth over the next year. It’s very possible growth will be higher. Using this approach, we get $59. We’ve got a nice range to work with from $38 to $59, not counting any share buybacks. Shares are currently at $29, so this would indicate the strong possibility of price appreciation over the next year.
Hartford certainly has some company-specific risks. I don’t feel completely comfortable with the variable annuity business. I also don’t like that the company's combined ratio is relatively high. I’d prefer an insurer that worries most about profit, not revenue. I’d like the CEO to continually say that and to ensure that’s the culture of the company. Hartford doesn’t stress that approach. On the industry level, the threat of inflation is a big negative and the municipal bond market is a problem. Because of those things and the proximity to the financial crisis, valuations are likely to continue to be depressed over the near term. Even with this risk and in this environment, Hartford seems to be attractively priced. However, it's important to keep in mind that the company's results won't be as predictable as some of its competitors.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HCC over the next 72 hours.
