Progressive May Break $20, Allstate Slightly Riskier

Includes: ALL, PGR
by: Takeover Analyst

Progressive (NYSE:PGR) and Allstate (NYSE:ALL) are two insurers that have margin pressure and operational challenges, but are still rated more towards a "buy" on the Street. With that said, a general consensus is that the firms will struggle to create value, let alone outperform the S&P 500. I similarly find that the companies have limited upside due to ratio concerns and macro headwinds.

From a multiples perspective, Progressive is the cheaper of the two. It trades at a respective 11.3x and 11.7x past and forward earnings while offering a dividend yield of 2.2%. Allstate, on the other hand, trades at a respective 40.2x and 7.1x past and forward earnings while offering a dividend yield of 3.2%. Over the last 1 year, 5 year, and 10 year periods, Progressive has also outperformed. Since 12 months ago, the stock has fallen by only 6.4% while Allstate's value has fallen by 16.6%. During this time period, insurers have underperformed the broader market.

At the third quarter earnings call, Allstate's CEO, Tom Wilson, noted both weakness and signs of improvement:

We strengthened the breadth of the Allstate brand standard auto insurance profitability by improving combined ratios in New York and Florida. Both of those states continue to have loss ratios that are higher than the countrywide average, though the results have improved significantly relative to 2010, reducing the pressure on countrywide results. The rest of the country continues to have strong results. The overall combined ratio for Allstate brand standard auto insurance is 94.2 for the quarter and 95.8 for the first 9 months of the year. The Allstate brand homeowners combined ratio was 131.9 for the quarter, of which 55.8 was due to catastrophe losses. To improve returns, we continued to increase prices and downsize this business with average premiums are up 5% and then there's a 4% reduction in items in force versus a year ago. The underlying combined ratio was 72.3 for the 9 months, which is a 0.9 improvement from the prior year for the quarter. It was 1.7 points better than the prior year.

Nevertheless, weak premium trends, poor reputation, and underwriting losses will limit stock appreciation as investors shift to safer companies. Allstate's homeowners business is likely to see margin contraction despite raising deductibles and rates. In auto, premiums have now declined for the fifth straight quarter, as promotion has seemingly proved futile. On the positive side, Esurance will start being accretive to EPS in 2012 and the $1B repurchase program announced in November will be doubly beneficial in boosting ROE and motivating investor entry.

Consensus estimates for Allstate's EPS are that it will decline by 72.9% to $0.77 and then turnaround to grow by 376.6% and 6.8% in the following two years. Assuming a multiple of 9x and a conservative 2012 EPS of $3.54, the rough intrinsic value of the stock is $31.86, implying 22.1% upside. This is not enough, in my view, to merit calling the investment a value play.

The same goes for Progressive, which is experiencing declining underwriting margins as the combined ratio trends to a 96% run-rate. A lack of no prior-year reserve releases ia adding to risk while slowdown in direct channel is depressing cash generation. Loss ratios and EPS of $0.08 for October were also disappointing. Nevertheless, the company has generally outperformed competitors, notably in auto, and its expansion in Florida and New York appears promising in cost-effectively targeting ideal demographics.

Consensus estimates for Progressive's EPS are that it will decline by 4% to $1.45 and then turnaround to grow by 8.3% in both of the following two years. Of the 14 revisions to estimates, the majority, 11, have gone up for a net change of 0.7%. Reduced volatility in EPS compared to Allstate is reflected by the fact that Progressive has a beta of almost half that of its competitor. Assuming a multiple of 15x and a conservative 2012 EPS of $1.53, the rough intrinsic value of the stock is $22.95, implying 24.9% upside. If the multiple were to decline to 11.3x and 2012 EPS turns out to be just 5.1% below the consensus, the stock would decline by 8.3%. The Street thus currently prefers Progressive over Allstate.

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